Dr.Smita Sahoo

CLASSIFICATION OF

COSTS

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What is Cost?

“Cost is a measurement, in monetary terms, of theamount of resources used for the purpose of productionof goods or rendering services”

-Institute of Cost & Works Accountants of India

Manufacturing of goods or rendering services involves consumption of resources. Cost is measured by the sacrifice made in terms of resources or price paid to acquire goods and services. The type of cost is often referred in the costing system depends on the purpose for which cost is incurred. For example material cost is the price of materials acquired for manufacturing a product.

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Classification of Costs

Classification means ‘the arrangement of items in logical groups having regard to their nature (subjective classification) or purpose( objective classification)’.

Classification of costs according to their nature

Classification of costs according to their purpose

Other cost classifications

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Classification of costs according to their nature

Material costs: cost of obtaining materials and receiving them within the organisation.

Labour Costs: those costs incurred in the form of wages and salaries, together with related employment costs.

Overheads : these are external costs such as rent , electricity , insurance etc.

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Classification of costs according to their purpose

Direct Costs: A direct cost can be clearly identified with what ever we are trying to cost ( examples are cost of material, labour charges etc.)

Indirect Costs: These are the costs which can not be directly attributed to a product.

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Other Classification of costs

Fixed & Variable costs Production, selling and distribution, and

administration costs Controllable and non-controllable costs Normal and abnormal costs Relevant and non-relevant costs

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Cost behaviour

Cost behaviour means the way in which costs are affected by fluctuations in the level of activity ( measured in terms of number of units produced, miles traveled, hours worked, percentage of capacity utilised etc.).

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Fixed Costs

Variable Costs

Semi-VariableCosts

Common cost behaviour pattern

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Fixed Costs: ‘A cost which is incurred for an accounting period, and which, within certain output or turnover limits, tends to be un affected by fluctuations

of levels of activity (Output or turnover)’

0 1 2 3 4 5

400 –

300 –

200 –

100 –

– – ––Volume

(Thousands of Units)

Tot

al F

ixed

C

osts

(Rs.

In

thou

sand

s)

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Relevant Range

Fix

ed C

osts

(R

s.)

Volume in Units

400,000 –

300,000 –

200,000 –

100,000

0 5,000 10,000 15,000 20,000 25,000

– – –

Relevant Range

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Variable Costs: ‘ A cost which varies with a measure of activity”

0 1 2 3 4 5

24 –

18 –

12 –

6 –

– – ––

Volume(Thousands of Units)

Tot

al V

aria

ble

Cos

ts

(Rs.

In

thou

sand

s)

Dr.Smita Sahoo

Semi-variable Costs: ‘A cost containing both fixed and variable components and which is thus partly affected by a change in the level of

activity’.

0 125 250 375 500 625

2,850 –

2,100 –

1,350 –

600 –

– – ––Volume (in thousand units)

Tot

al C

osts

in

Rs.

’000

VariableCost

FixedCost

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What is a Cost Centre?

“Any unit of Cost Accounting selected with a view to accumulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery , a group of employees or a combination of several units. This may also be a budget centre.”

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Cost Centre may be of two types – personal and impersonal cost centers. Personal cost centre consists of a person or a group of persons. Cost centres which are not personal cost centres are impersonal cost centers.

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Again Cost centers may be divided into broad types i.e. Production Cost Centres and Service Cost Centres. . Production Cost Centres are those which are engaged in production like Machine shop, Welding shop, Assembly shop etc. Service Cost centers are for rendering service to production cost centre like Power house, Maintenance, Stores, Purchase office etc.

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What is a cost unit?

“Cost unit is a form of measurement of volume of production or service. This unit is generally adopted on the basis of convenience and practice in the industry concerned.”

Examples of Cost Units : Power - MW Cement - MT Automobile - Number etc

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Classification of costs by relation to Cost Centre

Classification should be on the basis of method of allocation of cost to a cost unit. If an expenditure can be allocated to a cost centre or cost object in an economically feasible way then it is called direct otherwise the cost component will be termed as indirect.

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According to this criteria for classification, material cost is divided into direct material cost and indirect material cost, labour cost into direct labour cost and indirect labour cost and expenses into direct expenses and indirect expenses. Indirect cost is also known as overhead.

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Classification of costs by relation Classification of costs by relation to Cost Centreto Cost Centre

COST

DIRECT INDIRECT

MATERIAL LABOUR OVERHEAD

MATERIAL LABOUROVERHEAD

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Classification of costs by Classification of costs by functions/activitiesfunctions/activities

Costs should be classified according to the major functions for which the elements are used into

the following four major functions

COST

PRODUCTIONADMINISTRATION

SELLING &

DISTRIBUTION

RESEARCH &

DEVELOPMENT

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COST SHEETCOST SHEETDirect Material Cost* xxxDirect Labour Cost xxxDirect Expenses xxxPRIME COST XXXAdd: Factory Overhead** xxxFACTORY COST XXXAdd: Administrative overhead xxxCOST OF PRODUCTION XXXAdd: Selling & Distribution cost xxxCOST OF SALES XXXAdd: Profit Margin xxxSELLING PRICE XXX

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• Direct material consumed = Open. Stock of DM+ Purchase of DM-Closing Stock of DM

• Works cost = Gross Works cost + Open. WIP-Closing WIP

• Cost of production of goods sold = cost of production +open. stock of FG – Closing stock of FG

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NotesNotesTo arrive at value at different points as

indicated above adjustment with opening and closing stock is necessary at following different points :

(*) opening and closing stock of raw materials

(**) opening and closing stock of work-in-progress & finished goods