Fundamentals of Cost Accounting

Classification of Costs

Classification of Costs essentially means the grouping of costs according to their similar characteristics. Now, in costing there are a dozen ways to classify costs as per their nature, functions, traceability etc. Here we will be focussing on five such classifications. Let us learn this in detail.

Classification of Costs

1] Classification by Nature

This is the analytical classification of costs. Let us divide as per their natures. So basically there are three broad categories as per this classification, namely Labor Cost, Materials Cost and Expenses. These heads make it easier to classify the costs in a cost sheet. They help ascertain the total cost and determine the cost of the work-in-progress.

  1. Material Costs: Material costs are the costs of any materials we use in the production of goods. We divide these costs further. For example, let’s divide material costs into raw material costs, spare parts, costs of packaging material etc.
  2. Labor Costs: Labor costs consists of the salary and wages paid to permanent and temporary employees in the pursuit of the manufacturing of the goods
  3. Expenses: All other expenses associated with making and selling the goods or services.

Classification of Costs

2] Classification by Functions

This is the functional classification of costs. So the classification follows the pattern of basic managerial activities of the organization.

The grouping of costs is according to the broad divisions of functions such as production, administration, selling etc.

  • Production Costs: All costs concerned with actual manufacturing or construction of the goods
  • Commercial Costs: Total costs of the operation of an enterprise other than the manufacturing costs. It includes the admin costs, selling and distribution costs etc.

Learn more about Meaning of Cost, Costing and Cost Accounting here in detail

3] Classification by Traceability

This aspect one of the most important classification of costs, into direct costs and indirect costs. This classification is based on the degree of traceability to the final product of the firm.

  • Direct Costs: So these are the costs which are easily identified with a specific cost unit or cost centers. Some of the most basic examples are the materials used in the manufacturing of a product or the labor involved with the production process.
  • Indirect Costs: These costs are incurred for many purposes, i.e. between many cost centers or units. So we cannot easily identify them to one particular cost center. Take for example the rent of the building or the salary of the manager. We will not be able to accurately determine how to ascertain such costs to a particular cost unit.

4] Classification by Normality

This classification determines the costs as normal costs and abnormal costs. The norms of normal costs are the costs that usually occur at a given level of output, under the same set of conditions in which this level of output happens.

  • Normal Costs: This is a part of the cost of production and a part of the costing profit and loss. These are the costs that the firm incurs at the normal level of output in standard conditions.
  • Abnormal Costs: These costs are not normally incurred at a given level of output in conditions in which normal levels of output occur. These costs are charged to the profit and loss account, they are not a part of the cost of production.

Solved Question on Classification of Costs

Q: There was a loss in the factory due to a fire. This is a type of ____ cost

  1. Normal cost
  2. direct cost
  3. abnormal cost
  4. fixed cost

Ans: The correct answer is C. Abnormal costs are unusual and irregular costs which do not occur in normal levels of output under standard conditions.

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