Ways of classification ofcosts on the basis of theircommon characteristicsare:• 1. By nature or element• 2. By functions• 3. By identifiably• 4. By variability• 5. By controllability• 6. By normality• 7. Other Costs
1. BY NATURE OR ELEMENT Material Cost Labour Cost Expenses
MATERIAL COSTCost of materials used for the manufacture of a product,a particular work order, or provision of a service.Example: Cloth for making a dress, stores used formaintaining machines and buildings such as lubricants,cotton waste, bricks etc.
LABOUR COSTLabour cost is defined as the total expenditure borneby employers in order to employ workers. Labourcosts include the direct costs linked to remuneration forwork carried out such as direct remuneration, bonusesand ex gratia payments not paid at each pay period,payments for days not worked, severance pay, benefits inkind. They also include indirect costs linked toemployees, independently of the remuneration paid bythe employer, such as direct social benefits, vocationaltraining costs and so on.
EXPENSESExpense is defined as money expended or cost incurredin a firms efforts to generate revenue, representing costof doing business. They may be in the form of actualcash payments (such as wages and salaries), a computedexpired portion (depreciation) of an asset, or anamount taken out of the firms earnings (such as baddebts).Whereas all expenses are costs, not all costs (such asthose incurred in acquisition of income generatingassets) are expenses.
2. BY FUNCTIONS 1. Production 3. Distribution 2. Selling Cost Cost Cost 4. 6. 5. Research Administrative Development Cost Cost Cost 7. Pre- 8. Conversion 9. Product production Cost Cost Cost
PRODUCTION COSTThe cost of the sequence of operations which beginswith supplying materials, labour and services and endswith primary packing of the product. Thus it includesthe cost of direct materials, direct labour, direct expensesand factory overheads.
SELLING COSTThe cost seeking to create and stimulate demand(sometimes termed ‘marketing’) and of securing orders.
DISTRIBUTION COSTThe cost of the sequence of operations which beginswith making the packed product available for dispatchand ends with making the reconditioned returnedempty package, if any available for re-use.It also includes expenditure incurred in transportingarticles to central or local storage as well as in movingarticles to and from prospective customers as in case ofgoods on sale or return basis. In gas, electricity and waterindustry distribution means pipes, mains and serviceswhich may be regarded as the equivalent of packing andtransportation.
ADMINISTRATIVE COSTThe cost of formulating the policy, directing theorganization and controlling the operations of anundertaking which is not related directly to aproduction, selling & distribution, research ordevelopment activity or function.
RESEARCH COSTThe cost of researching for new or improvedproducts, new applications of materials, or improvedmethods.
DEVELOPMENT COSTThe cost of the process which begins with theimplementation of a decision to produce a new orimproved product or to employ a new or improvedmethod and ends with commencement of formalproduction of that product or by that method.
PRE-PRODUCTION COSTThe part of development cost incurred in making a trialproduction run preliminary to formal product.This term is sometimes used to cover all activities priorto production including Research & Development, butin such cases the usage should be made clear in thecontext
CONVERSION COSTThe sum of direct wages, direct expenses and overheadcost of converting raw materials to the finished stage orconverting a material from one stage of production tothe next.In some cases this also includes any excess material costor loss of material incurred at the particular stage ofproduction.
PRODUCT COSTThese are inventoriable cost. These are the costs whichare assigned to the product. Under marginal costingvariable manufacturing cost and under absorptioncosting, total manufacturing cost constitutes productcost.
DIRECT COSTThe expenses on material and labour economically andeasily traceable to a product, service or job areconsidered as direct costs. In the process of manufactureor production of articles, materials arepurchased, labourers are employed and the wages arepaid to them, certain other expenses are also incurreddirectly. Since all these take an active and direct part inthe manufacture of a particular commodity, hence arecalled direct costs.Example: Cost of meat in a burger
INDIRECT COSTThe expenses incurred on those items which are notdirectly chargeable to production are known as indirectcosts. Example: In production, salaries oftimekeepers, storekeepers, foremen are paid, certainexpenses for running the administration are incurred.All of these cannot be conveniently allocated toproduction and hence are called indirect costs.
FIXED COSTThe cost which does not vary but remains constantwithin a given period of time and range of activity inspite of the fluctuations in production, is known as fixedcost. Example: rent, insurance of factory buildings etc.remain the same for different levels of production.
VARIABLE COSTThese costs tend to vary with the volume of output. Anyincrease in the volume of production results in anincrease in the variable cost and vice versa.Example: cost of material, cost of labour etc.
Semi-variable CostThe cost which does not vary proportionately butsimultaneously cannot remain stationery at all times isknown as semi variable cost. It can also be called assemi-fixed cost.Example: Depreciation, repairs etc.
STEP COSTSCertain costs remain fixed over a range of activity andthen jump to a new level as activity changes. Such costsare treated as “Step Costs”.Example: A foreman is in a position to supervise a givennumber of employees. Beyond this number it will benecessary to hire a second then a third and so on.
5. BY CONTROLLABILITY Controllable Costs Uncontrollable costs
CONTROLLABLE COSTSThese are the costs which can be influenced by theaction of a specified member of an undertaking. Abusiness organization is usually divided into a numberof responsibility centres and each centre is headed by anexecutive. The executive can thus control the costsincurred in that particular responsibility centre.
UNCONTROLLABLE COSTSCosts which cannot be influenced by the action of aspecified member of an undertaking.Example: Expenditure incurred by the tool room iscontrollable by the foreman in charge of that section butthe share of the tool room expenditure which isapportioned to a machine shop is not to be controlled bythe machine shop foreman.
