What is Cost classification?
What is Cost classification?Concept or meaning of cost Accounting? and Costing and cost accounting
Cost classification
What is Cost classification?Concept or meaning of cost Accounting
What is Cost classification?Concept or meaning of cost Accounting
Introduction
Cost accounting involves collecting, classifying, recording and appropriate allocation of expenditures for determining the cost of products or services. Costs have different features or characteristics. For proper control and managerial decisions, management is to be provided wit
h necessary data to analyst and classify costs. costs are classified according to their common characteristics. The process of grouping costs according to their common characteristic is known as "classification of cost". For this purpose, the total cost is classified on the basis of production and process, elements of cost, faction, behaviors, controllability etc.
Concept or meaning of cost
The term "cost" has a variety of interpretations in common use. In ordinary language, it may mean price. The oxford dictionary defines "cost" as the price paid for something. But in cost accounting. It is considered different from price.
In cost accounting, cost is the amount of resources given up in exchanges for some goods or services. The resources given up are generally in terms of money of if not in term of money; they are always expressed in monetary units. It consists of all the expenses incurred in producing a commodity or exciting a contract. If signified or monetary outlay to secure some benefit.
The term 'cost' itself has no significant meaning, therefore, it is always used with an adjective or phrase that conveys the meaning intended, such as prime, direct, indirect, fixed, variable, controllable, opportunity, marginal, replacement and the like. Such description implies a certain characteristic, which is important in computing and analyzing the cost.
"Cost may be defined as the sacrifice or giving up resources for a particular purpose. Cost is frequently measured by mandatory units that must be paid for good and service." –horngren, sundem and Stratton,
From the above definitions, it is clear that cost is the expenditures or sacrifice made for good or services.
Cost center
Cost center is a location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. ICMA defines cost center as "a production or services. Factions, activity or item of equipment whose costs may be attributed to cost units. A cost center is the smallest organizational sub-unit for which separate cost allocation is attempted." For functional point of view, a cost center may be relatively easy to establish, because a cost center is any unit of the organization to which costs can be separately attributed. A cost center is an individual activity or group of similar activities for which costs are accumulated. For example, production departments, a machine or group of machines within a department or work group is considered as cost center.
Cost unit
A cost unit is a unit of product or unit of service to which costs are ascertained by means of allocation, apportionment and absorption. CIMS defines cost units as "a quantitative unit of product or service in relation to which cost are ascertained". It is a unit of quantity of product, service or time or a combination of these in relation to which costs are expressed or ascertained. It is useful measurement of cost for comparative purposes. In preparing cost accounts, it becomes necessary to select a unit with which expenditures may be identified. The examples of some cost units are given below:
Industry/enterprise Cost unit
Brick works
Collieries
Textile mills
Electricity companies
Transport companies
Steel mills
Screws manufacturing
Gas
Car Per 100 bricks made.
Per ton of cost raised.
Per yard or per ib of cloth manufactured.
Pr unit of electricity generated.
Per passenger-kg., per ton-kg.
Per ton of steel made.
Per 100 screws.
Per cubic meter.
Per unit.
Costing and cost accounting
Costing is 'the technique and process of ascertaining costs. "It provides only the basis and information for ascertainment of cost. Once the information is made available, the costing can be carried out arithmetically, by means from of memorandum statements or by method of integral accounting. Cost accounting is different from costing in the sense that it is the process of accounting for costs. It includes the account ting procedures relating to recording of all income and expenditures and the preparation of periodical statements and reports will the object of ascertain and controlling costs. It is the formal mechanism by means of which cost of products or services are ascertained and controlled.
Classification of cost
The various groups, into which costs are classified, are known as ' classes'. Costs may be classified according to different bases or characteristics, such as;
1. On the basis of production and process
2. On the basis of element or nature
3. On the basis of function
4. On the basis of behavior or variability
5. On the basis of controllability.
On the basis of production and process
In cost accounting, a factory has to bear various types of cost in the process of production. These production costs may be sub-divided into following two types.
Direct expenditure
It included all those expenditures which can be easily identified wholly with a unit of cost. It contains material expenses, labor expenses and direct expenses e.g. wood, labor are the good examples of direct expenses for a furniture manufacturer.
