Classification Of Cost According to…….. 1. Nature2. Function3. Identifiably4. Behavior5. Association With Products6. Controllability7. Normality8. Time9. Relevance 10.Other Costs

Elements of costs

In order to interpret the term cost correctly and to ascertain the cost with respect to the cost centers, the cost attached with the manufacturing process may be subdivided, known as Elements of Costs.

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Elements of cost

Prime cost Overheads

Direct Direct DirectMaterial labour expenses Indirect Indirect

Indirect Material Labour Expenses

Factory Office & Selling & distributionOverheads administration overheads

o overheads

Element of cost

Cost object Cost Cost unit Cost centre Profit centre

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Cost object

It is an activity or item or operation for which a separate measurement of costs is desired

E.g. the cost of operating the personnel department of a company, the cost of a repair fob, and the cost for control

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Cost

It is the amount of expenditure incurred on a specific cost object

Total cost = quantity used * cost per unit (unit cost)

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Cost unit

It is a quantitative unit of product or service in which costs are ascertained, e.g. cost per table made, cost per metre of cloth

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Cost centre

It is a location or function of an organisation in respect of which costs are ascertained

E.g. the rent, rates and maintenance of buildings; the wages and salaries of strorekeepers

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Profit centre

It is location or function where managers are accountable for sales revenues and expenses

E.g. division of a company that is responsible for the sales of products

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Cost classification

Direct cost Indirect cost (overhead)

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Direct Costs

DefinitionDefinition: Direct costs are identifiable to a final cost objective (a particular contract). Examples: direct material and direct labor.

All costs identified specifically with a contract are direct costs for that contract and shall not be charged to another contract directly, or indirectly.

No cost shall be charged to a contract as a direct cost, if other costs incurred for the same purpose in like circumstances have been charged as an indirect cost.

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Cost that can be identified specifically with or traced to a given cost object

The direct costs consist of the following three elements:Direct materialsDirect labourDirect expenses

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Indirect Costs

DefinitionDefinition: Indirect costs are not directly identifiable with a final cost objective (e.g. a particular contract), but identified with two or more final cost objectives.

The distribution of indirect costs to various contracts should roughly be based on the benefits received on each contract.

No cost shall be charged to a contract as an indirect cost if other costs incurred for the same purpose in like circumstances have been charged as a direct cost to that contract or any other contract.

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The ProductThe Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

Classifications of Manufacturing Costs

Manufacturing costs are oftenclassified as follows:

DirectMaterialDirect

MaterialDirectLaborDirectLabor

Manufacturing

Overhead

Manufacturing

Overhead

PrimeCost

Conversion

Cost

Classification Of Cost

According To Nature Or Elements

Materials Cost

LabourCost

Expenses

IT IS A COST OF MATERIALS

WHICH ENTER INTO & FORM PART OF PRODUCT

e.g. - timber in furniture – making

- clay in brick making

DIRECT MATERIAL COST

Direct Materials

Raw materials that become an integral part of the product and that can be conveniently traced directly to it.

Example: A radio installed in an automobile

Example: A radio installed in an automobile

Direct materials Direct materials are the raw materials

that become part of the product. 

The cost of materials – the cost of materials used entering into and becoming the elements of a product or service

E.g. fabrics in garments

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INDIRECT MATERIAL COST IT IS THE COST OF MATERIAL WHICH DO

NOT FORM THE PART OF PRODUCT BUT WHICH HELP THE PRODUCTION

e.g- LUBRICATING OIL , FUEL etc.

Small items like thread, gum , nails etc

Though forms part of product but difficult to calculate cost per unit of that material

----so consider as direct material

Indirect materials

Such as stationery, consumable supplies, spare parts for machine that assist to the production of final products

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LABOUR COST

Direct Labor The definition of direct labor is pretty easy. 

Direct labor represents the people who do the core work of the business.  For example, if the business is a construction company, direct labor would be the people actually constructing the building.  They would be the people with hammers and saws in their hands.  In a retail store, direct labor would be the people helping on the sales floor doing the basic work that takes place serving the customers.  In a grocery bag factory, direct labor are the people running the machines actually making the bags.  I think of direct labor as the people who make or build the product.

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Labour cost

“The labour cost is the cost of remuneration of the employees of an undertaking.” such as

Wages, salaries, commissions, bonus, etc.

There are two types of labour cost are1. Direct Labour cost2. Indirect Labour cost

Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workers

Example: Wages paid to automobile assembly workers

Direct labour

The cost of remuneration for working time

E.g. assembly workers’ wages in toy assembly

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Indirect labour

Such as salaries of factory supervision and office staff that do not directly involve in production of the final product

If a person's labor cannot be easily linked to a specific customer's order or the person does not directly build the product, the person's labor is called "indirect labor."

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EXPENSE COST

Expenses cost

“The cost of services provided to an undertaking and the notional cost of the use of owned assets.”

Expenses are two types

1. Direct Expenses

2. Indirect Expenses

Direct expenses

Other costs which are incurred for a specific product or service

E.g. royalties

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Indirect expenses

Such as rent, rates, depreciation, maintenance expenses that do not have instant relationships with the manufacturing processes

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OVERHEADS

The definition for overhead is easy.  Here it is......

If a cost is not direct labor or direct materials, the cost is overhead.

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Overheads

“The aggregate of Indirect material cost, Indirect wages and Indirect expenses”

Three types such as

1. Indirect material cost

2. Indirect labour cost

3. Indirect expenses

Manufacturing OverheadManufacturing costs that cannot be easily

traced directly to specific units produced.

Examples: Indirect materials and indirect labor

Examples: Indirect materials and indirect labor

Indirect cost (overhead) Cost that cannot be identified

specifically with or traced to a given cost object

They are identified with cost centres as overheadsIndirect materialsIndirect labourIndirect expenses

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Indirect expenses overheads1. Factory overheads

2. Office & administration overheads

3. Selling & distribution overheads

Direct Material Cost

+

Direct Labour Cost

+

Direct Expenses Cost

Indirect Material Cost+

Indirect Labour Cost+

Indirect Expenses Cost

Prime Cost

Overheads

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Assigning Costs to Cost Objects

Direct costs•Costs that can be

easily and conveniently traced to a unit of product or other cost object.

•Examples: direct material and direct labor

Indirect costs•Costs that

cannot be easily and conveniently traced to a unit of product or other cost object.

•Example: manufacturing overhead

Nonmanufacturing Costs

Administrative Costs

All executive, organizational, and

clerical costs.

Cost accumulation

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•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overheadOR

= Direct materials + Conversion cost*Conversion cost is the production cost of converting raw materials into finished product

•Total cost = Prime cost + Overheads (admin, selling,distribution cost)OR

= Production cost + period cost (administrative, selling, distribution and finance cost)

•Period cost is treated as expenses and matched against sales for calculating profit, e.g. office rental

Major Cost Elements

Direct Labor Cost Labor Categories Labor Rates Labor Hours

Direct Material Cost The Actual Materials

○ Raw material○ Purchased parts and/or

assemblies Subcontracts Miscellaneous material Discounts, Scrap,

Inventory Shrinkage, & Freight-in

Indirect Costs Material Handling Fringe Benefits Overhead (or burden) G&A Expenses

Other Direct Costs Nonrecurring costs Subcontracts Travel

Profit or Fee Cost of Money EscalationEscalation

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