METHODS OF COST CLASSIFICATION

DONE BY : NIVED, KARTIK, PETER, NIRMAL, VEDASHREE

VARIOUS CLASSIFICATIONS OF COST
 ON THE BASIS OF ELEMENTS

◼ The cost elements of a product are Material, Labour and Expenses.

◼ Materials :-
◼ Material Cost can be defined as “the cost of commodities, other than fixed assets, introduced into
the products or consumed in the operation of an organisation.”
◼ Material Costs are divided into two parts:-
◼ Direct Materials Costs :-
◼ Direct material cost can be defined as “the cost of materials entering into and becoming
constituent elements of a product or saleable service.” Eg: Cotton in cotton textile, Timber in
furniture industry.
◼ Indirect Material Cost :-
◼ Indirect material cost can be defined as “material cost other than direct material cost.” Eg:
Consumable stores such as oil, cotton waste, small tools, works stationery.
 ON THE BASIS OF ELEMENTS

◼ Labour :-
◼ Labour is the physical or mental effort expended in production. The remuneration for such
efforts is known as wages. It is further classified into Direct Labour Cost and Indirect Labour
Cost.
◼ Direct Labour Cost :-
◼ Direct labour cost can be defined as “the cost of remuneration for employee’s efforts and skills
applied directly to a product or a saleable service.”
◼ Indirect Labour Cost :-
◼ Indirect Labour Cost can be defined as “labour cost other than direct labour cost.” Eg :- salaries
and wages paid to foreman, supervisor, chargeman, inspectors, workers, etc. Overtimes etc.
 ON THE BASIS OF ELEMENTS

◼ Expenses :-
◼ Expenses could be defined as “costs other than materials or wages which are incurred for a
specific product or a saleable service.” They can direct or indirect.
◼ Direct Expenses :-
◼ Direct Expenses can be defined as “costs other than materials and wages which are incurred for a
specific product or a saleable service.” Direct Expense form a part of Prime Cost. Eg: Cost of
drawing and patterns, Repairs and maintenance, research expenditures, royalty.
◼ Indirect Expenses :-
◼ These can be defined as “expenses other than direct expenses.” These expenses are not directly
charged in production. Eg : Rent and rates, salaries of general manager, staff welfare, canteen,
lighting, telephone expenses etc.
 ON THE BASIS OF FUNCTIONS

◼ Factory Costs :-
◼ This is the cost which is incurred for a series of operations i.e. right from the supply of materials,
labours and expenses incurred till the completion of the production. Eg : material, labour,
factory rent, rates and taxes, lighting and power etc.
◼ Administration Costs :-
◼ This is the cost of running a concern i.e. for framing policies, directing and controlling all the
activities of the organisation other than manufacturing and selling and distribution expenses. Eg
: Director’s fees and allowance, Salaries of office staff, Legal expenses etc.
◼ Selling and Distribution Costs :-
◼ Selling costs are those costs which are incurred for attracting the potential customers and
retaining the existing ones. Eg : Advertisement, Salaries of salesman and sales staff, cost of
brochures, showroom expenses etc.
 ON THE BASIS OF FUNCTIONS

◼ Distribution expenses are incurred for dispatching the products which are ready after packing.
Eg : Carriage outward, Warehouse expenses, Packing Costs, Running and maintenance cost of
delivery van etc.
◼ Research and Development Costs :-
◼ Research cost is defined as “the cost of seeking new or improved products, applications of
material or methods.” Development costs is defined as “the cost of process which begins with the
implementation of the decision to produce a new or improved methods and ends with the
commencement of formal production of that product or by that method.”
 ON THE BASIS OF IDENTIFIABILITY

◼ According to Identifiability the costs are classified into Direct cost and Indirect costs.
◼ Direct Costs :-
◼ All the costs which can be conveniently allocated to cost unit or cost centre is known as Direct
cost. Eg : the cost of cotton in case of textile industries, cost of timber in furniture industry etc.
◼ Indirect Costs :-
◼ It is a cost which is of a general character and which cannot be identified with a particular unit of
cost. These costs cannot be allocated, but can be apportioned to cost unit or cost centres.
 ON THE BASIS OF BEHAVIOUR

