Cost classification and its importance

CLASSIFICATION OF COST
AND ITS IMPORTANCE


COST- cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

Cost comprises 3 elements:

1. Material cost- is the cost of substances from which products are made by an undertaking.
2. Labour cost- is the cost of remunerating ( by wages, commission, bonus, etc ) the workers of an undertaking.
3. Expenses- are the cost of services provided to an undertaking and the notional cost of the use owned assets ( i.e., depreciation ).

COST SHEET- a cost sheet is a statement which is prepared so as to find out the cost of production. It brings out the composition of total cost under proper classifications and sub-divisions.

A cost sheet comprises 4 overheads-

1. Factory overhead- all the indirect expenses incurred in the factory are recorded under this overhead. E.g- power & fuel, indirect wages, etc

2. Office and administration overhead- all the indirect expenses incurred in relation to administration of an organization and inside the office are included under this overhead. E.g- salaries of office staff, depreciation on office furniture, etc.

3. Selling and distribution overhead- all the indirect expenses incurred in relation to making the goods available for sale and selling the goods are included under this overhead. E.g- commission to salesman, secondary packing expenses, etc.

4. Distribution overhead- all the indirect expenses incurred in distributing the goods
to the final consumers at their places are recorded under this overhead.
E.g- expenses of running the delivery van, other distribution expenses, etc


On adding these 4 overheads and other direct expenses incurred during production such as cost of raw materials, wages paid to labourers, cost of desing, royalty on production, cost of hire of special machinery, etc, we get the cost of manufacturing goods and thus we can find out the profit which we would make on our sales.







CLASSIFICATION OF COST

Cost can be classified under several basis:

1. On the basis of variability:

a. Fixed cost- fixed cost can be defined as that cost which remains unchanged as the output changes. Even when the output is zero some amount of fixed cost has to be incurred. E.g- rent paid for the factory building.


b. Variable cost- variable cost can be defined as that cost which changes in the same proportion in which the output changes. When output is zero variable cost is also zero. E.g- wages paid to labourer.

c. Semi-variable cost- this cost contains elements of both fixed cost as well as that of variable cost. Therefore this cost is partly affected due to changes in the level of production. E.g- electricity bill.

2. On the basis of function:

a. Production cost- production cost is the cost which is involved in producing the
goods.

b. Administration cost- administration cost is the cost which is involved in the
administration and running of the organization.

c. Selling cost- selling cost is the cost which is involved in selling the product to the
to the final consumers.

d. Distribution cost- distribution cost is the cost which is involved in distributing the
goods to the various consumers.

3. On the basis of direct and indirect nature of cost-

a. Direct cost- direct cost is that cost which can be traced to a particular product.
Thus direct cost is also known as traceable cost. Thus direct cost can be identified
with a particular product and changes in the same proportion in which that
particular product for which it has been incurred changes.

b. Indirect cost- indirect cost is that cost which cannot be traced to a particular
product. Thus indirect cost are also known as untraceable costs. It cannot be
identified with any particular product and does not change in any fixed proportion



4. On the basis of time period-

a. Historical cost- historical cost is 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. Preparation of budget: classification of cost helps in preparation of the budget of the organization. For preparing the budget of an organization one must know how and where exactly the expenses have been incurred in relation to manufacturing the product. On the basis of this classification of the cost an organization accordingly prepares its budget.

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2. Helps in measuring efficiency: classification of cost helps in measuring the
efficiency of the organization. On the basis of the places where the costs have been
incurred and the amount of cost that has been incurred the efficiency of the
organization can be judged.

3. Controlling cost:

a. Labour cost: with the help of classification of cost an organization can control its labour cost as well. If the labour complete their task well in time and with much efficiency then the organization would be able to reduce its labour cost.

b. Material cost: material cost can be controlled if material wastage is avoided and proper standardization of materials is used. Thus with the help of classification of cost an organization is able to reduce the cost incurred on materials and thus able to control material cost.


c. Overhead cost: overhead comprises indirect expenditure incurred in manufacturing. By knowing the amount that has been incurred under various heads an organization can device ways to reduce the cost. Thus with the help of classification of cost an organization is able to control overhead cost.

4. Expansion of the organization: if an organization knows where exactly it incurs expenditure then it can device ways to control these costs. Once an organization is able to control its cost then it can concentrate on its expansion. Thus with the help of classification of cost an organization is able to device ways for its expansion.

Thus, classification of cost is of immense importance for an organization. With the help of classification of cost an organization can make progress and also expand its production by controlling its cost. Thus in the long run an organization can move towards higher productivity and thus higher profits and can achieve its goals.


CONCLUSION

We all are familiar with the term ‘cost’. It has become a part and parcel of our daily lives. Almost everywhere these days we find the term cost, be it at shops, entertainment, food, etc. However accounting goes a step further. It classifies cost under various heads. It has also devised several ways of measuring costs and also determining the costs of various goods. The process of preparing a cost sheet so as to calculate the cost of production is completely a concept of accountancy. Thus we can conclude saying classification of cost is of immense importance not only from the point of view of a manufacturing organization but also from an individual point of view.