Cost Classification refers to the process of grouping costs according to their common characteristics such as nature of expenses, function, variability, controllability and normality. Cost Classification can be done on the basis of time, their relation with the product and accounting period. Cost classification is also made for planning and control and decision making. Thus classification is essential for identifying costs with cost centers or cost units for the purpose of determination and control of cost.
A) Nature of expenses – Costs can be classified in to material labour and expenses.
B) By function-
- Production cost – It begins with the process of supplying material labour and services and ends with primary packing of the finished product.
- Administration cost is the aggregate of the costs of formulating the policy , directing the organization and controlling the operation of an undertaking, which is not related directly to production, selling, distribution, research and development activity or function.
- Selling costs refers to the expenditure incurred in promoting sales and retaining customers.
- Distribution costs begins with the process of making the packed product available for dispatch and ends with making the reconditioned empty package available for use.
- Research & development cost relates to the costs of researching for new or improved products, new application of materials or new or improved methods, processes, and cost of implementation of the decision including the commencement of commercial production of that product or by that process or method.
- Preproduction cost refers to the part of development cost incurred in making trial production run preliminary to formal production, either in a new or running factory , this cost then represents research and development costs also. Pre-production costs are normally considered as deferred expenditure and are charged to the cost of future production.
C) By Variability –
Costs are classified in ti fixed, variable and semi fixed/ semi-variable costs according to their tendency to vary with the volume of output.
- Fixed Cost- It tends to remain unaffected by the variation or changes in the volume of output, such as supervisory salary, rent, taxes, etc.
- Variable costs- It tends to vary directly with volume of output, such as direct material, direct labour and direct expenses.
- Semi-fixed/semi—variable cost – it is partly fixed and partly variable, such as telephone expenses, electricity charges, etc.
D) By Controllability-
Costs can be classified under controllable and uncontrollable cost.
- Controllable cost can be influenced by the action of a specified member of an undertaking.
- Uncontrollable costs can not be influenced by the action of a specified member of an undertaking.
E) By Normality- Costs can be divided in to normal and abnormal cost.
- Normal costs refers to the cost, at given level of output in the conditions in which that level of output is normally attained.
- Abnormal cost is a cost which is not normally incurred at a given of output in the conditions in which that level of output is normally attained.
F) On the basis of time - Costs can be classified in to historical or actual costs and predetermined or future cost.
- Historical cost- It relates to the usual method of determining actual cost of operation based on actual expenses incurred during the period. Such evaluation of costs takes longer time, till the accounts are closed and finalized, and figures are already for use in cost calculations.
- Predetermined cost- It is prepared in advance before the actual operation starts on the basis of specializations and historical cost data of the earlier period and all factors effecting cost. Predet3ermined cost is therefore future cost and may be either estimated or standard.
- Estimated cost is prepared before accepting an order for submitting price quotation. It is also used for comparing actual performance.
- Standard cost is scientifically predetermined cost of a product or service applicable during a specific period of immediate future under current or anticipated operating conditions. The method consists of setting standards for each elements of cost, evaluating the variance from standard cost and finding reasons for such variance, so that remedial steps can be taken promptly to check inefficient performance.
G) In relation to Product – Costs may be classified in to direct and indirect costs.
- Direct costs are those, which are incurred for a particular cost unit and can be conveniently linked with that cost unit. Direct costs are termed as product cost.
- Indirect costs are those which are incurred for a number of cost units and also include cost which through incurred for a particular cost unit are not linked with the cost unit. Since such costs are incurred over period and the benefit is mostly derived within the same period, they are called period costs.
H) Cost analysis for decision making- Costa are classified under relevant costs (eg. Marginal cost, additional fixed cost , incremental costs, opportunity cost and irrelevant cost( e.g. Sunk cost, committed costs, etc)