Indirect expenditure
Indirect expenditure are those expenditure which are incurred for the advantage of number of cost center and are not easily identified with a particular cost center e.g. paints, nail etc. on furniture.
On the basis of element or nature
On the basis element, cost can be divided into material, labor and expense. They have been mentioned in details in the following.
Materials
Materials are needed to produce or provide services. They can be classified into direct and indirect are given below:
Direct material: means the materials which from part of finished output and can be identified with the finished product easily. For example: wood, plywood, adhesive, wood polish, mails etc. in case of manufacturing cloth, cost of iron in case of manufacturing machinating cotton yarn, cost of yarn in case of manufacturing furniture, cost of iron in case of manufacturing machinery etc. the main feature of direct materials in that enter into and form part of the finished product.
Indirect material cost: refers to the material cost, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost unit. These are the materials, which cannot be traced as part of the product, and their cost is distributed among the various cost center or cost units on some equitable basis.
Examples of indirect materials are cost and fuel for generating power, cotton waste, lubricating oil and grease used in maintaining the machinery, materials consumed for repair and maintenance work, dusters and brooms used for cleaning the factory etc.
Labor
Lab our is needed to convert the raw materials into finished products. It is also needed to supply the goods in the hand of ultimate consumer. It can further be divided into two types as given below:
Direct labor: is the workforce, which is directly involved on production. It refers to lab our cost, which can be identified with and allocate to cost centers or cost units. It includes the remuneration paid for converting the raw material into finished products or for altering the construction, composition or condition of the or ducts manufactured by an undertaking. For example, wages paid for spinning yarn inn case of spinning mills, wages paid for weaving cloth in case of cloth mills, wages paid to a mason for construction of a building by a building contractor etc.
Indirect labor cost: refers to the labor cost or wages, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost units. For example; salary paid to factory manager, salary paid to factory supervisor or foremen, salary paid to general manager or sales manager etc.
Other expenses
The expenses which are needed in course of production and distribution except material and labor fall into this category. They can be divided into two types as mentioned below:
Direct expenses: these costs are also called chargeable ex
penses. They are the expenses other than direct material and labor cost, and can be identified with and allocated to cost centers or cost units. Direct expenses are those which are incurred for each unit of manufacture specifically and identifiable with them. For example, royalties paid on the basis of output, hire charges of special plant or machinery, carriage and freight on direct material purchased, import duty and octopi paid on the purchase of imported direct materials, amount payable to sub-contracts etc.
Indirect expense: refer to the expenses, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost units, for example; rent taxes, and insurance of factory building, factory lighting, repairs to factory building, depreciation to plant and machinery, repairs to machinery, depreciation and insurance of office building, depreciation and insurance of showroom building etc. are known as indirect expenses.
On the basis of faction
Based on the functions, the cost be classified into production cost, administration cost, selling and distribution cost, and research and development cost.
Production cost
It includes all direct material, direct labor, direct expenses and manufacturing expenses. It refers to cost concerned with manufacturing activity, which starts with supply of material and ends with primary packing of the product.
Administration cost
It is incurred for carrying the administrative function of the organization i.e. cost of policy formulation and its implementation to attain the objective of the organization. It should not be related to research, development, production, distribution or selling activities. It is also called office cost.
Selling and distribution cost
The selling cost refers to the cost of selling function i.e., the cost of activities relating to create and stimulate demand for company's products and to secure orders. The distribution costs are incurred to make goods available to the customers. These costs include the cost of maintaining and creating demand of product, making the goods available in the hand of customer. They are also called total cost or cost of sales.
Research and development costs
The research cost is the cost of searching for new products, new manufacturing process, improvement of existing products, processes or equipment and the development cost is the cost of putting research result on commercial basis.
On the basis of behavior or variability
On the basis of the behaviors in relation to changes in the volume of activity, cost may be classified as, fixed cost, various costs and semi-variable cost.
Fixed cost
The costs, whose total amount remains constant, up to a certain capacity is called fixed cost. The level of production changes, but total amount of fixed cost remains constant. Fixed cost is also called capacity cost, periodic cost, standing cost and burden cost. If the level of production increase then per unit cost decreases and vice-versa, but total amount of fixed cost remain constant. These costs remain fixed in total but their per unit cost changes with changes in output or sales. The per unit fixed cost increase with decrease in output and vice versa.Rent, depreasciation and salary of permanent staff are the examples of fixed cost.
