Cost of Classification | Definition and Explanations

Cost of Classification | Definition and Explanations

Do you know the cost of classification uses of organizations?

Cost Classification refers to a complete and transparent idea of separation of expenses in the different sector as like manufacturing cost, product cost, sunk cost, variable cost, direct cost, and indirect cost etc. Classifications of cost are a vital part of a company. It is almost impossible to operate a business without understanding it properly. Recently I was researching on cost classification. I have gathered a complete idea about it. Today I am writing to you about the importance of cost classification. So, are you fond of knowing it? Let’s look at this paragraph for one time.

Cost classification is an extensive motive. We can divide the cost classification into several categories. Here are including the main categories.

  • Classification of cost according to the element
  • Cost classification according to function
  • Depending on behavior
  • According to relevancy
  • According to management

Classification of cost according to the element:

In according to element cost can be divided into two main categories. It is also known as classifications of cost by nature.

Direct cost:

It is such a cost that is able to mark directly any particular cost such as raw materials, labor included operating expenses and some other costs are belongs to the direct cost. These costs are bind in a unit. For example, we can say a total cost of an advertisement for several products. The direct cost has some subcategories.

  • Direct element: Direct element refers to that material which is related all of the finished product. This material is a part to complete any product. It can have imposed conveniently on the particular product. The purchased and upcoming requisite products are including in direct element. As like, all kinds of initial packing material.
  • Direct labor: Direct labor means the paid salary to the employee who is directly engaged in manufacturing, handling and processing a product. Actually, they are responsible for the observation and maintenance of the product also.
  • Direct expense: Which cost is directly related to any particular expenses is called direct expense. If a company needs to buy some specific product, equipment or tools are the examples of direct expense.

Indirect cost:

Indirect cost means the opposite side of direct cost. Which cost is related to a unit or department and can’t trace for any specific product is called indirect cost. The indirect cost has also some subcategories.

  • Indirect element: Some example of indirect materials is cleaning chemicals, small tools, glue, and maintenance work. Fuel etc. These element costs are incurred as a unit.
  • Indirect labor: Indirect labor is covering the supervisors and the inspector’s salary. The worker of cleaner and storekeeper wages is also including in the indirect labor.
  • Indirect expenses: Indirect expenses are house rent, hospital service, lighting, insurance, and welfare trust.

Indirect cost and the overhead cost is often the same. It follows the indirect labor cost formula.

  • Factory overheads:

It is related to all kinds of indirect costs like manufacturing products and time keeper’s salary.

  • Selling and distribution overhead:

This overhead is included with advertising expense and packing materials costs such as free advertising, marketing on the field.

  • Administration and office overhead:

Administrative expenses is an expense of office works related expenses such as office lighting, rent welfare trust are including here.

Cost classification according to function:

Cost is classified by the following categories. The main four categories of functional costs are given below-

  • Prime cost: Prime cost is the adjustment of the direct material, direct labor, and direct costs. It is actually the result of these three elements.
  • Product cost: It means the factory cost with administrative and office overheads
  • Factory cost: Factory cost is also known as work cost. It is combined with work cost and work expenses

Cost classifications depending on behavior:

By behavior or variability cost is classified as Variable cost, Fixed cost and Mixed cost which is explained below.

  • Variable cost: Variable cost is such a cost which proportion is changing with the amount of production. Such as direct material and changeable costs
  • Fixed cost: This cost won’t change with the proportion of production. It is maximum time fixed. But it is notable that this cost may be changed after a long time. For example, office rent, insurance, and hospital cost.
  • Mixed cost: Mixed cost can change overall but not with the proportion of production. More changeable cost is count under a Mixed cost. The example of a mixed cost is electricity expenses.

Cost classification according to relevance:

Relevance base cost is mainly divided into five categories which are given below;

  • Relevant cost: Which cost can be by making a new decision is called relevant cost. Occasionally there may have many relevant costs. This cost is not fixed from before.
  • Opportunity cost: Opportunity cost is the system of getting some extra advantages from the existing things of a factory like land, money and time etc. Someone can rent his office for another purpose of advantages. Moreover, they can rent their other things also. It is actually an extra benefit for a company.
  • Standard cost: Standard cost is fixed from the previous experience. It was fixed according to the specific budget, the volume of an industry. The actual cost is also included with this cost.
  • Controllable cost: Which cost can be controlled by management is called controllable cost. The manager can control some cost.
  • Sunk cost: It is known as a historical cost. Sunk cost effect is most important for a company. It is such a cost which is already lost and can’t be undone anymore. If a company is paid their monthly rent than we can say this rent cost is sunk cost.

Classification of cost according to management:

These costs are mainly divided into two categories; Manufacturing cost and Non-manufacturing cost given are givn below;

  • Manufacturing cost: Manufacturing cost refers to the total cost of a product from the raw materials to finish the product. It is mainly the combination of direct material cost, labor cost, and manufacturing overheads.
  • Non-manufacturing cost: In order, the rules of GAAP Non-manufacturing cost are not actual product cost. It is a part of the company’s income statement.

Final Words:

A proper knowledge of classifications of costs mandatory for increasing development of a company perfectly. Moreover, the accounting students must have to clear idea about it. I hope this article will be helpful to you to know the cost classification on your organization and you will able to maintain this very well.

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