This document discusses cost classification concepts in managerial accounting. It defines cost as a sacrifice of resources measured monetarily. Management accountants pay attention to costs for planning, evaluation, and decision making. Costs can be classified in various ways depending on their intended use, including by manufacturing vs. non-manufacturing, traceability, behavior, and controllability. Common classifications include direct/indirect materials, direct/indirect labor, variable/fixed, and controllable/uncontrollable costs. Techniques for estimating the fixed and variable components of mixed costs include account analysis, scatter graph, high-low method, and regression analysis. Cost behavior is only valid within a relevant range of activity levels.

1. COST CLASSIFICATION
CONCEPT OF COST:
DEFINITION:
A SACRIFICE OR GIVING UP OF RESOURCES FOR A PARTICULAR PURPOSE FREQUENTLY
MEASURED BY THE MONETARY UNITS (RUPEES, DOLLARS) THAT MUST BE PAID FOR
GOODS AND SERVICES .
 EMPHASIS ON COST INFORMATION:
MANAGEMENT ACCOUNTANTS PAY A LOT OF ATTENTION TO COSTS BECAUSE COST
HAVE A VITAL ROLE TO PLAY IN PLANNING , EVALUATING AND DECISION MAKING. FOR
EXAMPLE IN PLANNING THE ROUTE AND FLIGHT SCHEDULES THE MANAGER OF AN AIR
LINE MUST CONSIDER AIR CRAFT FUEL COST, SALARIES OF FLIGHT CREWS, AND COST
OF LANDING ETC.
 CLASSIFICATION OF COST:
BEFORE MANAGEMENT ACCOUNTANTS CAN CLASSIFY COST THEY NEED TO CONSIDER
HOW MANAGERS WILL USE THE INFORMATION. DIFFERENT COST CONCEPTS AND
CLASSIFICATIONS ARE USED FOR DIFFERENT PURPOSE, SOME ARE USED FOR PLANNING
AND CONTROL AND OTHER ARE RELEVANT FOR COSTING PRODUCTS AND REPORTING
RESULTS. THE SAME COST CAN BE CLASSIFIED IN NUMBER OF WAYS DEPENDS ON
INTENDED USE OF THE COST INFORMATION.
 COMMON COST CLASSIFICATIONS IN MANAGERIAL ACCOUNTING
THE FOLLOWING ARE SOME BASIS ON WHICH COST CAN BE CLASSIFIED INTO VARIOUS
TYPES
1. MANUFACTURING (PRODUCT COST)
2. NON MANUFACTURING(PERIOD COST)
3. TRACEABILITY
4. BEHAVIOR
5. CONTROLLABILITY

2. 1. MANUFACTURING COST: THE COST INCURRED WITHIN THE MANUFACTURING
AREA
CLASSIFICATION:
a. DIRECT MATERIAL
b. DIRECT LABOR
c. FACTORY OVERHEADS (INDIRECT MANUFACTURING COST)
USED TO:
i. ESTIMATE COST OF PRODUCT
ii. COGS ( PROFIT AND LOSS ACCOUNT)
iii. INVENTORY FOR BALANCE SHEET
RECALL THE LECTURE “CONCEPT OF COST” OF COST ACCOUNTING.
2. NON MANUFACTURING COST (PERIOD COST): REFERRED TO ALL COST INCURRED
OUTSIDE THE MANUFACTURING AREA.
CLASSIFICATION:
a. SELLING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES (OPERATING
EXPENSES)
USED TO:
i. PREPARE PROFIT AND LOSS ACCOUNT
ii. BALANCE SHEET
3. TRACEABILITY: REFERRED TO MANUFACTURING COST THAT CAN BE TRACED TO
PRODUCT IN ECONOMIC OR NON ECONOMIC MANNER.
CLASSIFICATION
b) DIRECT PRODUCT COST (D/M , D/L)
b) INDIRECT PRODUCT COST (MANUFACTURING OVERHEADS, INCLUDES
SUPPORT OR SERVICE DEPARTMENT COST AS WELL.
USED TO:
i. COST OF PRODUCT
ii. CONTROL COSTS
iii. TO ALLOCATE COST OF SERVICE DEPARTMENT
iv. COST OF DEPARTMENT

