Cost Classification

Cost Classification

Introduction:

In this assignment I will be discussing how costs incurred in any organization may be classified in a number of different ways for a number of different purposes. I will also be looking to find companies that use a variety of different costing techniques and methods. I will also be discussing the comparisons between marginal and absorption costing and how the concept of activity based costing can also be compared with these. To complete the assignment I will be using a combination of lectures notes, text books and the internet to research the various ways of cost classification, and how different companies use these, to enable me to answer the assignment question.

Findings:

1. Cost classification

Cost classification is the breakdown of costs in to similar categories and sub-categories. Cost classification can be done with various methods and for different reasons, depending upon the reason for use. For example, a management may use controllable and uncontrollable cost classification, to identify which costs are controlled by management and which are not. The main areas in which costs can be classified are decision making, planning, control and stock valuation. (Management Accounting Techniques, 1994, Page 1).

1.1 Direct v Indirect Costs

Direct costs are those which can be identified with the end product. This includes raw materials used in manufacturing the product (direct material); machine operators who make the product (direct labour), royalties paid or special plant hire (direct expenses). (Management Accounting Techniques, 1994, page 2).

Direct labour costs are established by measuring the time taken for a job to be completed. In the past direct labour costs have been restricted to wage-earning factory workers, but in recent years, with the development of systems for costing services (service costing), the costs of some salaried staff might also be treated as a direct labour costs.

Other expenses are those that have been incurred as a direct consequence of making a product, or providing a service. This depends on what are been costed.

Indirect costs are those that cannot be identified with, or traced to the end product and include the following: scrap material (indirect material): the salaries of factory supervisors (indirect labour): rent, rate and depreciation (indirect expenses). Indirect costs are often called overheads. (Management Accounting Techniques, 1994, page 2). This means that all indirect costs are therefore those which are not charged directly to a product.

Total expenditure for direct and indirect costs can be analyses as follows:

Material cost = Direct material cost + Indirect material costs

+ + +

Wages Direct wages + Indirect wages

+ + +

Expenses = Direct expenses + Indirect expenses

Total cost = Prime cost + Overhead

Prime cost is the aggregate of all direct costs and overhead is the aggregate of all indirect costs. Total cost is the sum of prime cost and overhead. (Cost and Management Accounting 1, 1991, page 10)

An example of a sector that uses direct v indirect costs is the horse racing sector. Direct cost incurred in the upkeep of a racing horse is the special grooming and racing fees. Indirect costs would include: hay and straw, depreciation, rent, rates, wages of stable managers salary, wages of stable boy etc.

1.2 Cost behaviour

Cost behaviour is �the way in which costs per unit of output are affected by

fluctuations in the level of activity’. The level of activity refers to the amount of work done, or the number of events that have occurred. (Cost and Management Accounting 1, 1991, page 20)

1.21 Fixed v Variable costs

Fixed costs are expenses whose total does not change in proportion to the activity of a business, within the relevant time period or scale of production. (Figure 1, Cost and Management Accounting 1, 1991, page 21)