Cost Classification

Background:
Generally , what are the common expenses on a manufacturing company?? There are many line items of cost. For Example : For a Jeans
Manufacturing company
▪ Jeans Cloth
▪ Thread
▪ Oil as Lubricating in Machine Used
▪ Diesel in Generator of Running Electricity
▪ Coal
▪ Chalk & So on
If all the Line items has accounts in the company , there will be much more line items in every company then expected and it will be very difficult
for operations. As, Accouting is the process of summarization , classification and analysis of information. In the same pattern Cost Accounting
also requires summarization , classification and analysis for understanding records maintained in more logical and better way. So , on different
basis we can classify our costs.
It means the grouping of costs according to their common characteristics. The Important ways of classification of costs are :
A) By Element :
Cost Classification
Note : If You see the product , you will only see the material used in the product but not the other associated cost incurred on making of that
product.
By looking at the nature of Cost you will analyze two aspects by nature one is Tangible cost, and another is Intangible cost.
Tangible means the thing for which you have incurred cost can be touched while Intangible means which cannot be touched but you can be feel
that cost has been incurred for the same.
So , all tangible costs are grouped as material costs as Material means tangible resources.
So , only Material in itself will not make the product but will require other things who would work on the material, or some Human effort is
required to change the material to a finished product is known as Labour( which is intangible as labour is the effort made or work done by
Humans can also be understand as cost associated with Labour).
In the Same way only , Material and labour are not sufficient in itself for making the product like Cleaning Expenses , bills of utilities like
Electricity and Water charges , Maintenance Cost of Machine if available , Cost of Security Guard , Rental of Factory Space Used , Cost of
Designing.
So , All the above cost are summarised in one single Heading Known as Expenses.
1) Material
2) Labour &
3) Expenses
are the three basic Elements of Costs .
Cost Classification
1) Material Cost[Tangible Input] is the cost of material of any nature used for the purpose of production of a product or a
service. It Includes Cost of Materials , Freight Inwards , Duties & Taxes , Insurance and so on directly attributable to
acquisition but excluding trade discounts.
2) Labour Cost[Intangible Input] means the payment made to the employees either they are permanent or temporary for the
services the have provided. It Includes Salary & Wages Paid to permanent employees, temporary employees and to the
employees of the contractor. Here Salary & Wages includes all the benefits like Social Security Fund , Provident Fund ,
Gratuity , Overtime , Bonuses , Incentive and So on,
3) Expenses[both Tangible and Intangible Input] means anything other than material cost or labour cost which are involved in
an activity of making a product or providing a service.
NOW !!!
What is Cost Object ???
Cost Object is anything for which a separate measurement of cost is required. It is any thing for which you are calculating a Cost
for.
Cost object may be a product , a service , a project , a brand category , an activity , a department or a programme and so on.
Cost Classification
Examples of Cost Object are:
Particulars Details
Product Smart Phone , Tablet , Computer , SUV Car , Book and so on.
Service An airline flight from Kathmandu to Pokhara , Concurrent Audit Assignments , Utility Bills Payment Facility and
so on.
Project Road Projects , Hydroelectricity Projects , Irrigation Projects and so on.
Activity Quality Inspection , Order Placement , Procurement and so on.
Process Refinement of Crudes in Oil refineries , melting of billets or ingots in rolling mills and so on.
Department Production Department , Finance & Accounts Department , Safety Department , Human Resources Department
and so on.

What is your Cost of Taking Class on You Tube or any Online Media ?????
✓ Bills are per Internet Consumed
✓ Electricity Cost for Units Consumed by Laptop and Lighting
✓ Cost of Pen or Pencil Used for Writing
Cost Classification
✓ Cost allocated for Depreciation of Laptop being used.
In the Same way you can calculate cost of anything for which a separate measurement of cost is required. Like , You Can
Calculate Cost for :
❖ A Day Spent travelling
❖ Cost of Studying ACCA
❖ Cost of Coming to college today
❖ Cost of Studying till SEE
❖ and so on for which you think you would require cost for is called COST OBJECT.
NOW !!!
Let’s Know What is Cost Unit ???
Till now whatever the amount of cost you have calculated or get comes in total for a particular Cost Object . And Total amount
can be in Hundreds , Thousands and Millions. So , we can make cost simpler or short by dividing total amount or cost in Unit
Level/Rate Level.
Cost Unit is a unit of a product , service or time ( or combination of these ) in relation to which costs may be ascertained or
expressed. Cost Units are usually the units of physical measurement like number , weight , area , volume , length , time and
Value.
