Classification of Costs and Cost Behavior
LEARNING OBJECTIVE
I. Classification of Costs
II. Cost Behaviour Patterns
III. Direct Costs and Indirect Costs
I. Classification of Costs
Classification is a means of analyzing costs into logical groups so that they can be summarizes into meaningful information for management use or for preparing external financial report.
The criteria used for the classifications will depend on the information being collected. Some possible classifications are:
- Nature – material, labor or expenses
- Key responsibility or function
- Product costs and period costs
- Controllable costs and uncontrollable costs
- Cost behaviour pattern
- Direct costs and indirect costs
Functional or Responsibility Analysis of Costs:
The exact functions will depend on the type of organization and the following show some possible functions within an organizations:
Production costs and Periodic Costs:
- Product costs or production costs are the costs of making, or buying, an item of inventory. For example the material and labor costs.
- Period costs are those costs charged in the income statement for the period that are not directly related to the production of the goods i.e. rental cost.
Controllable Costs and Uncontrollable Costs:
- Controllable costs e. labor cost, material cost…etc.
- Uncontrollable costs e. rental cost.
Direct Costs and Indirect Costs:
- Direct costs directly attributed to a particular cost center or cost unit.
- Indirect costs indirectly attributed to a particular cost center or cost unit.
Cost Analysis by Behavior:
Analysis of costs by behavior involves determining how a cost will vary if the level of activity in the organization varies.
Costs can be classified by behavior into:
- Fixed costs
- Variable costs
- Semi-variable costs
- Stepped costs
II. Costs Behavior Patterns
Fixed Costs
Fixed costs are costs that are not affected in total by the level of activity. For example, the rent paid on a factory is $5,000 per month whether 2 or 200 units are produced.
If we change the total cost in vertical to cost per unit, we will see that the cost per unit will be gradually decreased.
Variable Costs
Variable costs are costs that change in total in direct proportion to the level of activity. For example, if the cost of materials for a unit of output is 2 kg at $2 per kg, this amounts to $4 per unit. So, if 2 units are made, total cost is $8 and if 200 units, total cost is $800.
If we change total cost in vertical to cost per unit, then variable cost remains constant.
Semi-variable Costs
Semi-variable costs are costs that have both a fixed element and a variable element. For example, a telephone bill might be a semi-variable cost. Line rental is fixed, but there is also a variable cost of calls.
Stepped Costs
Stepped costs are costs that are constant for a range of activity level, and then change, and are then constant again for another range. For example, a bonus of supervisor could depend on the level of output, say, $200 for 0 – 100, $300 for 100 – 200.
III. Direct Costs and Indirect Costs
A direct cost is expenditure that can be directly identified with a specific cost center or cost unit. Direct costs normally include the material input into the product (direct materials) the costs of the labor working on the product (direct labor) and any expenses specifically attributable to the product (direct expenses).
Indirect cost (or overhead) is expenditure that cannot be directly identified with a specific cost center or cost unit. It’s jointly incurred and must be shared out on an equitable basis.
Prime Cost = Direct Material + Direct Labor + Direct Expense
Factory Cost = Prime Cost + Production Overheads
Total Cost = Factory Cost + Non-production Overheads
Source:
- KAPLAN
- BPP
- Phnom Phenh HR