Cost
Cost means the total expenses a business spends to produce goods or services. This includes money spent on raw materials, wages of workers, rent of factory or building etc. In simple word, Amount of expenditure incurred to given thing or activity.
Costs can be classified in various in various different ways depending on its nature and a specific purpose. There are various of costs classified into logical grouping. These groups are such that each and every item of cost can be classified.
These classification of costs make the cost information meaningful. It is of at most importance to the management of a manufacturing concern. It is first step towards their decision making process relating to costs and costing.
For example if a company spends 5,000 on raw material, 3000 on wages and 2000 on now the total cost = 10,000.
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Cost concept: various cost concepts and classification
According to the chartered institute of management accounts, cost is the amount of expenditure actual or rational incurred on an attributed to a specified thing an activity similarly according to Antony and Wilson cost is a measurement in monetary terms of the amount of resource used for some purpose.
Cost has defined by the committee on cost terminology of the American accounting association as “the forgoing in monetary terms incurred or potentially to be incurred in the realization of the objectives of management which may be manufacturing of a product on rendering of a service”
Form the above it may be stated that cost means the total of all expenses incurred for a product on a service thus can say prime cost on works cost on fixed cost etc. we want to explain is essential while computing measuring or analyzing the various aspects of costs.
Classification of costs
Classification of costs implies the of grouping costs according to their common characteristics. A proper classification of costs is absolutely necessary to mention the costs are classified according to their nature like material, labour, overhead among others. An ideal cost figure may be classified in various ways according to the needs of the firms.
According to elements - under the circumstances cost are classified into three broad categories material, labour and overhead.
According to functions - the total cost is divided into different segments according segments accounting to the purpose of the firm.
Accounting to variability - practically costs are classified according to their behaviour relating to the charge increase or decrease in their volume of activity. The cost which varies directly in proportion to every increase or decrease in volume of output or production is variable cost. For example, cost of direct material, wages of labour etc. The cost which does not vary but remain constant within a given period of time and range of activity in spite of fluctuation in production is known as fixed cost. For example, rent, insurance charges, management etc. The cost which does not vary proportionately but simultaneously cannot remain stationery at all times is known as semi variable cost. For example – depreciation, repair etc.
- Fixed cost
- Variable cost
- Semi variable cost
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| Fixed cost |
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| Variable cost |
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| Semi variable cost |
According to controlling - costs may, again or subdivided according to the performance done but any member of the firm they are
- Controllable costs and uncontrollable cost - controllable costs are those costs which may be influence by the decision taken by a specified member of the administration of the firm on it may be stated that the costs which at least partly depend on the management and is controllable by them example all direct cost, direct material, direct labour and chargeable expenses components of prime cost are controllable by management level and is done accordingly.
According to Normality - under this condition cost are classified according to the normal need for a given level of output for a normal level of activity product for such output.
- normal costs
- abnormal costs
Product Cost and Period Cost
Costs which become part of cost of product rather than an expense of the period in which they are incurred are called as product cost. For example, cost of raw material, direct wages etc.
Cost which are not associated with production with production are called period cost. They are treated as an expense of the period in which they are incurred. For example, administration cost, Salesman salaries and commission etc.
According to time
- Historical costs
- Predetermined costs
Shutdown and sunk cost
During shutdown period through no work is done yet certain fixed costs, such as rent and insurance of building, depreciation etc. for entire plant will have to be incurred. Such cost of the idle plant known as shutdown cost.
Sunk cost or historical cost – these are the cost which have been created by a decision that was made in the past that cannot be changed by any decision that will be made in future. For example – investment in plant & machinery, building etc.
According to traceability –
- Direct traceable cost,
- Indirect (Non traceable cost)
Direct cost and indirect cost - The expense on material and labour economically and easily traceable to a product service or job are considered as direct costs. For example, material purchased, labour wages etc.
The expense incurred on those items which are not directly chargeable to production are indirect cost. For example – salary of time keeper, storekeeper etc.
Relevant and irrelevant costs
Relevant cost is those cost which would be change by managerial decision.
Irrelevant cost is those which would not be affected by the decision. For example – closing down of unprofitable retail shop.
According to planning and central –
- Budget cost,
- Standard cost
- Standard costs are product technical for each element, material, labour and overhead.
- The cost per unit is determined to make an estimated total output for the future period for material, labour, overhead
- The cost must depend on the past experience and experiments and specification of the technical staff
- The cost must be experienced in terms of rupees
Differential, incremental or decremental cost
The difference in total cost between two alternative is termed as differential cost. In case the choice of an alternative in increase in total costs such increase in costs is known as incremental costs.
- In case the choice of an alternative results in increase in total costs such increase in costs is known as incremental cots.
- In case the choice results in decrease in total costs such decrease in total costs is termed as decremental cost.
FAQ's
Why is cost classification important?
• Helps in cost control and reduction • Supports budgeting and forecasting • Aids in pricing decisions • Improves decision-making • Facilitates financial reporting and analysis
How do companies use cost classifications in real life?
Companies use cost classifications for: • Setting product prices • Evaluating profitability • Budget planning • Performance measurement • Investment decisions