Feature of fixed cost
i. The amount of fixed cost is never zero, even thought the production is zero.
ii. The amount of fixed cost is constant up to a certain range.
iii. Per unit fixed cost charges in opposite direction of production activity.
iv. Fixed cost are either capacity costs or periodic and by the lower level responsibility.
v. Generally, fixed costs are unavoidable and uncontrollable costs.
Variable cost
The costs that change proportionately with the change in output are known as variable costs. An increase in the volume means a proportionate increase in the total variable costs and decrease in volume will lead to a proportionate decline in the total variable costs. There is a linear relationship between volume and variable costs. The variable cost per unit is always constant.
When production is zero, the total amount of variable cost is also zero. Variable cost is also called margin cost, direct cost, pocket costs etc. direct material cost; direct labor cost and direct expenses are the example of variable costs.
Feature of variable cost
i. Per unit variable cost remains constant.
ii. When the production is zero, then the total amount of variable cost is also zero, but per unit variable cost will never be zero.
iii. Total amount of variable cost changes according to changes in level of production.
iv. Variable cost is a controllable cost.
Semi-variable cost
The costs which are neither perfectly variable nor absolutely fixed in relation to changes in volume are called semi-variable costs. Neither total amount nor per unit cost of semi-variable cost remains constant. If the levels of production increase than total amount of semi-variable cost also increase and per unit cost decreases but not proportionately. These costs have the characteristics of both fixed and variable costs. Electricity charges, telephone charges, water supply charge re the example of semi-variable costs. They are also called mixed costs, combined costs or semi-fixed costs.
Features of semi-variable cost
i. Neither total amount nor per unit cost remains constant.
ii. Semi-variable cost can never be zero.
iii. When the level of production increase then total amount of semi-variable cost also increase but per unit semi-variable cost decreased and vice-versa.
On the basis of controllability
An effective cost control requires knowledge of cost controllability. Controllable may be defined in terms of charge or alternatives of costs.
Controllable cost
The cost subject to control or substantial influence of a particular manager or individual is called controllable cost. The cost than can be changed or alternated by the action of a specific manager is treated as controllable costs.
Uncontrollable cost
Cost that is not subject to influence by the action of manage is called uncontrollable costs. These costs remain unchanged.
Cost accounting involves collecting, classifying, recording and appropriate allocation of expenditures for determining the cost of products or services. Costs have different features or characteristics. For proper control and managerial decisions, management is to be provided wit
Concept or meaning of cost
The term "cost" has a variety of interpretations in common use. In ordinary language, it may mean price. The oxford dictionary defines "cost" as the price paid for something. But in cost accounting. It is considered different from price.
In cost accounting, cost is the amount of resources given up in exchanges for some goods or services. The resources given up are generally in terms of money of if not in term of money; they are always expressed in monetary units. It consists of all the expenses incurred in producing a commodity or exciting a contract. If signified or monetary outlay to secure some benefit.
The term 'cost' itself has no significant meaning, therefore, it is always used with an adjective or phrase that conveys the meaning intended, such as prime, direct, indirect, fixed, variable, controllable, opportunity, marginal, replacement and the like. Such description implies a certain characteristic, which is important in computing and analyzing the cost.
"Cost may be defined as the sacrifice or giving up resources for a particular purpose. Cost is frequently measured by mandatory units that must be paid for good and service." –horngren, sundem and Stratton,
From the above definitions, it is clear that cost is the expenditures or sacrifice made for good or services.
Cost center
Cost center is a location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. ICMA defines cost center as "a production or services. Factions, activity or item of equipment whose costs may be attributed to cost units. A cost center is the smallest organizational sub-unit for which separate cost allocation is attempted." For functional point of view, a cost center may be relatively easy to establish, because a cost center is any unit of the organization to which costs can be separately attributed. A cost center is an individual activity or group of similar activities for which costs are accumulated. For example, production departments, a machine or group of machines within a department or work group is considered as cost center.