Cost Classification
Examples of Cost Unit are:
Industry or Product Cost Unit
Automobile Number
Cement Ton , Ton/Per Bag
Chemicals Liter, Gallon, Kilogram , Ton and so on.
Power Kilo-Watt Hour (KWh)
Audit Firm/Consulting Firm Per Client Per Hour
Hotel Per Room Per Day
Bus Per Passenger Per Kilometer

Look here , Where Single Cost Unit are Used and Where Double Cost Units are used ?
The Case of Double Cost Units used is called Composite Cost Units.
So , In theme Cost Units is how you express the calculated total cost for a particular Cost Object so that it can easily be
understood by everyone who wants to know the actual cost. So , for making others to understand the cost in Lump Sum is not
always easy and becomes hectic if we repeat every time the amount in Hundreds , Thousands and Millions. So , we calculate the
rate for the total cost for making it simple to be understood by everyone who is willing to know about the cost of the anything .
Cost Classification
What is Cost Driver ????
Driver or bases what drives the cost associated with a particular activity.
For Example : If Volume of Bases Increased , it’s associated cost will also increase !!
i. Material Cost is based on the units of materials purchased.
ii. Electricity Cost is based on the units of electricity consumed.
iii. Rental Cost is based on the area of the space occupied
A Cost Driver is a factor or variable which effects the level of cost. Generally , it is an activity which is responsible for cost
incurrence. Level of activity or Volume of Production is an example of a cost driver. An activity may be an event , task , or unit of
work.
Examples of Cost Drivers ;
1) Number of Machines Setting Ups
2) Number of Purchase Orders
3) Hours Spent on Inspection of a Product
4) Number of Tests Performed
Cost Classification
By Relation to Cost Centre or Cost Unit :
Product/Cost Object/Cost Centre
1) Traceable Cost : Looking at the cost object / Product you can directly see what cost has been incurred there. So , it is the cost
that you can visualize or identify in amount with certainty that has been incurred in that Product/Cost Object. The Group of
Traceable Costs are called DIRECT COSTS. The Sum of All Direct Costs is called PRIME COST which includes Direct
Material , Direct Labour and Direct Expenses.
2) Non-Traceable Cost : Looking at the cost object / Product you can't directly see what cost has been incurred there but you
realize it when someone makes you aware about that cost has been incurred for making that product. So , it is the cost that you
can’t visualize or can’t identify in amount with certainty that has been incurred in that Product/Cost Object. The Group of Non-
Traceable Costs are called INDIRECT COSTS. These costs are commonly called OVERHEADS.[ As it was over the head
which was not usual to expect for making the product or services, so it is non-traceable cost]. Overheads includes Indirect
Material , Indirect Labour and Indirect Expenses.
Summary : If 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.
DIRECT COSTS:
1) Direct Materials : Materials which are present in the finished product ( Cost Object ) or can be economically identified in the
product are termed as direct materials.
Cost Classification
For Example :
1) Cloth in Making Dress
2) Materials Purchased for a Specific Job
However , in some cases a material may be direct, but it is treated as indirect ; because it is used in small quantities as it is not
economically feasible to identify that quantity.
So , those materials which are used for purposes ancillary to the business are also treated as Indirect Materials.

2) Direct Labour : Labour which can be economically identified or attributed wholly to a cost object is termed as Direct Labour.
For Example :
1) Employee engaged on the actual production of the product or in carrying out the necessary operations for converting the raw
materials into finished product.
3) Direct Expenses : All expenses other than direct material or direct labour which are specifically incurred for a particular cost
object and can be identified in an economically feasible way are termed as Direct Expenses.
For Example : 1) Hire Charges For Special Machinery
2) Cost of Defective Work
Cost Classification
INDIRECT COSTS:
1) Indirect Materials : Materials which do not normally/specifically form part of finished product ( Cost Object ) are known as
Indirect Materials .
For Example :
1) Stores Used For maintaining Machines and Buildings ( Lubricants , Cotton Waste , Bricks etc. )
2) Stores Used By Service Departments Like Powerhouse , Boiler House , Canteen etc.
2) Indirect Labour : Labour Cost which cannot be allocated but can be apportioned to or absorbed by Cost Units or Cost
Centres or finished product ( Cost Object ) are known as Indirect Labour .
For Example :
1) Salary paid to Supervisors
2) Salary Paid to Maintenance Workers.
