Classification of cost

1. The process of grouping costs according to their common characteristics is
called classification of cost. It is a systematic placement of like items
together according to their common features. The followings are the
important ways of classifying costs.
Classification According to Functions
Classification based on cost behaviour
Classification based Product Costs and Period Costs
Classification according to Identifiability with Cost Units
Classification According to Controllability
Classification According to Element wise

2. A business has to perform a number of functions like manufacturing, administration, selling, distribution and
research. Cost may have to be ascertained for each of these functions.
Classification According to Functions
(i)Manufacturing cost : This is the cost of the sequence of
operations which begins with supplying materials, labour
and services and ends with completion of production.
(ii) Administration cost : It includes all expenditure incurred
in formulating the policy, directing the organisation and
controlling the operations of an undertaking.
(iii) Selling and distribution costs : Selling cost is the cost of
seeking to create and simulating demand and of securing
orders. Distribution cost is the cost of sequence of
operations which begins with making the packed product
available for despatch and ends with making the
reconditioned returned empty package for re-use.
(iv) Research and development cost : It is the cost of
searching new or improved products or methods. It
comprises wages and salaries of research staff, payments
to outside research organisations, materials used in
laboratories and research departments, etc.
The management may decide to produce a new improved
product or to employ a new or improved method.
Development cost is the cost of implementation of the
decision to produce a new product or to employ a new or
improved method and ends with the commencement of
formal production of that product or by that method.

3. Classification based on cost behaviour
Variable cost : The variable cost is a cost that tends to
vary in accordance with level of activity within the
relevant range and within a given period of time. Direct
material, direct labour and direct expenses tend to vary
in direct proportion to the level of activity. An increase
in the volume means a proportionate increase in the
total variable costs and a decrease in volume will lead
to a proportionate decline in the total variable costs.
There is a linear relationship between volume and
variable costs.
Fixed cost : The fixed cost is a cost that tends to be unaffected by
changes in the level of activity during a given period of time. The
fixed costs remain constant in the total regardless of changes in
volume upto a certain level of output. They are not affected by
changes in the volume of production. There is an inverse
relationship between volume and fixed cost per unit. Fixed costs
tend to remain constant for all levels of activity within a certain
range. Fixed costs will continue to be incurred even when the
activity comes down to nil.
Semi-variable cost or semi-fixed cost : Many costs fall between these two extremes. They are called as semi-variable cost or semi-
fixed costs. They are neither perfectly variable nor absolutely fixed in relation to changes in volume. They change in the same
direction as volume but not in direct proportion thereto. For e.g.telephone expense, electricity charges, etc.

4. Product Costs and Period Costs
Product costs are those costs which not be
incurred if there is not production. These
consist of direct materials, direct labour
and some of the factory overhead. Product
costs are ‘absorbed by’ or ‘attached to’ the
units produced.
Period costs are those which are not necessary
for production and are written off as expenses in
the period in which these are incurred. Such cost
are incurred for a time period and are charged
to Profit and Loss Account of the period, rent,
salary of company executives, travel expenses
are examples of period costs.
Classification into product-and period cost is important from the point of view of profit
determination. This is so because product cost is carried forward to the next accounting period
as part of the unsold finished stock whereas period cost is written off in the accounting period in
which it is incurred.

5. Classification according to Identifiability with Cost Units
Direct costs : These are those costs which are
incurred for and may be conveniently
identified with a particular cost unit, process
or department. Cost of raw materials used,
wages of machine operators are common
examples of direct costs.
Indirect costs : These costs cannot be conveniently
identified with a particular cost unit, process or
department. These are general costs and are incurred
for the benefit of a number of cost units or cost
centres. Examples of indirect costs are rent, repairs,
depreciation, managerial salaries, coal, lubricating oil,
wages of foreman, etc.
This classification is important from the point of view of accurate ascertainment of cost. Direct
costs of product can be conveniently determined while the indirect costs have to be arbitrarily
apportioned to various cost units.

6. Classification According to Controllability
Controllable costs : These are the costs which may be
directly regulated at a given level of management authority.
Variable costs are generally controllable by department
heads. For example, cost of raw material may be controlled
by purchasing in larger quantities.
Uncontrollable costs : These are those costs which cannot be
influenced by the action of a specified member of an
enterprise. Fixed costs are generally uncontrollable. For
example, it is very difficult to control costs like factory rent,
managerial salaries, etc.

7. Classification According to Element wise
Material Cost: Material cost is the cost of
material of any nature used for the purpose
of production of a product or a service. It
includes cost of materials, freight inwards,
taxes & duties, insurance etc. directly
attributable to acquisition,
Labour Cost: Labour cost means the payment made
to the employees, permanent or temporary for their
services. Labour cost includes salaries and wages paid
to permanent employees, temporary employees and
also to the employees of the contractor. Here salaries
and wages include all the benefits like provident
fund, gratuity, ESI, overtime, incentives etc.
Expenses: Expenses are other than material cost or labour cost which are involved in an activity.