Cost unit
A cost unit is a unit of product or unit of service to which costs are ascertained by means of allocation, apportionment and absorption. CIMS defines cost units as "a quantitative unit of product or service in relation to which cost are ascertained". It is a unit of quantity of product, service or time or a combination of these in relation to which costs are expressed or ascertained. It is useful measurement of cost for comparative purposes. In preparing cost accounts, it becomes necessary to select a unit with which expenditures may be identified. The examples of some cost units are given below:
Industry/enterprise Cost unit
Brick works
Collieries
Textile mills
Electricity companies
Transport companies
Steel mills
Screws manufacturing
Gas
Car Per 100 bricks made.
Per ton of cost raised.
Per yard or per ib of cloth manufactured.
Pr unit of electricity generated.
Per passenger-kg., per ton-kg.
Per ton of steel made.
Per 100 screws.
Per cubic meter.
Per unit.
Costing and cost accounting
Costing is 'the technique and process of ascertaining costs. "It provides only the basis and information for ascertainment of cost. Once the information is made available, the costing can be carried out arithmetically, by means from of memorandum statements or by method of integral accounting. Cost accounting is different from costing in the sense that it is the process of accounting for costs. It includes the account ting procedures relating to recording of all income and expenditures and the preparation of periodical statements and reports will the object of ascertain and controlling costs. It is the formal mechanism by means of which cost of products or services are ascertained and controlled.
Classification of cost
The various groups, into which costs are classified, are known as ' classes'. Costs may be classified according to different bases or characteristics, such as;
1. On the basis of production and process
2. On the basis of element or nature
3. On the basis of function
4. On the basis of behavior or variability
5. On the basis of controllability.
On the basis of production and process
In cost accounting, a factory has to bear various types of cost in the process of production. These production costs may be sub-divided into following two types.
Direct expenditure
It included all those expenditures which can be easily identified wholly with a unit of cost. It contains material expenses, labor expenses and direct expenses e.g. wood, labor are the good examples of direct expenses for a furniture manufacturer.
Indirect expenditure
Indirect expenditure are those expenditure which are incurred for the advantage of number of cost center and are not easily identified with a particular cost center e.g. paints, nail etc. on furniture.
On the basis of element or nature
On the basis element, cost can be divided into material, labor and expense. They have been mentioned in details in the following.
Materials
Materials are needed to produce or provide services. They can be classified into direct and indirect are given below:
Direct material: means the materials which from part of finished output and can be identified with the finished product easily. For example: wood, plywood, adhesive, wood polish, mails etc. in case of manufacturing cloth, cost of iron in case of manufacturing machinating cotton yarn, cost of yarn in case of manufacturing furniture, cost of iron in case of manufacturing machinery etc. the main feature of direct materials in that enter into and form part of the finished product.
Indirect material cost: refers to the material cost, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost unit. These are the materials, which cannot be traced as part of the product, and their cost is distributed among the various cost center or cost units on some equitable basis.
Examples of indirect materials are cost and fuel for generating power, cotton waste, lubricating oil and grease used in maintaining the machinery, materials consumed for repair and maintenance work, dusters and brooms used for cleaning the factory etc.
Labor
Lab our is needed to convert the raw materials into finished products. It is also needed to supply the goods in the hand of ultimate consumer. It can further be divided into two types as given below:
Direct labor: is the workforce, which is directly involved on production. It refers to lab our cost, which can be identified with and allocate to cost centers or cost units. It includes the remuneration paid for converting the raw material into finished products or for altering the construction, composition or condition of the or ducts manufactured by an undertaking. For example, wages paid for spinning yarn inn case of spinning mills, wages paid for weaving cloth in case of cloth mills, wages paid to a mason for construction of a building by a building contractor etc.
Indirect labor cost: refers to the labor cost or wages, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost units. For example; salary paid to factory manager, salary paid to factory supervisor or foremen, salary paid to general manager or sales manager etc.
Other expenses
The expenses which are needed in course of production and distribution except material and labor fall into this category. They can be divided into two types as mentioned below:
Direct expenses: these costs are also called chargeable ex
Indirect expense: refer to the expenses, which cannot be allocated but can be apportioned to or absorbed by cost centers or cost units, for example; rent taxes, and insurance of factory building, factory lighting, repairs to factory building, depreciation to plant and machinery, repairs to machinery, depreciation and insurance of office building, depreciation and insurance of showroom building etc. are known as indirect expenses.