3) Indirect Expenses : Expenses other than direct expenses are known as indirect expenses. Theses cannot be directly ,
conveniently and wholly allocated to cost centres.
For Example : Factory Rent and Rates , Insurance of Plant and Machinery , Power , Light , Heating , repairing , telephone etc.,
are some examples of indirect expenses.
Cost Classification
INDIRECT COSTS:
The aggregate of indirect materials costs , indirect Labour Costs and Indirect expenses are termed as overheads. The Main
groups unto which overheads are subdivided as follows :
1) Production or Work Overheads : Indirect Expenses which are incurred in the factory and for the running of the factory. For
Example : Factory Rent & Power .
2) Administration Overheads : Indirect Expenses related to management and administration of business . For Example : Office
Rent , Lighting and Telephone Expenses.
3) Selling Overheads : Indirect Expenses Incurred For Marketing of a Product. For Example : Advertisement Expenses ,
Commission to Salespersons.
4) Distribution Overheads : Indirect Expenses Incurred For Dispatch of Goods . For Example : Warehouse Charges ,
Packaging Charges , Loading Charges.
5) Quality Control Overheads
6) Research & Development Overheads
Cost Classification
By Functions :
A business enterprise performs several functions like manufacturing , selling , research and so on. Costs may be required to be
determined for each of these functions and based on functional costs may be classified into following types :
1) Production or Manufacturing Costs : It is the sum of the cost of all items involved in the production of a product or service.
These refers to the costs of operating a manufacturing division of an undertaking and include all costs incurred by the factory
from the receipt of the raw materials and supply of labour and services until production is completed along with the finished
product packed with the primary packaging. The following costs are considered as production or Manufacturing costs;
i. Direct Materials
ii. Direct Labours
iii. Direct Expenses
iv. Factory/Manufacturing/Production Overhead
▪ Variable Production Overheads
▪ Fixed Production Overheads

2) Administration Costs : Administration costs are expenses incurred for general management of an organization. These are in
nature of indirect costs and are also termed as administrative overheads. Administration Cost Includes ;
Cost Classification
▪ Salary & Allowance of Staffs , Accountants and Directors
▪ Rent & Rates
▪ Depreciation of Office Assets
▪ Printing & Stationery
▪ Telephone Expenses
▪ Office Supplies and Expenses
▪ Other General Administration Expenses
3) Selling & Distribution Costs : Selling Costs are indirect Costs related to selling of product or services and include all indirect
costs in Sales Management for the organization. Selling Function includes activities directed to cerate and stimulate demands of
company’s product and secure orders.
Distribution Costs are Costs incurred in handling a product form the time it’s completed in the work until it reaches the ultimate
customers. These costs are incurred to make saleable goods available in the hands of the customers.
Examples :
▪ Salaries and Commission of Salesman and Sales Managers
▪ Expenses Related to Advertisement and Promotion
Cost Classification
▪ Rent , rates , depreciation and insurance of Sales offices and Warehouses.
▪ Maintenance of Delivery Vans
4) Research & Development Costs : Research & Development Costs are the costs for undertaking research to improve quality of
a present product or improve process of manufacture , develop a new products , market research & So on.
Examples :
▪ Development of New Product
▪ Improvement of Existing Product
▪ Finding New Uses for Known Products
▪ Solving Technical Problem arising in manufacture and application of products
Development Costs includes the cost incurred for commercialization /Implementation of research findings.
5) Pre-Production Costs : These are the Costs incurred when a new factory is in the process of establishment , a new project is
undertaken , or a new product line or product is taken up but there is no established or formal production to which such costs
are charged. Preproduction costs are normally treated as deferred revenue expenditure and charged to the costs of future
production.
Cost Classification
By Variability & Behaviour :
Examples :
Suppose following are the Cost Details
Units Costs 1 Cost 2 Cost 3
1,000 5,000 10,000 7,000
5,000 25,000 10,000 23,000
Identify the behaviour of each costs.
Check Cost 1
Units Cost 1 Rate /Unit
1,000 5,000 5
5,000 25,000 5
▪ Rate Per Unit is Constant
▪ Proportionate Change is Amount
Cost Classification
By Variability & Behaviour :
Examples :
Suppose following are the Cost Details
Units Costs 1 Cost 2 Cost 3
1,000 5,000 10,000 7,000
5,000 25,000 10,000 23,000
Identify the behaviour of each costs.
