COST CLASSIFICATION - Accounts and Finance for Managers

The costs are classified into various categories according to the purpose and requirements of the firm. Some of the most important classifications are as follows.

  1. By nature or Element or Analytical segmentation
  2. By functions
  3. Direct and Indirect cost
  4. By variability
  5. By controllability
  6. By normality
  7. By time
  8. According to planning and control
  9. For Managerial Decisions

By Nature or Element or Analytical segmentation

The costs are classified into three major categories Materials, Labour, and Expenses.

By Functions

Under this methodology, the costs are classified into various divisions or functions of the enterprise. viz Production cost, Administration cost, Selling & Distribution cost and so on.

The detailed classification is that total of production cost sub classified into cost of manufacture, fabrication or construction.

And another classification of cost is commercial cost of operations; which is other than the cost of manufacturing and production.

The major components of commercial costs are known as administrative cost of operations and selling and distribution cost of operations.

Direct and Indirect Cost

Direct cost: This classification of costs are incurred for the manufacture of a product or service; can be conveniently and easily identified.

Material cost for the product manufacture- Direct material-For garments factory- cloth is the direct material for ready made garments.

Labour cost for production- Labour who directly involved in the production of a product as well as attributable to single product expenses and so on.

Indirect cost: The costs which are incurred for and cannot be easily identified for any single cost centre or cost unit known as indirect cost.

Indirect material cost, Indirect labour cost and Indirect expenses are the three different components of the indirect expenses.
Indirect material- Cost of the thread cannot be conveniently measured for single unit of the product.

Indirect Labour-Salary paid to the supervisor.

By Variability

The costs are grouped according to the changes taken place in the level of production or activity.
It may be classified into three categories:
Fixed cost: It is cost which do not vary irrespective level of an activity or production
Rent of the factory, salary to the manager and so on.

Variable cost: It is a cost which varies in along with the level of an activity or production.
e.g. Material consumption and so on.

Semi variable cost: It is a cost which is fixed upto certain level of an activity, then later it fluctuates or varies in line with the level of production. It is known in other words as step cost. e.g. Electricity charges.

By Controllability

The cost are classified into two categories in accordance with controllability, as follows:

Controllable costs: Cost which can be controlled through some measures known as controllable costs. All variable cost are considered to be controllable in segment to some extent.

Uncontrollable costs: Costs which cannot be controlled are known as uncontrollable costs. All fixed costs are very difficult to control or bring down; they rigid or fixedirrespective to the level of production.

By Normality

Under this methodology, the costs which are normally incurred at a given level of output in the conditions in which that level of activity normally attained.

Normal cost: It is the cost which is normally incurred at a given level of output in the conditions in which that level of output is normally achieved.

Abnormal cost: It is the cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained.

By time

According to this classification, the costs are classified into Historical costs and Predetermined costs:

Historical costs: The costs are accumulated or ascertained only after the incurrence known as Past cost or Historical costs.

Predetermined costs: These costs are determined or estimated in advance to any activity by considering the past events which are normally affecting the costs.

For Planning and Control

The following are the two major classifications viz standard cost and budgetary control:

Standard cost is a cost scientifically determined by way of assuming a particular level of efficiency in utilization of material, labour and indirect expenses.

The prepared standards are compared with the actual performance of the firm in studying the variances in between them. The variances are studied and analysed through an exclusive analysis.

Budget: A budget is detailed plan of operation for some specific future period. It is an estimate prepared in advance of the period to which it applies. It acts as a business barometer as it is complete programme of activities of the business for the period covered.

The control is exercised through continuous comparison of actual results with the budgets.
The ultimate aim of comparing with each other is to either to secure individuals' action towards the objective or to provide a basis for revision.

For Managerial Decisions

The major classifications are sunk cost and marginal cost.

Marginal cost is the amount at any given volume of output by which aggregate costs are changed if the volume of output is decreased or increased by one unit.


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