STUDY MATERIAL

Classification Of Cost – 9 Types Of Classification Of Cost

There are some common characteristics on which ground we can clássify the cost It meahs placing of similar items in one group. This classification is necessary to organise that which cost relates to which center. So the classification of cost means grouping the various items of cost on the basis of common characteristics. Cost can be classified on the following basis:

(1) According to Nature or Element

(2) According to Variability

(3) According to Functions

(4) According to Normality

(5) According to Controlability

(6) According to Time

(7) According to Planning & Control

(8) According to Capital & Revenue

(9) According to Managerial Decisions

(1) According to Nature or Element

A. Direct Cost : Direct cost is that cost which can directly be attributed to the product or in other words the expenditure which are directly related to the production and can be directly charged to the product is known as direct cost.

B. Indirect Cost: Indirect cost is that cost which can not directly be attributed to the product or in other words the expenditure which are for the purpose of production but they don’t become the part of the product and are not directly chargeable to the product are called indirect cost. For Example raw material required for production is direct cost whereas electricity required for production is indirect cost.

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(2) According to Variability

A. Fixed Cost : Fixed cost are those which remain constant at each level of production. They remain unaffected with the change in volume of output. Any expenditure which is paid according to time and not according to production is known as fixed cost. For example salary of employees, rent of warehouse, insurance premium etc. Fixed cost give us large scale economies because they remain unchanged at each level of production upto the installed capacity. So at increased level of output the fixed cost will remain the same and per unit cost will be reduced.

B. Variable Cost: Variable costs are those which varies according to the change in output. They increases when output level increases and decreases when output level decreases.

C. Semi-variable Cost: These are those costs which remain fixed upto a certain extent and then becomes variable. In other words these are partly fixed and partly variable. These expenditures do increase but not in the same proportion in which output changes. For example maintenance charges, telephone charges, electricity charges etc. In these cases a certain fixed amount is to be paid whether or not the services are used and after that they are to be paid according to their use.

According to Functions

A. Manufacturing Cost : Any organisation which produces any kind of product it needs material and then all the expenditures are incurred to convert the raw material into finished product. So all expenses which are related to the process of manufacturing are known manufacturing cost. For example all expenses which comes under Prime cost and Work are manufacturing cost.

B. Office & Administrative Cost : The production process can hamper iF it is not well administered. Office is the place where planning is made and all the decisions are taken to successfully handle the production process. So all expenses incurred in these connection are known as Office & Administrative Cost.

C. Selling & Distribution Cost : When product is ready the next job is to sale it into the market For this the creation of demand is required. Demand can be created only through promotional expenditure. All expenses which are incurred to make the product available to the customer is known as Selling & Distribution cost.

D. Research & Development Cost : To be successful in the market it is necessary to update the ing for new and improved products. Development cost is the cost of process which existing product. For this research & development is required. Research cost is the cost of search begins with implementation of the decision to produce a new or improved method and ends with the start of production process of that praduct.

According to Normality

(A) Normal Cost : The expenditure which are incurred to obtain a particular level of output in normal circumstances are known as Normal Cost. These expenditures become the part of the production cost.

(B) Abnormal Cost : The expenditure which are incurred to obtain a particular level of output in abnormal circumstances are known as abnormal cost. These costs are not expected when the work was started. This may cause due to power breakdowns, fire, accident, flood, earth-quake theft, termite etc. Whenever the process of production is started the expected costs are calculated and the expenditure which are beyond these expectations are known as abnormal costs.

According to Controllability

(A) Controllable Cost : These are those expenditures which are under the control of management to some extent. Business organisation divides itself into various responsibility centre for the purpose of controlling. For each responsibility centre the separate manager is appointed who takes decisions regarding the expenditures incurred in his area. Normally, all kind of direct expenses like material, labour and some of the overheads are controllable by lower level management.

(B) Uncontrollable Cost : These are those expenditures which are not under the control of management. Inspite of dividing whole organisation in responsibility centers these expenditures can not be influenced by the action of any manager. All fixed costs are uncontrollable. For example if the building in which production process is to be done, is on rent then whether or not the production is going on the rent of the huilding is to be paid.

According to  Time

(A). Historical Cost : The costs which are ascertained after they are incurred are known as historical cost. In this system all the expenditures are done when required and later on total cost of production is calculated. These costs can not be of any advantage for the purpose of controlling. Features of Historical costs are-

  • These can be verified because the vouchers of each entry is available.
  • These are based on the facts recorded in the books of account.
  • These costs are mostly objective because these are related to the events which have already taken place

(B). Pre-determined Cost : That costs which are estimated in advance very well before the production process is started. Whenever any kind of tender is to be fulfilled it requires prior estimation of cost. So on the basis of previous cost which we consider as standard cost the estimation for future is made and tenders are fulfilled. These pre-determined costs when serve as standard cost also help in controlling. Because taking these standard cost as base the actual cost can be compared to find out if any deviations are there.