3. 4. BEHAVIOR: REFERRED TO THE RELATIONSHIP BETWEEN A COST AND THE LEVEL OF
ACTIVITY.
CLASSIFICATION:
a VARIABLE COST
b FIXED COST
c SEMI VARIABLE COST
d STEP FIXED COST.
FIXED COST: A FIXED COST IS A COST WHICH IS INCURRED FOR A PARTICULAR PERIOD
OF TIME AND WHICH WITHIN CERTAIN ACTIVITY LEVELS IS UNAFFECTED(IN TOTAL) BY
CHANGES IN THE LEVEL OF ACTIVITY
EXAMPLE: SALARY OF MANAGING DIRECTOR, RENT OF A SINGLE FACTORY BUILDING,
STRAIGHT LINE DEPRECIATION OF A SINGLE MACHINE
VARIABLE COST: A COST WHICH TENDS TO VARY WITH THE LEVEL OF ACTIVITY( PER
UNIT FIXED)
EXAMPLE: COST OF RAW MATERIAL (PROVIDED NO DISCOUNT ON BULK PURCHASE),
DIRECT LABOR COST (THOUGH BASIC WAGES ARE FIXED) CLASSIFIED AS VARIABLE
COST, SALES COMMISSION ETC
SEMI VARIABLE COST: ARE COST WHICH ARE PARTLY FIXED AND PARTLY VARIABLE
WITH THE CHANGE IN THE LEVEL OF ACTIVITY
EXAMPLE: SALE REPRESENTATIVE SALARY WHICH IS PARTLY FIXED AND PARTLY
COMMISSION SAY 10% OF SALES.
STEP COST: A COST WHICH IS FIXED IN NATURE UP TO CERTAIN LEVEL OF ACTIVITY
EXAMPLE: RENT IS A STEP COST IN SITUATION WHERE ACCOMMODATION
REQUIREMENT INCREASE AS OUTPUT LEVEL GET HIGHER, BUS FARE
USED TO:
i. FORECAST BUDGET
ii. CONTROL COST
iii. MAKE DECISIONS

4. 5. CONTROLLABILITY: THE CONTROL OF COSTS CAN BE ENHANCED BY
CLASSIFYING RESPONSIBILITY CENTRE COST AS EITHER CONTROLLABLE OR
UNCONTROLLABLE. IF A MANAGER CAN CONTROL OR SIGNIFICANTLY INFLUENCE
THE LEVEL OF COST THE COST IS CLASSIFIED AS CONTROLLABLE OTHERWISE
UNCONTROLLABLE COST. FOR EXAMPLE A MANAGER OF McDonald’s RESTAURANT
CAN PROBABLY CONTROL OR INFLUENCE THE QUANTITY OF FOOD USED IN
RESTAURANT BUT NOT INFLUENCED THE PRICE CHARGED BY SUPPLIERS.
USED TO:
i. CONTROL COST
ii. MEASURE PERFORMANCE
WHAT HAPPENED IF COST COMPRISES OF MIXED COST (SEMI VARIABLE COST)
WHAT IS MIXED COST?
RECALL THE LECTURE OF CLASSIFICATION OF COST ON THE BASIS OF BEAHVIOR
IS IT NECESSARY TO WORK OUT THE VARIABLE AND FIXED ELEMENT OF MIXED COST
SEPARATELY?
TO PREDICT HOW MUCH COST A COMPANY WILL INCUR AT VARIOUS ACTIVITY LEVELS,
THE MANAGERIAL ACCOUNTANT MUST KNOW HOW MUCH OF THE TOTAL COST IS FIXED
AND HOW MUCH IS VARIABLE.
TECHNIQUES AVAILABLE FOR ESTIMATING FIXED
AND VARIABLE COST IN MIXED COST
THERE ARE FOUR TECHNIQUES AVAILABLE FOR THE ABOVE ESTIMATION
1. ACCOUNT ANALYSIS (BASED ON PROFESSIONAL JUDGMENT)
2. SCATTER GRAPH APPROACH
3. HIGH – LOW METHOD.
4. REGRESSION ANALYSIS.
1. ACCOUNT ANALYSIS :