Check Cost 2
Units Cost 1 Rate /Unit
1,000 10,000 10
5,000 10,000 2
▪ Total Amount is Constant
▪ Rate per unit decrease with increases in Activity Level/Units.
Cost Classification
By Variability & Behaviour :
Examples :
Suppose following are the Cost Details
Units Costs 1 Cost 2 Cost 3
1,000 5,000 10,000 7,000
5,000 25,000 10,000 23,000
Identify the behaviour of each costs.
Check Cost 3
Units Cost 1 Rate /Unit
1,000 7,000 7
5,000 23,000 4.6
▪ Total Amount is Changing but not proportionately
▪ Total Amount is also not constant.
▪ Rate per unit neither decrease with increases in Activity Level/Units nor Rate Per unit is Constant.
Cost Classification
Cost Card : Template
Cost Per Unit
Direct Material
***
Direct labour
***
Direct Expenses
***
PRIME COST
***
Variable Production Overheads
***
Total Variable [ Marginal ] Production Cost
***
Fixed Production Overheads
***
Total Production [ Absorption ] Cost
***
Variable Non-Production Cost
***
Fixed Non-Production Cost
***
Total Cost
***
Cost Classification
Total Cost ( TC ) = Fixed Cost(FC) + Variable Cost Per Unit ( VC/Unit ) * Activity Level
CASE I : High Low Method for Separating a Mixed Cost
STEP 1 : Select the Highest and Lowest Activity Levels , and their associated Costs
STEP 2 : Calculate the Variable Cost Per Unit
Variable Cost Per Unit = Cost at Highest Level of Activity – Cost at Lowest Level of Activity
Highest Level of Activity – Lowest Level of Activity

STEP 3 : Calculate the Fixed Cost per Unit by Substitution , using either higher or lower activity Level
Fixed Cost = Total Cost at Activity Level – ( Variable Cost Per Unit * Activity Level )

STEP 4 : Calculate the total cost for different activity levels

Cost Classification
Question For Practice :
1) Illustration 2
2) Illustration 3
3) Test Your Understanding 7
CASE II : High Low Method for Separating a Mixed Cost with Stepped Fixed Cost
STEP 1 : Select the two activity levels where fixed cost remain unchanged and calculate the variable cost per unit
and total fixed cost using Steps in CASE I
STEP 2 : Make Adjustment For Fixed Costs when calculating the total cost for a new activity Level.
Question For Practice :
1) Illustration 4
Cost Classification
By Variability & Behaviour :
Graph of Variable Cost
Cost Classification
By Variability & Behaviour :
Graph of Fixed Cost
Cost Classification
By Variability & Behaviour :
Graph of Stepped Fixed Cost
Cost Classification
By Variability & Behaviour :
Graph of Semi Variable Cost
Cost Classification
Cost Equation : Cost equation are derived from historical cost data. Cost equation are assumed to have a linear
function and therefore the equation of Straight Line can be applied :
y = a + bx
Where
a = the intercept , the point at which the line y = a + bx cuts y axis ( the value of y when x = 0 )
b = the gradient/slope of the line y = a + bx cuts y axis ( the change in y when x increases by one unit )
x = Independent Variable
y = Dependent Variable
This Formula can be related to the results of the high low calculation as follows :
a = the intercept / the Fixed Cost
b = the gradient(slope of the line)/ Variable Cost per Unit
x = Independent Variable / Activity Level
y = Dependent Variable / Total Cost
Cost Classification
Suppose a cost has a cost equation of y = $5,000 + 10x , which can be shown graphically as follows :
Cost Classification
Questions :
1) Illustration 6
2) Test Your Understanding 5
3) Test your Understanding 6
4) Test Your Understanding 9
5) Test Your Understanding10
Cost Classification
Cost Codes :A code is a system of symbols designed to be applied to a classified set of items , to give a brief accurate
reference , which helps entry into the records , collation ( Assembling in a proper numerical or logical Sequences )
and analysis. A cost code is a code used in a costing system.
Accounting codes are not universal as every accountant , accounting firm , institution or business may create its own
coding system in accounting tailored to its own organization needs.
For Example : For a Tailoring Centre costs are :
Cloth -> 01
Button -> 02
Thread -> 03
Chalk -> 04
Stitching -> 05
Purchase -> P
Sales -> S
P 01 -> Cloth in Purchase
Cost Classification
Requirement of Efficient Coding System :
1) Unique Numbering
2) Elasticity and Comprehensive ( Capable of Expanding to accommodate new items )
3) Brief and Meaningful
4) Central Code ( Maintenance Related to coding should be centrally controlled. It should not be possible for an
individual to independently add new codes to existing coding system )
5) Same Length ( Errors should be easier to spot and assists computerized data processing )
Cost Classification
The first step in creating a cost code will be to determine the cost centre to which the cost relates and then allocate
the correct cost centre code.