NORMAL COSTSIt is the cost which is normally incurred at a given levelof output under the conditions in which that level ofoutput is normally attained.ABNORMAL COSTSIt is the cost which is not normally incurred at a givenlevel of output in the conditions in which that level ofoutput is normally attained. This is charged to CostingP&L A/c
7. OTHER COSTS Product Costs and Period Costs Decision making Costs and Accounting Costs Relevant and Irrelevant Costs Shutdown and Sunk Costs Avoidable / Escapable and Unavoidable / Inescapable Imputed or Hypothetical Costs Differential, Incremental or Decremental Cost Out of Pocket Costs Opportunity Cost Traceable, Untraceable Costs Joint Costs and Common Costs
PRODUCT COSTSCosts which become part of the cost of the productrather than an expense of the period in which they areincurred are called as “Product Costs”. In financialstatements such costs are treated as assets until thegoods they are assigned to are sold. They become anexpense at that time. These costs may be fixed as well asvariable.Example: Cost of raw materials and directwages, depreciation on plant & equipment etc.
PERIOD COSTSCosts which are not associated with production arecalled “Period Costs”. They are treated as an expense ofthe period in which they are incurred. They may also befixed as well as variable. Such costs include GeneralAdministration costs, Salesman salaries andcommission, depreciation on office facilities etc. Theyare charged against the revenue of the relevant period.
DECISION MAKING COSTSThese are special purpose costs that are applicable onlyin the situation in which they are compiled. They haveno universal application. They need not tie into routinefinancial accounts. They do not and should not conformto the accounting rules.
ACCOUNTING COSTSThese costs are compiled primarily from financialstatements. They have to be altered before they can beused for decision making. Moreover they are historicalcosts and show what has happened under an existing setof circumstances, while decision making costs are futurecosts.Example: Accounting costs may show the cost of theproduct when the operations are manual, while decisionmaking costs might be calculated to show the costswhen the operations are mechanised.
RELEVANT & IRRELEVANT COSTRelevant costs are those costs which would be changedby the managerial decision, while irrelevant costs arethose which would not be affected by the decision.Example: If a manufacturer is considering closing downof an unprofitable retail sales shop, wages payable to theworkers of the shop are relevant in this connection sincethey will disappear on closing down of the shop. Butprepaid rent for the shop or unrecovered costs of anyequipment which will have to be scrapped, will beirrelevant costs which must be ignored.
SHUTDOWN COSTSA manufacturer or an organization rendering servicemay have to suspend its operations for a period onaccount of some temporary difficulties such as shortageof raw materials, non availability of labour etc. Duringthis period though no work is done yet certain fixedcosts such as rent and insurance of buildings,depreciation etc. for the entire plant will have to beincurred. Such costs of the idle plant are known as shutdown costs.
SUNK COSTSThese are costs which have been created by a decisionthat was made in the past that cannot be changed by anydecision that will be made in the future. Investment inplant & machinery are prime examples of such costs.Since sunk costs cannot be altered by later decisions,they are irrelevant for decision making.
OPPORTUNITY COSTThis cost refers to the advantage, in measurableterms, which has been foregone on account of not usingthe facilities in the manner originally planned.Example: If an owned building is proposed to be utilizedfor housing a new project plant, the likely revenue whichthe building could fetch if rented out is the opportunitycost which should be taken into account whileevaluating the profitability of the project.
JOINT COSTSThese are a sort of common costs. When two or moreproducts are produced out of one and the same materialor process, the costs of such material or process arecalled joint costs.Example: When cotton seeds and cotton fibre areproduced from the same raw materials, the costincurred till split off or separation point will be jointcosts.
COMMON COSTSCommon costs are those which are incurred for morethan one product, job, territory or any other specificcosting unit. They are not capable of being identifiedwith individual product, and are therefore apportionedon a suitable basis.Example: Rent, lighting and supervision costs arecommon costs to all departments located in the factory.
TECHNIQUES OF COSTING 1. Historical Cost: Under this method cost is ascertained on the basis of actual expenses incurred after the production is complete. To ascertain the price of a tender or quotation, actual cost figures of previous year are used as a basis. 2.Standard Cost: The standard cost of a commodity or a service is estimated before actual production. After the production standard cost is compared with actual cost of production and the amount and causes of variance are known. On the basis of actual costs necessary adjustments are made in standard cost and future standard costs are fixed. 3. Marginal Costing: In this technique only such expenses are included in cost which are directly related to production that is which are variable to quantity of production. no part of fixed expenses is included in this cost. if the production of the factory is increased in future within the production capacity, the additional cost of production is called marginal cost.
METHODS OF COSTING1. Single Costing: This method is also known as output costing or unit costing. This method is used in such industries where only one item is produced in large quantities during the whole year EXAMPLES cement, flour, sugar and coal. Under this method cost per tone is computed.2. Operating Costing: In industries where no commodity is produced but public utility service is provided. EXAMPLES railways, bus transport, and electric supply.
3. Process Costing: In the industries where the production is completed through many processes or where the production may be sold after completion of one or a few or all processes, this method of costing is used. EXAMPLES chemical, textile, and oil industries4. Departmental Costing: When in a factory more than one item is manufactured, it is necessary to ascertain the cost of each item separately. For this purpose total expenses are divided between various departments on some fair basis and cost per unit of each department is ascertained. EXAMPLES boxes, bed, and tables.