Classification of costs is the process of grouping costs according to their common characteristics. In order to identify costs with cost centre or cost units a suitable classification of costs is of much significance, cost may be classified from different viewpoints which are follows according to nature of items cost may be of 2 types
1)
Direct cost
2)
Indirect costs
Direct cost: A
cost that can be directly traced to producing specific goods or services.
Direct cost refers to those costs which can be easily identified with product,
process or department, material used and labour employed in manufacturing in
article or in a particular process of production are common example of direct
cost. Costs which are traceable to the specific activity. Labour and material
inputs are the most common direct costs but there can also be other traceable
costs such as marketing, selling or administrative type costs. Direct costs
together with indirect costs determine the total cost of providing a good or
services.
Direct
cost is a cost that can easily and economically be identified either with an
individual unit of production or with a responsibility centre. Direct cost is a
cost which can be allocated in full to a product, service, customer, and cost
centre or business activity. A group of staff dedicated to developing a
customer application is an example.
Indirect cost:
costs which are not traceable to specific activities. Examples of indirect
costs may be: salaries of chairs and administrative staff, regular telephone
services, supplies not specifically charged out. Indirect costs together with
direct costs, determine the total cost of providing a particular good or
service. Indirect cost is also known as facilities and administrative costs.
The costs of operations which cannot be assigned to specific projects, such as
electricity and central administrative services, sometimes referred to as
"overhead”. Indirect cost is a cost that cannot be easily and conveniently
traced to the particular cost object under consideration.
Cost from the view point of their
variability classified into 3 types
1) Fixed Cost:
A production cost which does not vary with the volume of output eg.
Administrative costs. Fixed cost is a cost that remains constant in the short
term when the quantity produced increases or decreases within certain scales of
production. Fixed costs are operating expenses that are incurred when providing
necessities for doing business and have no relation to the volume of production
and sales (as opposed to "variable costs"). Examples are rent,
property taxes, and interest expense.
2) Variable costs:
Any costs that change significantly with the level of output eg. Cost of
materials is variable cost. Variable cost is also known as , operating costs,
prime costs, on costs and direct costs, are costs which vary directly with the
rate of output, for example, labour, fuel, power and cost of raw material.
3) Semi variable costs:
some cots have tendency to vary with changes in the volume of output or sales,
but not in direct proportion to the change. These costs are partly fixed and
partly variable and as such these cots are known as semi-variable costs. A Cost
that is partly fixed and partly variable at the same time. Total costs are an
example of a semi variable cost
From the view point of their
controllability cost may be classified as:
1) Controllable costs:
controllable costs refer to those costs which can be influenced by the action
of a specified member of an undertaking.
2) Uncontrollable costs:
uncontrollable costs, on the other hand, refer to those costs which cannot be
influenced by the action of a specified member of an undertaking.
From the view point of their normality:
1) Normal costs:
normal costs refer to those costs which are normally incurred ata given level
of output in the conditions in which that level of output is normally attained.
Such costs cannot be avoided at all.
2) Abnormal costs:
abnormal or avoidable costs refer to those costs which are not normally
incurred at a given level of output in the condition in which the level of
output is attained. From the point of relevance decision making and control
cost may be defined as:
i)
Sunk
costs: sunk costs are costs which cannot be
recovered. Costs incurred in the past which are irretrievable and therefore not
relevant to current decisions. For example, a small bakery might buy an over at
a fixed cost, but which it could sell at some future date should it want to. It
also might pay out a large amount in advertising its services. However, this
latter cost could not be recovered later on - once paid for, the advertising
has gone, whether or not the promotion is successful. Sunk costs represent a
barrier to entry in an industry because they scare potential entrants from
entering - should they fail, they would have. In economics and in business
decision-making, sunk costs are costs that have already been incurred and which
cannot be recovered to any significant degree. Sunk costs are sometimes
contrasted with incremental costs, which are the costs that will change due to
the proposed course of action. In microeconomic theory, only incremental costs
are relevant to a decision. If we let sunk costs influence our decisions, we
will not be assessing a proposal exclusively on its own merits.
ii)
Out
of pocket costs: out of pocket cost refers to those costs which
signify the present of future cash expenditure regarding a certain decision
that will vary depending upon the nature of decision made.
iii)
Opportunity
costs: opportunity cost is a term used in
economics, to mean the cost of something in terms of an opportunity foregone
(and the benefits that could be received from that opportunity), or the most
valuable foregone alternative. For example, if a city decides to build a
hospital on vacant land that it owns, the opportunity cost is some other thing
that might have been done with the land and construction funds instead. In building
the hospital, the city has forgone the opportunity to build a sporting cent.
iv)
Imputed
costs: imputed costs refer to those costs which
are not included in costs but are considered for making management decision.
v) Differential
costs: these refer to difference in total costs
between two alternatives according to point of view of function cost may be
defined as:
· Production
costs: production costs refer to those costs
which arise in the course of production from the acquisition of raw material
till the finished products have been turned out.
· Administration
costs: administration costs refer to those costs
which are required for formulating the policy, directing the organization, and
controlling the operation of an undertaking.
· Selling
costs: selling costs refer to those costs which
are incurred to create and stimulate demand and to secure orders.
· Distribution
costs: distribution costs refer to the costs of
the sequence of operation which starts with making the packed product available
for dispatch and ends with making the reconditioned returned empty package
available for re-use.