On the basis of faction
Based on the functions, the cost be classified into production cost, administration cost, selling and distribution cost, and research and development cost.
Production cost
It includes all direct material, direct labor, direct expenses and manufacturing expenses. It refers to cost concerned with manufacturing activity, which starts with supply of material and ends with primary packing of the product.
Administration cost
It is incurred for carrying the administrative function of the organization i.e. cost of policy formulation and its implementation to attain the objective of the organization. It should not be related to research, development, production, distribution or selling activities. It is also called office cost.
Selling and distribution cost
The selling cost refers to the cost of selling function i.e., the cost of activities relating to create and stimulate demand for company's products and to secure orders. The distribution costs are incurred to make goods available to the customers. These costs include the cost of maintaining and creating demand of product, making the goods available in the hand of customer. They are also called total cost or cost of sales.
Research and development costs
The research cost is the cost of searching for new products, new manufacturing process, improvement of existing products, processes or equipment and the development cost is the cost of putting research result on commercial basis.
On the basis of behavior or variability
On the basis of the behaviors in relation to changes in the volume of activity, cost may be classified as, fixed cost, various costs and semi-variable cost.
Fixed cost
The costs, whose total amount remains constant, up to a certain capacity is called fixed cost. The level of production changes, but total amount of fixed cost remains constant. Fixed cost is also called capacity cost, periodic cost, standing cost and burden cost. If the level of production increase then per unit cost decreases and vice-versa, but total amount of fixed cost remain constant. These costs remain fixed in total but their per unit cost changes with changes in output or sales. The per unit fixed cost increase with decrease in output and vice versa.Rent, depreasciation and salary of permanent staff are the examples of fixed cost.
Feature of fixed cost
i. The amount of fixed cost is never zero, even thought the production is zero.
ii. The amount of fixed cost is constant up to a certain range.
iii. Per unit fixed cost charges in opposite direction of production activity.
iv. Fixed cost are either capacity costs or periodic and by the lower level responsibility.
v. Generally, fixed costs are unavoidable and uncontrollable costs.
Variable cost
The costs that change proportionately with the change in output are known as variable costs. An increase in the volume means a proportionate increase in the total variable costs and decrease in volume will lead to a proportionate decline in the total variable costs. There is a linear relationship between volume and variable costs. The variable cost per unit is always constant.
When production is zero, the total amount of variable cost is also zero. Variable cost is also called margin cost, direct cost, pocket costs etc. direct material cost; direct labor cost and direct expenses are the example of variable costs.
Feature of variable cost
i. Per unit variable cost remains constant.
ii. When the production is zero, then the total amount of variable cost is also zero, but per unit variable cost will never be zero.
iii. Total amount of variable cost changes according to changes in level of production.
iv. Variable cost is a controllable cost.
Semi-variable cost
The costs which are neither perfectly variable nor absolutely fixed in relation to changes in volume are called semi-variable costs. Neither total amount nor per unit cost of semi-variable cost remains constant. If the levels of production increase than total amount of semi-variable cost also increase and per unit cost decreases but not proportionately. These costs have the characteristics of both fixed and variable costs. Electricity charges, telephone charges, water supply charge re the example of semi-variable costs. They are also called mixed costs, combined costs or semi-fixed costs.
Features of semi-variable cost
i. Neither total amount nor per unit cost remains constant.
ii. Semi-variable cost can never be zero.
iii. When the level of production increase then total amount of semi-variable cost also increase but per unit semi-variable cost decreased and vice-versa.
On the basis of controllability
An effective cost control requires knowledge of cost controllability. Controllable may be defined in terms of charge or alternatives of costs.
Controllable cost
The cost subject to control or substantial influence of a particular manager or individual is called controllable cost. The cost than can be changed or alternated by the action of a specific manager is treated as controllable costs.
Uncontrollable cost
Cost that is not subject to influence by the action of manage is called uncontrollable costs. These costs remain unchanged.
This article on Characteristics Of Fixed And Variable Costs is also helpful. Thanks for this.
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