Cost is defined as the cash amount (or the cash equivalent) given up for an asset.

Cost includes all costs necessary to get an asset in place and ready for use. For
example in production of a car, we sacrifice material, electricity, the value of
machine's life (depreciation), and labor wages etc. Thus these are our costs.
Costs are usually classified as follows:
As to type
1. Product Cost
- inventoriable cost
- necessary to production
- assetable
2. Period Cost
- not necessary to production
- expensed as incurred
The costs are further classified into:
1. Direct materials:
- Represents the cost of the materials that can be identified directly with
the product at reasonable cost.
- For example, cost of paper in newspaper printing.
2. Direct labor
- Represents the cost of the labor time spent on that product, for
example cost of the time spent by a petroleum engineer on an oil rig,
etc.
3. Manufacturing overhead
- Represents all production costs except those for direct labor and direct
materials
- for example the cost of an accountant's time in an organization,
depreciation on equipment, electricity, fuel, etc.
Fixed Costs Vs. Variable Costs
1. Fixed costs
- are costs which remain constant within a certain level of output or
sales. This certain limit where fixed costs remain constant regardless of
the level of activity is called relevant range.
- For example, depreciation on fixed assets, etc.
2. Variable costs
- are costs which change with a change in the level of activity.
- Examples include direct materials, direct labor, etc.

Absorption costing

is used in preparing financial statements for external reporting purposes.

GAAP states that all product costs should be expensed as cost of goods sold and thus should be
matched against revenues when products are sold. That is, product costs can be incurred in one
(i.e. when goods are manufactured) and recognized in another period (i.e. when goods are sold).
On other hand, period costs such as administrative and selling (i.e. SG&A) expenses are
recognized when incurred because these costs have no future benefits.

Variable costing: On the other hand, under variable costing approach, product and period costs are
divided into two groups: variable and fixed costs. Variable costing approach treats all variable costs as
inventory costs and all fixed costs as period costs.
Throughput costing: Finally, under throughput costing, only direct materials are recorded as inventory
costs while all other manufacturing costs (including direct labor and variable factory overhead) are
expensed as period costs. Selling and administrative costs are expensed as period costs as well.