1) Generic or Functional Codes : It’s a general code allocated to the group of expenses involved in the
organization. Once Correct Cost Centre codes are allocated, they we can allocate codes to the codes to the
group of expenses incurred as follows which is called generic or functional codes.
For Example : Cost Center : Machining Department is allocated Code : 07 , after that there are different cost
incurred in that department which is displayed as follows :
1) Oil-> Indirect Materials
2) Parts of Machine -> Indirect Expenses
3) Machine Operator for a specific product -> Direct Labour
4) Depreciation -> Indirect Expenses
5) Repair & Machinery -> Indirect Expenses
Here the Group is Direct Labour referred as 23 , Indirect Materials referred as 24 , Indirect Expenses referred as
25.
Cost Classification
2) Specific Codes :Finally, after functional allocation , it may be necessary for cost allocation , decision making or
accounting purposes to allocate a code which specifically identifies the item of cost are called specific codes.
For Example : Cost Center : Machining Department is allocated Code : 07 , after that there are different cost
incurred in that department which is displayed as follows :
1) Oil-> Indirect Materials
2) Parts of Machine -> Indirect Expenses
3) Machine Operator for a specific product -> Direct Labour
4) Depreciation -> Indirect Expenses
5) Repair & Maintenance -> Indirect Expenses
Here the Group is Direct Labour referred as 23 , Indirect Materials referred as 24 , Indirect Expenses referred as
25.
Then the specific codes are used for every item of expenses like Oil referred as 04 , Parts of Machine referred as 05
, Machine operator for a specific product referred as 06 , Depreciation referred as 07 and Repair & Maintenance
referred as 08.
Cost Classification
Coding Systems
1) Mnemonic Code : It Means something that aids the memory or understanding. This uses an alphabetical
coding rather than a numerical coding system. It is often used to abbreviate or simplify information.
For Example : In Accounting we might use :
Code Meaning
ACT Accounting
NCA Non-Current Assets
EXP Expenses
REV Revenue
GTL Grand Total
MA Management Accounting
FA Financial Accounting
DT Date
Cost Classification
Coding Systems
2) Block Codes : Codes that are assigned to a block also known as group classification.
For Example : In Accounting we might use :
Code Meaning
3000 Current Assets
2000 Non-Current Assets
0000 Expenses
1000 Revenue
4000 Long Term Liability
5000 Equity
In a block it is possible to classify up to any number of line items related to the Group.
Cost Classification
Coding Systems
3) Faceted Codes : Codes that are refinement of group classification.It Includes Series of Group Number that
represents different headings.
For Example : In Accounting we might use
1000 as Group Code For Revenue
Code Meaning
01 Revenue from Online Sales
02 Revenue from Counter Sales
03 Revenue from Other Sales
0000 as Group Code For Expenses
Code Meaning
00 Expenses for Sales & Marketing
01 Expenses for Office Supplies
03 Expenses For Labour
Cost Classification
Coding Systems
4) Hierarchical Codes : It’s a type of faceted code which can infinitely expand upon if needed in a manner that is
structured or logical.
For Example : We might use
808 as Group Code Assets
Code Meaning
808.01 Financial Assets
808.01.001 Type of Financial Assets ( Act as sub-Section )
809 as Group Code Liabilities
Code Meaning
809.01 Current Liabilities
809.01.001 Type of Current Liabilities ( Act as sub-Section )
Cost Classification
Coding Systems
5) Sequential Codes : This is the most basic type of code. Its progressive /serial code that uses number/alphabet in
a consecutive order. Planning is required in advance to determine how many codes might be needed in total.
For Example : Let’s assume we are making a coding list for different types of expenses.
Code Meaning
01 Motor Expenses
02 Communication Expenses
03 Utilities Expenses
..
..
..
04 Other Expenses
It can be used for as many types of expenses we want to make.
Cost Classification
Coding Systems
Advantages :
1) Saves Time as smaller than description
2) Reduce Ambiguity ( Unclearness )
3) Facilitates Computerized Accounting
4) Maintains Secrecy ( Desires to maintain secrecy for some specific item or cost )