Costs can be classified or grouped according to their common characteristics. Proper classification of costs is very important for identifying the costs with the cost centers or cost units. The same costs are classified according to different ways of costing depending upon the purpose to be achieved and requirements of a particular concern. The important ways of classification are:
1. By Nature or Elements. According to this classification the costs are classified into three categories i.e., Materials, Labour and Expenses. Materials can further be sub-classified as raw materials components, spare parts, consumable stores, packing materials etc. This helps in finding the total cost of production and the percentage of materials (labour or other expenses) constituted in the total cost. It also helps in valuation of work-in-progress
2. By Functions: This classification is on the basis of costs incurred in various functions of an organization ie. Production, administration, selling and distribution. According to this classification, costs are divided into Manufacturing and Production Costs and Commercial costs
Manufacturing and Production Costs are costs involved in manufacture, construction and fabrication of products.
Commercial Costs are (a) administration costs (b) selling and distribution costs
3. By Degree of Traceability to the Product : According to this, costs are divided direct costs and indirect costs. Direct Costs are those costs which are incurred for a particular product and can be identified with a particular cost centre or cost unit. Eg:- Materials, Labour. Indirect Costs are those costs which are incurred for the benefit of a number of cost centre or cost units and cannot be conveniently identified with a particular cost centre or cost unit. Eg:- Rent of Building, electricity charges, salary of staff etc.
4. By Changes in Activity or Volume: According to this costs are classified according to their behavior in relation to changes in the level of activity or volume of production. They are fixed, variable and semi-variable. Fixed Costs are those costs which remain fixed in total amount with increase or decrease in the volume of the output or productive activity for a given period of time. Fixed Costs per unit decreases as production increases and vice versa. Eg:- rent, insurance of factory building, factory manager’s salary etc. Variable Costs are those costs which vary in direct proportion to the volume of output. These costs fluctuate in total but remain constant per unit as production activity changes. Eg:- direct material costs, direct labour costs, power, repairs etc. Semi-variable Costs are those which are partly fixed and partly variable. For example; Depreciation, for two shifts working the total depreciation may be only 50% more than that for single shift working. They may change with comparatively small changes in output but not in the same proportion.
5. Association with the Product: Cost can be classified as product costs and period costs. Product costs are those which are traceable to the product and included in inventory cost, thus product cost is full factory cost. Period costs are incurred on the basis of time such as rent, salaries etc. thus it includes all selling and administration costs. These costs are incurred for a period and are treated as expenses.
6. By Controllability: The CIMA defines controllable cost as “a cost which can be influenced by the action of a specified member of an undertaking” and a non-controllable cost as “a cost which cannot be influenced by the action of a specified member of an undertaking”.
7. By Normality: There are normal costs and abnormal costs. Normal costs are the costs which are normally incurred at a given level of output under normal conditions. Abnormal costs are costs incurred under abnormal conditions which are not normally incurred in the normal course of production.Eg:- damaged goods due to machine break down, extra expenses due to disruption of electricity, inefficiency of workers etc.
8. By Relationship with Accounting Period: There are capital and revenue expenses depending on the length of the period for which it is incurred. The cost which is incurred in purchasing an asset either to earn income or increasing the earning capacity of the business is called capital cost, for example, the cost of a machine in a factory. Such cost is incurred at one point of time but the benefits accruing from it are spread over a number of accounting years. The cost which is incurred for maintaining an asset or running a business is revenue expenditure. Eg:- cost of materials, salary and wages paid, depreciation, repairs and maintenance, selling and distribution.
9. By Time..Costs can be classified as
1) Historical cost and
2) Predetermined Costs.
The costs which are ascertained and recorded after it has been incurred is called historical costs. They are based on recorded facts hence they can be verified and are always supported by evidences. Predetermined costs are also known as estimated costs as they are computed in advance of production taking into consideration the previous periods’ costs and the factors affecting such costs. Predetermined costs when calculated scientifically become standard costs. Standard costs are used to prepare budgets and then the actual cost incurred is later-on compared with such predetermined cost and the variance is studied for future correction.
It refers to methods and processes involved in calculating cost actually incurred on the basis of actual data shown in cost records. It involves computation of historical cost i.e. the cost which has already been incurred. Different methods are there to ascertain cost depending upon the needs of individual methods like job costing, contract costing, process costing, operating costing etc.
It is useful to calculate actual cost so that inefficiencies, scrap can be eliminated but it cannot be used for price quotations for tenders, measuring performance efficiency etc.
It refers to methods and processes involved in pre-determination of cost i.e. estimation of cost of goods or services in advance. These kinds of cost are determined before the operations starts. Hence, these are future cost in contrast to historical cost in cost ascertainment. Cost estimation is based on past actual cost and also keeps into consideration the effect of forecasting future changes as well. It is there to overcome the limitations of cost ascertainment like price quotation can be done, inefficiencies can be reduced by comparing actual cost with those pre-determined cost. It is the main tool of cost control.
Thus, both cost ascertainment and cost estimation are required for effective cost control as cost estimation is done on the basis of past actual cost ascertainment and inefficiencies can be identified and checked by comparing actual cost with pre-determined standard cost.
Cost Allocation , Cost apportionment and Cost Absorption:
Cost allocation refers to the process of allocating whole cost item to a particular cost centre or unit as it is easily traceable and identifiable to that particular cost entre. It is the process of charging direct cost of all kinds to particular cost centre or unit. Like factory rent can be allotted in full to a product A if it is the only product being produced in that factory.
Cost apportionment involves the distribution and division of indirect cost into the different cost centres or cost units on some relevant basis like factory rent can be apportioned to different products produced in a factory on the basis of area used by them in a factory.
Thus, both cost allocation and cost apportionment are the two processes which involves the identification and distribution of cost to different cost centres or cost units.
Cost absorption takes place after cost allocation and cost apportionment to different cost centres. Once the cost of particular cost centre is calculated after that all indirect cost or overheads of that centre is charged to different cost units. This process of charging all indirect cost or overheads of cost centres to different cost unit is cost absorption so that each cost units bears an appropriate portion of its share of overheads. Like, after calculating factory overheads of a cost centre, factory overheads rate is to be calculated on the basis of which factory overheads are charged to per unit of different cost units.