Chapter 3 Cost Classification

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Chapter 3

Cost ClassificationIbrahim Sameer (MBA - Specialized in Finance,

B.Com Specialized in Accounting & Marketing)

www.ibrahimsameer.wordpress.com


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Total Cost / Service Costs

A direct cost is a cost that can be traced in full to

the product, service, or department that is being

costed. An indirect cost (or overhead) is a cost that is

incurred in the course of making a product,

providing a service or running a department, but

which cannot be traced directly and in full to

the product, service or department.


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Direct Cost & Indirect Cost

Primary data are data collected especially for a

specific purpose. Raw data are primary data

which have not been processed at all, and whichare still just a list of numbers.

For Eg: Telephone survey conduct by Dhiraagu to

monitor the effectiveness of the customer service.


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Examples of Direct Cost &

Indirect Cost


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Analysis of total cost


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Direct Materials

Direct materials is all material becoming part of

the product.

For eg: component part, part finished product,

primary packing materials.


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Direct Labour

Direct wages are all wages paid for labour

expended on work on the product itself.


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Direct Expenses

Direct expenses are any expenses which are

incurred on a specific product other than directmaterial cost and direct wages. It is also referred

as chargeable expenses.

For eg: the hire of tool or equipment for particular

job, maintenance costs of tool.


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Production overhead

Production OH include all indirect material costs,

indirect wages and indirect expenses incurredin the factory from receipt of the order until its

completion.


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Functional Costs

Classification by Function

Classification by function involves classifying

costs as production / manufacturing costs,administration costs or marketing / selling and

distribution cost.


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Functional Costs

Functional cost Includes:

Production cost

Administration cost

Selling cost

Distribution costs


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Fixed Costs & Variable Costs

A fixed cost is a cost which is incurred for a

particular period of time and which, within certain

activity levels, is unaffected by changes in the

level of activity.

Eg: Rent


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A variable cost is a cost which tends to varywith

level of activity.

Eg: Direct materials, sales commission


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Many items of expenditure are part fixed and part

variable and hence are termed as semi fixed or

semi variable costs.

Eg: telephone call charges


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Production & Non Production

Cost

For the preparation of financial statements, costs

are often classified as production costs and non

production costs.


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Cost

Production costs are all the costs involved in

the manufacture of goods. In the case of

manufactured goods, these costs consist of direct

material, direct labour and manufacturing

overheads.


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Cost

Non - Production costs are taken directly to the

income statement as expenses in the period in

which they are incurred; such cost consist of

selling and administrative expenses.


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Controllable cost & Period cot

Controllable cost

Controllable costs are items of expenditure which

can be directly influenced by a given managerwithin a given time span. OR

A cost which can be influenced by its budget

holder.


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Controllable cost & Period cot

Period cost

Period costs is charged against the sales for the

period. It is not carried forward in inventory to afuture period. OR

A cost that relates to a time period which is

deducted as expenses for the period and is not

included in the inventory valuation.


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Cost Codes

Once costs have been classified, a coding system

can be applied to make it easier to manage the

cost data, both in manual systems and in

computerized systems.


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Cost Codes

Feature of a good coding system

The code must be easy to use and

communicate.

Each item should have unique code.

The coding system must allow for expansion.

The coding system should be brief.

The likelihood of errorgoing undetected should be

minimized.


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Types of Codes

Sequential (or progressive) codes

Numbers are given to items in ordinary numeral

sequence, so there is no obvious connectionbetween an item and its code. For example

000042 42cm nail

000043 office stapler

000044 hand wash


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Types of Codes

Block (or group classification) codes

These are an improvement on simple sequence

codes, in that digit (often the first one) indicates theclassification of an item. For example

4NNNNN Nails

5NNNNN Screws

6NNNNN Bolts


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Types of Codes

Faceted codes

These are a refinement of block codes, in that

each digit of the code gives information about anitem. For example


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Types of Codes

The 1st digit: 1 Nails

2 Screws

3 Bolts

The 2nd digit: 1 Steel

2 Brass

3 Copper


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Types of Codes

The 3rd digit: 1 50mm

2 60mm

3 75mm

A 60mm steel screw would have a code of 212


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Types of Codes

Mnemonic codes

Under this type of coding the code means

something, it may be an abbreviation of the objectbeing coded. Most of the time airport use this type

of coding. For example

SIN Singapore

LAX Los Angeles


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Types of Codes

Hierarchical codes

This is a type of faceted code where each digit

represents a classification, and each digit further tothe right represents a smaller subset than those to

the left. For example

3 = Screws

31 = flat headed screws


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Advantages of Coding

A code usually brieferthan a description, thereby

saving clerical time in a manual system & storage

space in a computerized system.

A code is more precise than a description and

therefore reduce ambiguity.

Coding facilitates data processing.


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Cost unit, Cost object &

Responsibility centres

Cost centres

Cost centres are collecting places for costs

before they are further analysed. Cost are furtheranalysed into cost units once they have been

traced to cost centres.

Cost centres may include a department, a

machine, a project.


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Cost units

A cost unit is a unit of product or service to

which cost can be related. The cost unit is thebasic control unit for costing purpose.

Eg: room (in hotel), Barrel (in the brewing industry)


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Cost objects

If the user of management information wish to

know the cost of something, this something iscalled a cost object.

Eg: the cost of product, the cost of service, the

cost of operating a department.


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Some examples of profit centre:

A sales division selling products to customers.

A service division providing after sales service.

Individual shop in a retail chain.

Local branches in a regional or nationwide

distribution business.

A geographical region. Eg: a country


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Revenue centre

Revenue centres are similar to cost centres and

profit centres but are accountable for revenueonly.

Revenue centre managers should normally have

control over how revenues are raised.


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Investment centre

An investment centre is a profit centre whose

performance is measured by its return oncapital employed.


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Responsibility centre

A responsibility centre is a function or department

of an organization that is headed by a managerwho has direct responsibility for its

performance. (OR)

It is an organization unit for which a manager is

made responsible.


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Questions & Answers


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Thank You

Ibrahim SameerSeek knowledge from cradle to grave

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Chapter 3 Cost Classification