CLASSIFICATION OF

COSTS

Dr.Smita Sahoo
 What is Cost?

“Cost is a measurement, in monetary terms, of the

amount of resources used for the purpose of production
of goods or rendering services”
-Institute of Cost & Works Accountants of India
Manufacturing of goods or rendering services involves
consumption of resources. Cost is measured by the
sacrifice made in terms of resources or price paid to
acquire goods and services. The type of cost is often
referred in the costing system depends on the purpose
for which cost is incurred. For example material cost is
the price of materials acquired for manufacturing a
product.

Dr.Smita Sahoo
 Classification of Costs

Classification means ‘the arrangement of items in logical groups

having regard to their nature (subjective classification) or
purpose( objective classification)’.
■ Classification of costs according to their nature
■ Classification of costs according to their purpose
■ Other cost classifications

Dr.Smita Sahoo
Classification of costs according to
their nature

■ Material costs: cost of obtaining materials

and receiving them within the organisation.
■ Labour Costs: those costs incurred in the
form of wages and salaries, together with
related employment costs.
■ Overheads : these are external costs such
as rent , electricity , insurance etc.

Dr.Smita Sahoo
Classification of costs according to
their purpose

■ Direct Costs: A direct cost can be clearly

identified with what ever we are trying to
cost ( examples are cost of material, labour
charges etc.)

■ Indirect Costs: These are the costs which

can not be directly attributed to a product.

Dr.Smita Sahoo
 Other Classification of costs

■ Fixed & Variable costs

■ Production, selling and distribution, and
administration costs
■ Controllable and non-controllable costs
■ Normal and abnormal costs
■ Relevant and non-relevant costs

Dr.Smita Sahoo
 Cost behaviour

Cost behaviour means the way in which costs

are affected by fluctuations in the level of
activity ( measured in terms of number of
units produced, miles traveled, hours
worked, percentage of capacity utilised etc.).

Dr.Smita Sahoo
 Common cost behaviour pattern

Fixed Costs

Variable Costs

Semi-Variable
Costs

Dr.Smita Sahoo
Fixed Costs: ‘A cost which is incurred for an accounting period, and which,
within certain output or turnover limits, tends to be un affected by fluctuations

of levels of activity (Output or turnover)’

400 –
300 –
200 –
100 –
C de xi Fl at o T
as uoht nI . s R(

–
–

0 1 2 3 4 5
Volume
(Thousands of Units)
Dr.Smita Sahoo
 Relevant
Range

400,000 –

300,000 –
Relevant Range
200,000 –

100,000
R( st s o C de xi F

–
0 5,000 10,000 15,000 20,000 25,000
Volume in Units
Dr.Smita Sahoo
 Variable Costs: ‘ A cost which varies
with a measure of activity”

24 –
18 –
12 –
6 –
as uoht nI . s R(
bai r a Vl at o T

–
–

0 1 2 3 4 5
Volume
(Thousands of Units)
Dr.Smita Sahoo
 Semi-variable Costs: ‘A cost containing both fixed and variable
components and which is thus partly affected by a change in the level of
activity’.

2,850 –
2,100 –
Variable
1,350 – Cost

600 – Fixed
Cost
st s o Cl at o T

–
–

0 125 250 375 500 625

Volume (in thousand units)
Dr.Smita Sahoo
 What is a Cost Centre?

“Any unit of Cost Accounting selected with a

view to accumulating all cost under that
unit. The unit may be a product, a
service, division, department, section, a
group of plant and machinery , a group of
employees or a combination of several
units. This may also be a budget centre.”

Dr.Smita Sahoo
Cost Centre may be of two types – personal
and impersonal cost centers. Personal cost
centre consists of a person or a group of
persons. Cost centres which are not
personal cost centres are impersonal cost
centers.

Dr.Smita Sahoo
 Again Cost centers may be divided into
broad types i.e. Production Cost Centres
and Service Cost Centres. . Production
Cost Centres are those which are engaged
in production like Machine shop, Welding
shop, Assembly shop etc. Service Cost
centers are for rendering service to
production cost centre like Power house,
Maintenance, Stores, Purchase office etc.
Dr.Smita Sahoo
 What is a cost unit?

“Cost unit is a form of measurement of volume of

production or service. This unit is generally
adopted on the basis of convenience and
practice in the industry concerned.”
◆ Examples of Cost Units :
■ Power - MW
■ Cement - MT
■ Automobile - Number etc
Dr.Smita Sahoo
Classification of costs by relation to Cost
Centre

Classification should be on the basis of

method of allocation of cost to a cost unit.
If an expenditure can be allocated to a cost
centre or cost object in an economically
feasible way then it is called direct
otherwise the cost component will be
termed as indirect.

Dr.Smita Sahoo
 According to this criteria for classification,
material cost is divided into direct material cost
and indirect material cost, labour cost into direct
labour cost and indirect labour cost and expenses
into direct expenses and indirect expenses.
Indirect cost is also known as overhead.

Dr.Smita Sahoo
 Classification of costs by relation
to Cost Centre
COST

DIRECT INDIRECT

MATERIAL LABOUR OVERHEAD

MATERIAL LABOUR
OVERHEAD

Dr.Smita Sahoo
 Classification of costs by
functions/activities
Costs should be classified according to the major
functions for which the elements are used into
the following four major functions

COST

ADMINISTRATION RESEARCH &

PRODUCTION
DEVELOPMENT

SELLING &
DISTRIBUTION

Dr.Smita Sahoo
 COST SHEET
Direct Material Cost* xxx
Direct Labour Cost xxx
Direct Expenses xxx
PRIME COST XXX
Add: Factory Overhead** xxx
FACTORY COST XXX
Add: Administrative overhead xxx
COST OF PRODUCTION XXX
Add: Selling & Distribution cost xxx
COST OF SALES XXX
Add: Profit Margin xxx
SELLING PRICE XXX

Dr.Smita Sahoo
• Direct material consumed = Open. Stock of
DM+ Purchase of DM-Closing Stock of DM

• Works cost = Gross Works cost + Open.

WIP-Closing WIP

• Cost of production of goods sold = cost of

production +open. stock of FG – Closing
stock of FG

Dr.Smita Sahoo
 Notes
To arrive at value at different points as
indicated above adjustment with
opening and closing stock is necessary
at following different points :
(*) opening and closing stock of raw
materials
(**) opening and closing stock of
work-in-progress & finished goods

Dr.Smita Sahoo