CLASSIFICATION OF COSTS

Cost may be classified on the following bases:

  • Functions
  • Behaviour
  • Traceability to end product
  • Time
  • Identify with stock
  • Controllability
  • Relevance for decision making

1. Classification Function
On the basis of function, costs may be classified into production cost, administration cost, selling and distribution cost and research and development cost.

a) Production Cost
These are cost incurred in the factory in the production of goods e.g. Raw materials, labour, factory rent etc.

b) Administration Cost
These are costs incurred in the general management of the business e.g. office rent, salaries of office staff, depreciation of office machinery etc.

c) Selling and distributing cost
These are costs incurred in making the final products available in the market and convincing/ persuading customers to adopt them e.g. advertisement, delivery and sales commissions etc.

d) Research and development
These are costs incurred in developing new products and also improving on existing ones.

2. Classification traceability to end products

a) Direct cost

Are costs that can be traced to the final products i.e. they can specifically be identified with the end products e.g. direct materials like timber in furniture, direct labour like wages paid to carpenters and direct expense like the hire of special equipment.

b) Indirect Cost (Overheads)

Are costs which are not traceable to the final products or may be traceable but constitute small proportions of the overall cost. They include:

  • Indirect material like the cost of lubricating oils, paper, rivets, vanish etc.
  • Indirect labour e.g. the salaries paid to indirect workers like watchmen, cleaners etc.
  • Indirect expense like factory rents, factory power and other utilities, depreciation of factory plants and equipment etc.

Classification Cost Behaviour

Cost behaviour refers to the changes in the cost arising from the changes in activity level. Activity level in an enterprise may be measured using the number of unit produced, sales volume, labour hour etc. On the basis of behaviour cost can be classified into:-

i) Variable costs: Are cost which change with a change in the level activity. Variable costs can be described a straight line equation of the form y = bx

Where: y = total cost,  b = variable cost per unit,  X = number of unit (activity level)

ii) Fixed cost – are costs which remain constant irrespective of the changes in the level of activity. They are represented a straight line equation of the form

y = a Where:

y = Total cost

a = Total fixed cost

Mixed cost: – Are cost with characteristic of both variables and fixed cost hey are further classified into semi-variable cost and semi-fixed cost.
a) Semi- variable cost: – Are cost where some components are fixed and some varies with activity level. It can be described a straight line e.g… of the form.
Y= a+bx where y= total cost, b = variable cost per unit x = number of units (activity level) a= fixed cost.

Semi-fixed costs – Are cost which remain fixed within a given range of activity beyond which the cos changes to the new level where it remains constant within another new range of activity in a stepped /function.

Classified time

On the basis of time cost can be classified into:-

  • Sunk cost- is the cost that has already been incurred i.e. cost relating to 2 past transaction.
  • These are historical costs which are considered to be irrelevant for classification making purpose because they cannot affect future decision.
  • Future cost- are estimated for decision making purpose because the can affect future decision.

Classifications based on identification with stock.
1. Product cost:– refers to costs that are used in the valuation of the stock finishes gods. They‟re also referred to as inventoriable cost, since they form part of product cost. Such costs are into charged to the P&L a/c until the gods produced have been sold. If the goods are not sold, the cost is carried forward in the form of stock to be written off against future sales.
2. Period cost – there’re cost that arise virtue of passage of time and are W/off through the P&L a/c whether the good produced have been sold or e.g. insurance cost.

Classifications on the basis of controllability
1. controllable costs – are costs which can be influenced management in the long run without negatively affecting the business operating e.g. research cost, marketing costs a/c cost etc
2. Uncontrollable cost – they cannot be influenced managerial decision in the short run e.g. insurance cost.

Classification based on the relevance for decision making
i) Relevant cost – Are cost that result in a unique alternative in a decision making environment such cost usually differ between alternatives e.g. future cost, controllable costs etc.
ii) Irrelevant cost– They may not give a unique alternative in a decision making situation either because they‟re already been incurred or they do not differ between the alternative e.g. sunk cost, uncontrollable.

Other terminologies

  1. Incremental cost– refers to the change in total cost (both variable and fixed when comparing 2 alternatives or when among a decision.
  2. Marginal cost– refers to the change in variable cost when comparing 2 alternatives or when making a decision.
  3. Discreet cost – are cost which incurred at the discretion of management i.e. the management has the freedom to decide whether the cost should be incurred or not.
  4. Imputed cost– these are hypothetical cost which are not cost in the strict sense of the word because there are no financial obligations to pay any money e.g. the rent of premised which are owned the organization can sometimes be included as a cost in their books.

Cost Classifications

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