Introduction and Classification of Cost
Cost is defined as an amount of money spent for obtaining anything, goods or service. The amount spent in acquiring materials, labour and overheads in manufacturing concern is known as cost. It is something sacrificed in terms of monetary value in exchange for something.
Elements of Costs
Cost of product of an industry comprises of material cost, labour cost and overhead costs. Therefore, cost appears into material cost, labour cost, overhead costs under the classification of costs based on physical characteristics.
A) Material cost
The cost of things which are essential to produce goods and services are known as material costs. Material cost is classified as:
- Direct materials cost: The cost of materials having a physical identity with the finished product is defined as direct materials cost. Main raw materials and necessary components like import duties, transportation of materials, etc are a few examples of direct materials.
- Indirect materials cost: Materials that are not used as inputs of product are called indirect materials. Cost of materials incurred for repair of a machine used for printing of textbook is defined as indirect materials cost. It facilitates the task of production of goods and services. Eg: lubricants, grease, clothes, etc
B) Labour cost
The payment price or cost incurred made to the workers are known as labour cost. Labour cost is classified as:
- Direct labour cost: Labour or wages incurred for the operative workers engaged in production process are categorized as direct labour cost. Wages paid to the workers involved in production and handling materials, workers engaged in productive operation by way of supervision and maintenance etc are direct labour costs.
- Indirect labour cost: Smooth operation of an organization needs operation of account department, marketing department, and internal transport also besides production department. Indirect labour cost includes the wages paid to the watchman, sweeper, gatekeeper, etc.
C) Overhear Costs
The cost which is not directly connected with finished product but occur on account of operation are termed as overhead costs. All indirect expenses (indirect materials, indirect labour and other indirect expenses) are overhead costs. They are not directly involved in the production process:
- Factory Overhead: Indirect materials, indirect labour and other indirect expenses occurred in factory are called factory overhead. (Eg: lighting, heating, factory fuel, factory manager’s salary, hand tools, repair and depreciation of factory equipment & factory building, wages of foremen, etc)
- Administrative Overhead: The cost incurred for administrative function ie Director’s fees, office rent, rates and taxes, office repairs and maintenance general and miscellaneous, executive salary, staff salary telephone charges, postage and telegrams, printing and stationery, electricity, audit fee, office insurance, etc are known as administrative overhead.
- Selling and Distribution Overhead: The expenses paid for selling and distribution of finished goods are called selling and distribution overheads. This includes salaries of sales staff, salesman’s commission, training of salesmen, travelling expenses of sales representatives, Commission, rent of sales office and showrooms, Warehouse expenses, Provident fund, Entertainment and treatment to customers, Samples products, Bad debts and collection charges, etc.
- Distribution Overhead: The expenses associated with transporting finished goods from warehouse to sales depot, showroom and customers are termed as distribution overheads. This cost includes: Packing expenses, Freight outwards, Loading and unloading, Depreciation of delivery vans, etc
Classification of Costs
A) On the basis of element of cost
- Material cost: Material cost represents the total costs of main raw materials, components, consumable stores and packing materials. Materials cost also includes import duties, dock charges, transport cost, storing cost receiving and inspection cost, and other costs associated with the materials purchased.
- Labour cost: Labour cost is the total of wages incurred for the effort or services made by labours in the productions of goods and services. Therefore, wages paid to the workers are termed labour costs.
- Other Expenses: All the expenses which are incurred in acquiring other materials and labours for the production are known as other expenses.
B) On the basis of function:
- Manufacturing costs: All the costs which are incurred in the factory starting from the processing of materials till the finished products are known as manufacturing costs. It is also called factory overheads.
- Office/Administrative costs: The cost incurred for general administrative function or for office works are known as office or administration costs.
- Selling and Distribution costs: All the expenses which are incurred to create demand of product and distribution of such product is known as selling and distribution costs.
C) On the basis of variability: All costs which can be grouped on the basis of change in the volume of production is classified here They are:
- Fixed cost: Cost that does not change with output is cost. It remains fixed for a stipulated period and for a specific capacity output. It is also called create cost as it remains unchanged for a stipulated period. Fixed cost in total amount remains constant whereas fixed cost per unit changes inversely with output changes.
- Variable cost: Cost which changes proportionality with volume of output or services are called variable costs. They increase or decrease in total amount with the increase or decrease in volume of output. However, the per-unit variable cost is constant. Variable manufacturing cost is also called product cost.
- Semi-variable cost: Those costs which do not change proportionately like variable costs but vary as per the volume of production is termed as semi-variable cost. Examples of semi-variable costs are salary of supervisors, travelling salesman salary, repair and maintenance costs etc. such costs contain fixed and variable So, the semi-variable cost is also called mixed costs.
D) On the basis of Controllability: The costs are divided into two groups as per the influence of the manager. They are:
- Controllable costs: The cost subject to control by a manager or individual is called controllable cost. For example; direct materials, direct labour, other overheads such as indirect labour, factory supplies, cutting tools, power costs, repair and maintenance etc are controllable costs.
- Uncontrollable costs: Costs that are not subject to influence by the action of manager is called uncontrollable These costs remain unchanged. Example: managerial salaries, staff salaries, depreciation after purchase of equipment, rent. Some costs may be controllable in the short run but not in the long run.
E) On the basis of production process: Here the total costs are divided into two groups on the basis of cost incurred. They are:
- Direct costs: Direct costs are those materials, labour and other expenses which can easily be attributed or identified with a unit of product, process or operation. The cost of raw materials, productive labour, and carriage of materials paid are examples of direct cost. The total direct cost is termed as prime cost.
- Indirect costs: Indirect costs are those types of cost, which cannot easily be attributed to or identified with a unit of product, process or operation. Therefore, the total costs of indirect materials, indirect labour and indirect expenses are referred to as indirect costs. They are also called overhead costs. Examples of indirect costs are repair charges, salaries, rent, telephone and water.