◼ Fixed Costs :-
◼ Fixed Costs remain fixed in total amount and do not increase or decrease with the volume of
production. But the fixed cost per unit increases when volume of production decreases and
decreases when the volume of production increases. Eg : Rates, Taxes, Rents, Insurance.
◼ Variable Costs :-
◼ A cost which in aggregate tends to vary in direct proportions to changes in the volume of output
or turnover. In other words, when volume of output increases, the variable cost increases too,
and vice-versa. But variable cost per unit remains fixed. Eg : Direct Material Cost, Direct Labour
Cost, Direct expenses, Repairs, Royalties.
◼ Semi-Variable Costs :-
◼ This cost is partly fixed and partly variable. A semi-variable cost has often a fixed element below
which it will not fall in any level of output.
 ON THE BASIS OF CONTROLLABILITY

◼ Controllable Costs :-
◼ Controllable costs can be defined as “a cost chargeable to a cost centre, which can be influenced
by actions of a person in whom control of the centre is vested.” In other words, these are the costs
which may be directly regulated at a given level of management authority. Eg: Office expenses,
workers bonuses, charitable donation etc.
◼ Uncontrollable Costs :-
◼ Uncontrollable Costs can be defined as “a cost chargeable to a cost centre, which cannot be
influenced by the actions of the person in whom, control of the centre is vested.” They are not in
control of management. Eg: Rent expenses, Corporation overhead allocation, Depreciation
expenses.
 ON THE BASIS OF NORMALITY

◼ Normal Cost:-
◼ Normal costs can be defined as “the cost which is normally incurred to a given level of output in
the condition in which that level of output is normally attained.” It is a part of the cost of
production. Eg: Repairs, Maintenance, Salaries.
◼ Abnormal Cost :-
◼ It is defined as “a cost which is not normally incurred at a given level of output in the condition
in which that level of output is normally attained.” It is not a part of cost of production and
charged to costing Profit and Loss Account. Eg: Destruction due to fire, Shut down of machinery.
 ON THE BASIS OF TIME

◼ Historical Costs :-
◼ They are defined as “the costs that are ascertained after these have been incurred.” These costs
are available only when the production of a particular thing has already been done.
◼ Pre determined Costs :-
◼ It is defined as “the costs which are ascertained in advance of production on the basis of a
specification of all factors affecting cost.” These costs are set up from analysis and forecast made
before the event and thus, represent not what has happened, but what is expected to happen. Pre
determined costs determined on scientific basis becomes standard cost.
 ON THE BASIS OF ASSOCIATION

◼ Product Costs :-
◼ These costs are are described as the costs which are directly associated with the product. Thus
unit product is sold, these costs provide no benefit. Eg: Direct Material, Direct Labour.
◼ Period Costs :-
◼ It is described as the costs which are associated with a particular Accounting Period. These are
not related with the products delivered to the customers. Such costs are charged to Profit and
Loss Account of the period. Eg: Rent salaries of office staff, travelling expenses etc.
 ON THE BASIS OF INVESTMENT

◼ Capital Costs :-
◼ It is defined as “a cost which is intended to benefit in future period.” Capital cost is treated as
purchase of an asset. Eg: Purchase of premises, plant and machinery, furniture etc.
◼ Revenue Costs :-
◼ It is defined as “a cost which is incurred to benefit the current period.” Revenue cost is treated
as an expense. Eg: Salaries, postage, printing and stationery, rent and taxes, insurance, etc.
 ON THE BASIS OF RELEVANCY

◼ Relevant Costs :-
◼ Relevant Costs are those costs which have a bearing, or which have an effect on the decisions
under the consideration of the management. That means, they are the most pertinent costs and
therefore their effects are to be reckoned before taking a decision.
◼ Irrelevant Costs :-
◼ Irrelevant costs are those which have no effect on the decisions under the consideration of the
management. Eg: Sunk Costs (Expenditures which already have been incurred). Committed
Costs (Future costs which cannot be altered).
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