5.  ACCOUNT ANALYSIS REQUIRES THAT THE ACCOUNTANT USE THEIR
PROFESSIONAL JUDGMENT, TO CLASSIFY COST ACCOUNT AS EITHER FIXED
OR VARIABLE.
 THE TOTAL OF THE COST CLASSIFIED AS VARIABLE CAN BE DIVIDED BY A
MEASURE OF ACTIVITY TO CALCULATE THE VARIABLE COST PER UNIT.
LIMITATION:
 THE ACCOUNT ANALYSIS IS SOME WHAT SUBJECTIVE, THAT IS DIFFERENT
ACCOUNTANTS , VIEW THE SAME SET OF FACTS MIGHT REACH DIFFERENT
CONCLUSIONS REGARDING WHICH COST ARE FIXED AND WHICH COST ARE
VARIABLE.
2. SCATTER GRAPH APPROACH.(VISUAL FIT METHOD)
 IN SOME CASES ACCOUNTANT MAY USE ,COST INFORMATION FROM
SEVERAL REPORTING PERIODS TO ESTIMATE HOW COST CHANGE IN
RESPONSE TO CHANGES IN ACTIVITY .
 WEEKLY, MONTHLY, QUARTERLY REPORTS ARE PARTICULARLY USEFUL,
SOURCES OF COST INFORMATION.
 THE RELATIONSHIP BETWEEN PRODUCTION COST AND ACTIVITY IS
DEVELOPED BY MEANS OF PLOTTING GRAPH; THE PLOT OF DATA IS
REFERRED AS SCATTER GRAPH, THE COST ANALYST THEN VISUALLY FIT A
LINE TO THESE DATA BY LYING RULER ON THE PLOTTED POINTS, THE LINE
IS POSITIONED SO THAT A ROUGHLY EQUAL NUMBER OF POINTS LIE ABOVE
AND BELOW THE LINE.
LIMITATION:
 THE PRIMARY DRAW BACK OF THIS METHOD IS ITS LACK OF OBJECTIVITY;
TWO COST ANALYSTS CAN DRAW TWO DIFFERENT VISUAL FIT LINES FOR
THE SAME DATA.
EXAMPLE:
THE MONTHLY PRODUCTION AND ELECTRICITY COST INFORMATION, IS AVAILABLE
FOR UNION SKATE COMPANY, PRODUCES SKATES.
MONTH SKATE PRODUCTION (PAIRS) COST ( RS )
JANUARY 750 170,000
FEBRUARY 1,000 175,000
MARCH 1,250 205,000

6. APRIL 1,750 250,000
MAY 2,000 265,000
JUNE 2,250 275,000
JULY 3,000 400,000
AUGUST 2,750 350,000
SEPTEMBER 2,500 300,000
OCTOBER 1,250 210,000
NOVEMBER 1,000 190,000
DECEMBER 500 150,000
TOTAL 20,0000 2,940,000
REQUIRED :
PLOT A GRAPH , BETWEEN PRODUCTION AND COST ,WORK OUT VARIABLE AND FIXED
ELEMENT BY MEANS OF DEVELOPING VISUAL FIT LINE .
3. HIGH AND LOW METHOD:
 THE HIGH AND LOW METHOD IS ANOTHER SIMPLE WAY TO ESTIMATE COST
FUNCTION, THE COST FUNCTION IS CALCULATED USING ONLY TWO DATA
POINTS.
 THE OBSERVATIONS WITH THE HIGHEST AND LOWEST LEVELS OF ACTIVITY
ARE USED TO CALCULATE VARIABLE COST AND FIXED COST COMPONENTS,
THIS METHOD FITS STRAIGHT LINE TO THE DATA POINTS REPRESENTING
THE HIGHEST AND LOWEST LEVELS OF ACTIVITY, THE SLOPE OF THE LINE
IS THE ESTIMATE OF VARIABLE COST AND INTERCEPT IS THE ESTIAMTE OF
FIXED COST.
HIGHEST COST MINUS LOWEST COST
ESTIMATED VARIABLE COST = …………………………………………………………………………
HIGHEST LEVEL OF ACTIVITY MINUS LOWEST LEVEL OF
ACTIVITY
LIMITATION:
 A SIGNIFICANT WEAKNESS OF THE HIGH LOW METHOD IS THAT IT USES
ONLY TWO DATA POINTS, EVEN WHEN ADDITIONAL DATA IS AVAILABLE.
 FURTHERMORE THE TWO DAT POINTS MAY NOT REPRESENT THE GENERAL
RELATIONSHIP ESTIMATED BETWEEN COST AND ACTIVITY.
EXAMPLE: SAME AS IN CASE OF SCATTER GRAPH.

