Classification of Cost and its importance - Cost / Accounts Project

COST
Cost is the monetary measurement of the sacrifices made or the resources used for the purpose of production of goods or rendering services.

ELEMENTS OF COST

1. Material cost- Material cost refers to the cost of substances/raw materials purchased for the purpose of production of the final goods.
--direct material cost (variable in nature)
--indirect material cost (overhead)

2. Labour cost- Labour cost refers to the remuneration paid to the workers in forms of salary, wages, bonus, etc.
--direct labour cost (variable in nature)
--indirect labour cost (overhead)

3. Expenses- Expenses include rent, electricity charges, job processing charges, etc.
--direct expense (variable in nature)
--indirect expenses (overhead)

Adding all the indirect expenses i.e.(indirect material cost + indirect labour cost + indirect expenses) gives the overhead. Overheads can be again classified into :
1. Factory overhead
2. Administration overhead
3. Selling overhead
4. Distribution overhead

Now, a COST SHEET is the summation of all the elements of cost (mentioned above) in a systematic manner which helps a manufacturing firm to find out its cost of production.

CLASSIFICATION OF COST

1. Variability -

a. Fixed Cost- It is that cost which does not change with a change in the production level or output. Eg.-Factory cost.

b. Variable Cost- It is that cost which changes proportionately with a change in the level of production or output. Eg. wages.

c. Semi-variable Cost- Semi-variable costs are those costs which are partly variable as well as partly fixed in nature. Eg. electricity cost.

2. Function -

a. Production cost- The cost involved in the production of final goods is known as production cost.

b. Administration cost- The cost involved in the administration, management and running of an organization is known as administration cost.

c. Selling cost- The cost incurred for selling the goods produced/bought to the final consumers is termed as selling cost.

d. Distribution cost- The cost involved in the distribution of the goods to various wholesellers, retailers, consumers, etc is termed as distribution cost.

3. Direct and indirect nature -

a. Direct cost- Direct cost is that cost which can be associated to a particular cost centre (also known as traceable cost). Thus direct cost changes in the same proportion in which the production of the particular product to which it is related changes.

b. Indirect cost- Indirect cost on the other hand is that cost which cannot be associated to a particular cost centre (also known as untraceable cost). Thus indirect cost does not change according to the change in the level of output

Cost centre refers to any activity for which cost is incurred and Cost unit is the unit which is used to measure the cost incurred.


4. Time period -

a. Historical cost- In accounting, historical cost refers to the original monetary value of an economic item, i.e. the actual cost incurred in acquiring assets or producing goods and services.

b. Pre-determined cost- These costs are estimated prior to production on the basis of a specification of all the factors affecting cost of that product.

c. Standard cost- In case of standard cost a pre-determined norm is applied as a scale of a reference for assessing the actual cost irrespective of the fact whether these are more or less.

d. Estimated cost- Estimated cost of a product are prepared well in advance prior to the performance of operations or even before the acceptance of sale orders.

IMPORTANCE OF CLASSIFICATION OF COST

1. Controlling cost- The main objective of a firm is to maximize its profits and thus minimize its cost. Classification of cost helps in minimizing the cost as it enables a firm to focus on each and every component or element of cost which are:
a. Labour cost
b. Material cost
c. Overhead cost

2. Preparation of budget- Classification of cost helps a firm to prepare its budget for the year ahead as it enables the firm to know exactly where and how cost has been incurred previously in relation to the production process.

3. Helps in measuring efficiency- Efficiency of a firm can be measured with the help of cost classification on the basis of how effectively cost has been incurred at different places and different time and the allocation of scarce resources of the firm.

4. Expansion of the organization- Indirectly a firm can concentrate on expansion policies as cost can be controlled more effectively through cost classification. Once a firm can control the costs incurred it can easily think of growth and expansion.

CONCLUSION

Thus Cost and its classification are an integral part of all sorts of organizations. These concepts are not only important for a firm or company but also very important for individuals of any type. Cost being the monetary sacrifice, cost sheet a systematic representation of the sacrifices made, classification of cost - the classification of the sacrifices and cost control being the ultimate goal i.e. reducing the sacrifices and maximizing the benefits derived.