Classification of Costs

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Meaning of Cost 

The term cost means the economic value of expenditures for raw materials, equipment, supplies, services, labour, products, etc. It is an amount that is displayed as an expense classification in bookkeeping records.


Classification of Costs

Classification of cost in economics is the classification of cost based on various factors which are discussed below. The following will be the types of cost classification.

 Classification by Nature

This classification of cost is based on the nature of the expenditure, which are the three broad categories as per this, namely Labor Cost, Materials Cost and Expenses. This cost makes it easier to classify them on a cost sheet. They help in estimating the total cost and also to estimate the work-in-progress cost.

Material Costs: 

These are the costs of any materials that are used in the production of goods. This is further divided into further costs. For instance, we can classify material costs into spare parts, raw material cost, packaging material cost etc.

Labour Costs: 

This cost includes the salary and wages paid to temporary and permanent employees for the manufacturing of the goods.

Expenses: 

It includes all other expenses associated with manufacturing and selling the services or goods.


Classification by Functions

This is the classification based on functional costs. The cost classification by function flows the pattern of basic managerial activities. So, this cost is classified as production, administration and selling etc. 

  • Production Costs: 

These costs are related to real construction or manufacturing of the goods. 

  • Commercial Costs: 

This cost includes the operation of an enterprise except for the manufacturing costs. It consists of the admin costs, distribution and selling cost etc.


Classification by Traceability

This cost is classified into direct costs and indirect costs. This classification is classified on the degree of traceability to the final product of the firm.

  • Direct Costs:

These are the costs which are easily related to a specific cost unit. The most significant examples are the materials used to manufacture a product or the labour involved with the production process.

  • Indirect Costs: 

These costs are used for many purposes, which are between many cost centres or units. So we cannot put them to one specific cost centre—for instance, the rent of the place or the manager's remuneration. We will not be able to identify how to estimate costs to a specific cost unit.


Classification by Normality

This classification is based on the costs as the normal costs and abnormal costs. The normal costs are the costs that happen at a given point of output, under the same set of conditions in which this point of output occurs.

  • Normal Costs: 

The cost of production and also the part of the costing profit and loss. These are the type of costs that the organisation incurs at the standard level of output under normal conditions.

  • Abnormal Costs:

These costs are not normally occurring at a particular level of output in conditions in which normal levels of output happens. These costs are calculated according to the profit and loss account; they are not a part of the production cost.

FAQ (Frequently Asked Questions)

1. There Was a Loss in the Factory Because of a Short-Circuit. This is a Type of Cost is Categorised as 

  1. Direct Cost

  2. Normal Cost

  3. Abnormal Cost

  4. Fixed Cost

Ans: Abnormal costs are not normally occurring at a particular level of output in conditions in which normal output levels occur. These costs are calculated according to the profit and loss account; they are not a part of the cost of production. They are unusual and irregular costs that do not happen in normal output levels under standard conditions of work. So, this unexpected cost and hence this is an abnormal cost.

2. The Production Costs Consist of : 

  1. Direct Materials

  2. Direct Labour

  3. Direct Expenses

  4. Variable Production Overheads

  5. Fixed Production Overheads

Identify Which of the Above is a Part of Production Cost?

  1. (I) (II) (IV)

  2. (I) (II) (III)

  3. Only (I) and (II)

  4. All of the Above

Ans: Production Costs are the costs related to real construction or manufacturing of the goods. It includes Direct material, labour and expenses. It also includes variable production overhead and fixed production overheads.