According to Planning & Control

(A). Standard Costs : According to ICMA, “The pre-determined cost based on a technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions. ” is known as standard cost. It is an estimate of cost in advance of production of what the costs should be.

(B). Budgeted Costs : These are the estimate of expenditure for future business activities like manufacturing, administrative, sales, research and development etc. prepared for a definite period after proper discussion. In an organisation various kinds of budgets are prepared to exercise control on future activities like sales budget, cash budget, purchase budget, production budget etc.

The above two costs seems similar to some extent but they do differ in following respect.

    • Budgeted Costs are the projection of financial accounts whereas standard costs are the projection of cost accounts.
    • Budgeted Costs aims at planning functions of management whereas standard costs aims at controlling.
  • Budgeted Costs are mere estimate for the future made on the basis of past actual figures adjusted to future trends, while the standard costs are scientifically pre-determined costs for each element of cost.

According to Capital & Revenue

A. Capital Costs: The expenses incurred to increase the profit earning capacity of the business are known as capital costs. These types of costs are incurred at one point of time but the benefits accruing from it are spread over a number of years. For example amount spent on purchase of a machinery is considered as capital cost.

B. Revenue Costs : The expenses which does not increase the profit earning capacity of the business but they are incurred to maintain the existing earning capacity to its level are known as revenue expenditure.

According to Managerial Decisions

A. Marginal Cost : According to ICMA, “The amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit is known as marginal cost.”This means that only the variable costs are taken into consideration because fixed costs do not change with the change in volume of output.

B. Opportunity Cost: The available resources can be put to alternative uses. But we have to choose one. If with the money in hand we want to do business. We can not invest it somewhere else to earn interest. Therefore the sacrifice of that interest income is the opportunity cost of the resource which is money in hand in the given case. So opportunity cost is that maximum possible alternative earning which can be earned by the employment of the available resources and production capacity to some other use.

C. Shut-down Cost : If some circumstances come that the production has to be stopped for some duration or some business activities are to be postponed temporarily and still some costs are required to be incurred, these costs are known as shut-down cost. For example the cost of rent, rates and depreciation etc.

D. Sunk Cost : A cost which has been incurred in the past and is not relevant to the particular decision making is known as sunk-cost. These expenditures are done mainly for providing infrastructure to the organisation. When we decide to do some kind of production function then the first decision will be what to produce and where to produce. So the place where factory is to be established and machinery by which the product is to be produced are purchased. Now the future activities are to be taken place on that factory and machinery. We can take further decisions regarding different future activities but we can not think of changing the main land and machinery. The expenditure on these kind of land and machinery is known as sunk-cost. If in any case it is decided to replace the existing plant, the written down book value of the plant less the sale value of existing plant is a sunk or irrecoverable cost. These costs are historical in nature.

E. Imputed Cost : These are also known as notional cost. These expenditures are not actually done but taken into consideration while calculating total cost so that it can be made comparable with the cost of those business units which actually do spend these expenditures. It is a hypothetical cost. For example if we do business in our own premises and show the rent of that premises in the books of accounts even though we are not paying it, then this amount of rent will be known as imputed cost. When alternative capital investment projects have to be evaluated calculation of imputed interest on capital becomes important to come to any kind of decision.

F. Differential Cost : Differential cost is the change in the cost due to change in production method or level of output. If the change increases the cost, it will be termed as incremental cost. If there is decrease in cost resulting from decrease in output, it will be termed as decremental cost.

G. Out of Pocket Cost : These are those expenditures which involve actual payment to the outsiders and helpful in fixation of selling price or in make or buy decisions. For example depreciation is not paid in cash therefore it is not paid out of pocket so it is not an out of pocket cost. Expenditure such as material, wages, salary, rent whether fixed or variable are the examples of out of pocket cost because they are actually paid

H. Replacement Cost: It is the cost of replacing an existing asset or material by the similar one bu buying it from the market at current prices.

I. Conversion Cost : The cost incurred in conversion of raw material into finished goods is known as conversion cost. Thus conversion cost is calculated by deducting the cost of direct material from factory cost. In other words, sum total of direct labour, direct charges and factory overheads are known as conversion cost.

J. Explicit and Implicit Cost: Explicit costs refers to costs involving payment of cash. For example salaries, wages etc. These are also known as out of pocket cost. Implicit costs do not involve payment in cash e.g, depreciation. These costs are also known as economic costs

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