Classification of Costs | By Nature | By Function | By Behavior | By Controllability

 

Classification of Costs

Costs have been classified in different ways in accordance with their common characteristics.

The main classifications are given below:

Classification by nature or elements

Classification by functions

Classification by behavioral 

On the basis of controllability

 

 

Classification by Nature or Elements

Classification by nature is also called elements of cost.

There are three types of elements.

They are materials, labour and overheads.

 

MATERIAL

Materials are the most important parts in manufacturing company.

There are two types of materials.

They are direct materials and indirect materials.

Direct materials

It is the main part of finished goods. Such as:

Steel, woods or plastic in furniture

Cotton in cloth

Leather, clothes and rubber in shoes

Paper in copy and book

Sugarcane for sugar etc

 

Indirect materials

It is the small part in quantity in finished goods.

It helps to finish or complete to goods. Such as:

Sewing thread and buttons in clothe

Enamel, paints, polish and iron peg in furniture

Adhesive, glue and thread in book binding etc

 

LABOUR

To convert raw materials into finished goods, manpower is essential.

And such manpower needs expenses.

These expenses are wages, salary, bonus and provident funds etc.

There are two types of labour.

They are direct labour and indirect labour.

Direct labour

It is the direct cost, labour, wages incurred to product goods or service providing.

This cost is related to particular job, process or product. Such as:

Wage to tailor for stitching

Wage to carpenter

Wage to mason

Wage to washer man for cleaning the clothes etc

 

Indirect labour

It is the non-productive wage, cost, labour.

It helps to encourage labour to do work hard with honest and sincere. These are:

Allowances

Provident fund

Bonus (extra benefit)

Pension (money for retirement)

Gratuity (money for retirement or appreciation)

Medical facility etc

 

OVERHEAD

It is also called direct cost, expenses and overhead.

All the expenses that are not related to direct materials and direct labour are overhead.

There are two types of overhead.

They are direct overhead and indirect overhead.

 

Direct overhead

It is related to direct production of goods or service rendered.

They are import duty, royalty, research and development, architect fee etc.

 

Indirect overhead

It is not related to production.

These expenses help to do work easily.

They are rent, telephone, fax, internet, mobile expenses, taxes, insurance etc.

 

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Classification by Function

According to this classification, costs are classified into three functions.

They are factory cost, administrative cost and selling and distribution cost. 

Factory cost, production cost, manufacturing cost or work cost

It is the total of prime cost and factory expenses. 

It includes indirect materials, indirect labour, indirect expenses which are incurred inside the work place where production is carried-on. Like:

Factory rent, rates and taxes,

Lighting, heating, power, fuel, water and coke,

Factory wages, salary, pension, provident fund,

Labour benefits like canteen/cafeteria expenses, medical expenses and entertainment,

Repairs and maintenance, depreciation related to factory building, furniture and machinery,

Stationery, printing, phone, fax and internet expenses of factory,

Other production expenses etc.

 

Administrative expenses or office expenses

It is the total of factory expenses and office expenses.

Such as administrative, planning, coordinating, staffing and controlling. Office overhead includes:

Office  rent, rates and taxes,

Office lighting, heating and power,

Office wages, salary, pension, provident fund,

Office staff benefits like canteen/cafeteria expenses, medical expenses, entertainment,

Repairs and maintenance, depreciation related to office building, furniture and equipment,

Stationery, printing, postage, phone, fax, internet expenses of office,

Legal expenses, bank charge, audit fees etc.

 

Selling and distribution expenses

These expenses are necessary for sales promotion. It includes:

Advertisement, free sample and charity of goods,

Salary, travelling expenses and commission to sales staff and agents,

Expenses of sales department and show-room,

Rent, insurance, repairs and maintenance of warehouse/godown,

Bad debt on credit sales etc.

 

 

Classification by Behavior or Variability

It is also called classification on the basis of variability.

The relationship between cost and activities is called behavior.

According to this classification, costs are divided into three groups.

They are fixed cost, variable cost and semi variable cost.

 

Fixed cost

It is also called capacity cost, periodic cost and burden cost.

These expenses are not changed according to output.

This level is pre fixed. It is never be zero.

Generally, it is uncontrollable and unavoidable cost. 

Some fixed costs are rent, depreciation, salary for permanent staff, taxes, insurance etc.

 

Note: There are inverse/opposite rule for total fixed cost and fixed cost per unit.

 

Example: suppose fixed cost for one month is $/₹/Rs 5,00,000 upto 50,000 units

Output in units  (a)	Total fixed cost  (b)	Fixed cost per unit  ( c = b ÷ a)
0	5,00,000	5,00,000 ÷ 0           = ∞
5,000	5,00,000	5,00,000 ÷ 5,000   = 100
20,000	5,00,000	5,00,000 ÷ 20,000 = 25
50,000	5,00,000	5,00,000 ÷ 50,000 = 10

 

 

Variable cost

It is also called changeable cost, marginal cost, direct cost and running cost.

It is affected according to output or production.

There is close relationship between total variable cost and volume of output.

When output is zero then total variable cost is also zero but variable cost per unit never is zero.

 

Example:

Suppose variable cost per unit is Rs 6

Output in units  (a)	Variable cost per unit (b)	Total variable cost  (a x b)
0	6	0 x 6                  =  0
5,000	6	5,000 x 6          =  30,000
20,000	6	20,000 x 6        =  120,000
50,000	6	50,000 x 6        =  300,000

 

 

Semi variable cost, mixed cost or semi fixed cost

It is the mixed of fixed cost and variable cost.

Neither total amount nor per unit cost of semi variable cost remains constant.

If level of production increase, total semi variable cost decrease but never be zero and vice versa.

 

Example:

Suppose, electricity bill for household purpose is minimum Rs 80 upto 20 units. Afterward Rs 7.30 per unit upto 199 units then Rs 10 per unit from 200 units.

Units	Basis	Cost per unit	Total cost (semi variable cost )
0	Fixed	Fixed	80
20	Fixed	Fixed	80
30	Semi variable	Fixed + Rs 7.30	Rs 80 + 10 units x Rs 7.3      = 80 + 73              = Rs  153
199	Semi variable	Fixed + Rs 7.30	Rs 80 + 179 units x Rs 7.3   = 80 + 1,306.7      = Rs  1,386.7
200	Semi variable	Fixed + Rs 10	Rs 80 + 180 units x Rs 10    = 80 + 1800          = Rs 1,880

Note: Total cost = Fixed cost + (VCPU x Output)

 

 

Classification by Controllability

Under this classification, costs are classified into two groups.

If management can control cost, it called controllable cost.

If management cannot control, it is called uncontrollable cost.

Controllable cost

This type of costs can be controlled by management.

It can be changes or alter by action but time should be long.

If there is short time, it is difficult to control.

Generally, these are variable cost in nature.

Some controllable costs are direct materials, direct labour, direct overhead, indirect materials, indirect labour, indirect overhead, power cost, repairs and maintenance etc.

 

Uncontrollable cost

There are some kinds of cost that cannot be controlled by management.

It cannot be changed or altered.

Generally, these are fixed cost in nature.

Some uncontrollable costs are rent, salary to permanent staff, annual insurance, management salary etc.

 

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