Definition of Common Costs
Common costs are expenses that are shared by multiple products, processes, or departments. They are incurred prior to the point where joint products or by-products undergo separate treatment. These costs must be borne by all outputs, including the main product, joint products, and by-products.
Examples of Common Costs
- In a refinery producing multiple fuel types (e.g., gasoline, diesel, jet fuel), the cost of crude oil processing up to a certain stage would be a common cost.
- Rent in a multi-product manufacturing plant is a common cost as it remains unchanged irrespective of the number of products being manufactured.
- Overhead costs such as utilities and salaries of administrative staff that support multiple departments or processes.
Frequently Asked Questions
What distinguishes common costs from joint costs?
Common costs are the shared expenses up to the point where joint products are differentiated. Joint costs, a subset of common costs, specifically refer to the initial production costs incurred up to the split-off point where products become separate.
How are common costs allocated?
Common costs are allocated based on a systematic method such as relative sales value, units produced, or another equitable measure. There is no one-size-fits-all method; allocation must suit the specific business context.
Are all common costs fixed costs?
Although common costs are often fixed, they can also include variable costs if those costs benefit multiple cost objects before differentiation.
Why is allocation of common costs important in cost accounting?
Proper cost allocation ensures that expense burdens are fairly distributed between products and departments, leading to accurate pricing, profit analysis, and financial reporting.
Can common costs be considered when making managerial decisions?
Yes, common costs must be considered when making managerial decisions to ensure all relevant costs are accounted for, preventing under- or over-estimation of cost impacts.
Related Terms with Definitions
Process Costing
A methodology used in cost accounting where production costs are averaged over all units produced.
Joint Products
Products that are generated simultaneously from a shared cost input up to a split-off point where they can be separated and further processed individually.
By-Products
Incidental products that also originate from a main production process but have a lower value or less prominence than joint products.
Main Product
The primary product generated from a joint process, often holding the highest value or the primary purpose of the production process.
Fixed Costs
Expenses that do not change with the level of production or sales volume.
Cost Allocation
The process of identifying, aggregating, and assigning costs to cost objects (products, services, entities).
Relevant Cost
A managerial accounting term referring to cost information that is pertinent to a specific decision.
Online Resources
- Investopedia – Comprehensive financial and accounting glossary.
- AccountingTools – Articles and resources on various accounting topics.
- Coursera – Online courses on accounting and finance.
- edX – Business and management courses including accounting.
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan.
- “Management and Cost Accounting” by Colin Drury.
- “Introduction to Management Accounting” by Charles T. Horngren and Gary L. Sundem.
- “Accounting for Non-Accountants” by Wayne Label.
Accounting Basics: “Common Costs” Fundamentals Quiz
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