7. REGRESSION ANALYSIS:
 REGRESSION ANALYSIS IS A STATISTICAL TECHNIQUE , THAT USES ALL
AVAILABLE DATA TO ESTIMATE THE INTERCEPT AND SLOPE OF COST EQUATION.
THE LINE FITTED TO THE DATA BY REGRESSION ANALYSIS IS THE BEST STRAIGHT
LINE FIT TO THE DATA.
 WE CAN IMPROVE THE OBJECTIVITY AND ACCURACY F COST ESTIMATION, BY
USING STATISTICAL TECHNIQUES.
 THE LEAST SQUARE REGRESSION LINE WHICH IS SHOWN BELOW IN EQUATION
FORM INCLUDES TWO ESTIMATES, DENOTED BY a AND b IN THE EQUATION.
Y = a + b X
WHERE
X=THE INDEPENDENT VARIABLE (ACTIVITY)
Y= THE DEPENDENT VARIABLE (COST)
a = FIXED COST
b = VARIABLE COST PER UNI
CURVILINEAR COST:
CONCEPT: THE GRAPH OF ALL THE COST BEHAVIOR PATTERNS EXAMINED SO FAR CONSIST
OF EITHER STRAIGHT LINES OR SEVERAL STRAIGHT LINE SECTIONS , “ A CURVILINEAR
BEHAVIOR PATTERNS HAS A CURVED GRAPH.”
RECALL THE EARLIER CONCEPT OF
VARIABLE COST:
“VARIES PROPORTIONALLY (LINEARLY) WITH THE LEVEL OF ACTIVITY, STRAIGHT LINE
GRAPH.”
FIXED COST:
“COST THAT REMAINS UNCHANGED REGARDLESS OF THE LEVEL OF ACTIVITY.”
IN REALITY, A TRULY LINEAR RELATIONSHIP USUALLY DOES NOT EXIST BETWEEN
ACTIVITY LEVEL AND ALL VARIABLE COST, SO AS THAT FIXED COST NOT NECESSARILY
REMAINS FIXED AT ALL LEVELS OF ACTIVITY THE RELATIONSHIP BETWEEN THE LEVEL
OF ACTIVITY AND FIXED AND VARIABLE COST ONLY WORKS WITHIN RELEVANT RANGE
RELEVANT RANGE:

8. “THE LIMIT OF ACTIVITY LEVEL (WHICH MANAGEMENT EXPECTS THE COMPANY TO
OPERATE) WITHIN WHICH A SPECIFIC RELATIONSHIP BETWEEN COST AND ACTIVITY IS
VALID.”
EXAMPLE:
“SUPPOSE THAT A GENERAL ELECTRIC PLANT HAS A RELEVANT RANGE OF BETWEEN 40,000
AND 85,000 CASES OF LIGHT BULBS PER MONTH AND THAT TOTAL MONTHLY FIXED COST
WITHIN THE RELEVANT RAGE IS RS 100,000. WITHIN THE RELEVANT RANGE FIXED COST
REMAINS UNCHANGED(SAME), IF PRODUCTION FALLS BELOW 40,000 CASES CHANGES IN
PERSONNEL AND SALARIES WOULD SLASH FIXED COST TO RS 60,000 . IF OPERATION RISES
85,000 CASES INCREASE IN PERSONNEL AND SALARIES WOULD BOOST FIXED COST TO
RS 115,000.
 NOTE: IT IS TO BE NOTED THAT, EVEN WITHIN RELEVANT RANGE A FIXED COST
REMAINS FIXED ONLY OVER A GIVEN PERIOD OF TIME, USUALLY THE BUDGET PERIOD.
 THE IDEA OF RELEVANT RANGE ALSO APPLIES TO VARIABLE COST, THAT IS OUTSIDE A
RELEVANT RANGE , SOME VARIABLE COSTS SUCH AS FUEL CONSUMED , MAY BEHAVE
DIFFERENTLY , PER UNIT OF ACTIVITY, FOR EXAMPLE THE EFFICIENCY OF MOTORS IS
AFFECTED IF THEY ARE USED TOO MUCH OR TOO LITTLE ,( EXAMPLE OF GENERATOR)