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Chapter 3

Cost Classification
Ibrahim Sameer (MBA - Specialized in Finance,
B.Com Specialized in Accounting & Marketing)

www.ibrahimsameer.wordpress.com

Total Cost / Service Costs


A direct cost is a cost that can be traced in full to
the product, service, or department that is being
costed.
An indirect cost (or overhead) is a cost that is
incurred in the course of making a product,
providing a service or running a department, but
which cannot be traced directly and in full to
the product, service or department.

Direct Cost & Indirect Cost


Primary data are data collected especially for a
specific purpose. Raw data are primary data
which have not been processed at all, and which
are still just a list of numbers.
For Eg: Telephone survey conduct by Dhiraagu to
monitor the effectiveness of the customer service.

Examples of Direct Cost &


Indirect Cost

Direct Cost & Indirect Cost


Analysis of total cost

Direct Cost & Indirect Cost


Direct Materials
Direct materials is all material becoming part of

the product.
For eg: component part, part finished product,
primary packing materials.

Direct Cost & Indirect Cost


Direct Labour
Direct wages are all wages paid for labour

expended on work on the product itself.

Direct Cost & Indirect Cost


Direct Expenses
Direct expenses are any expenses which are

incurred on a specific product other than direct


material cost and direct wages. It is also referred
as chargeable expenses.
For eg: the hire of tool or equipment for particular
job, maintenance costs of tool.

Direct Cost & Indirect Cost


Production overhead
Production OH include all indirect material costs,

indirect wages and indirect expenses incurred


in the factory from receipt of the order until its
completion.

Functional Costs
Classification by Function
Classification by function involves classifying

costs

as

production

manufacturing

costs,

administration costs or marketing / selling and


distribution cost.

Functional Costs
Functional cost Includes:
Production cost

Administration cost
Selling cost

Distribution costs

Fixed Costs & Variable Costs


A fixed cost is a cost which is incurred for a
particular period of time and which, within certain
activity levels, is unaffected by changes in the
level of activity.
Eg: Rent

Fixed Costs & Variable Costs


A variable cost is a cost which tends to vary with
level of activity.
Eg: Direct materials, sales commission

Fixed Costs & Variable Costs


Many items of expenditure are part fixed and part
variable and hence are termed as semi fixed or
semi variable costs.
Eg: telephone call charges

Production & Non Production


Cost
For the preparation of financial statements, costs
are often classified as production costs and non
production costs.

Production & Non Production


Cost
Production costs are all the costs involved in
the manufacture of goods. In the case of
manufactured goods, these costs consist of direct
material,
overheads.

direct

labour

and

manufacturing

Production & Non Production


Cost
Non - Production costs are taken directly to the
income statement as expenses in the period in
which they are incurred; such cost consist of
selling and administrative expenses.

Controllable cost & Period cot


Controllable cost
Controllable costs are items of expenditure which

can be directly influenced by a given manager


within a given time span. OR
A cost which can be influenced by its budget
holder.

Controllable cost & Period cot


Period cost
Period costs is charged against the sales for the

period. It is not carried forward in inventory to a


future period. OR
A cost that relates to a time period which is
deducted as expenses for the period and is not
included in the inventory valuation.

Cost Codes
Once costs have been classified, a coding system
can be applied to make it easier to manage the
cost data, both in manual systems and in
computerized systems.

Cost Codes
Feature of a good coding system
The

code

must

be

easy

to

use

and

communicate.
Each item should have unique code.
The coding system must allow for expansion.
The coding system should be brief.
The likelihood of error going undetected should be
minimized.

Types of Codes
Sequential (or progressive) codes
Numbers are given to items in ordinary numeral

sequence, so there is no obvious connection


between an item and its code. For example
000042

42cm nail

000043

office stapler

000044

hand wash

Types of Codes
Block (or group classification) codes
These are an improvement on simple sequence

codes, in that digit (often the first one) indicates the


classification of an item. For example
4NNNNN

Nails

5NNNNN

Screws

6NNNNN

Bolts

Types of Codes
Faceted codes
These are a refinement of block codes, in that

each digit of the code gives information about an


item. For example

Types of Codes
The 1st digit:

Nails

Screws

Bolts

The 2nd digit:

Steel

Brass

Copper

Types of Codes
The 3rd digit:

50mm

60mm

75mm

A 60mm steel screw would have a code of 212

Types of Codes
Mnemonic codes
Under this type of coding the code means

something, it may be an abbreviation of the object


being coded. Most of the time airport use this type
of coding. For example
SIN Singapore
LAX Los Angeles

Types of Codes
Hierarchical codes
This is a type of faceted code where each digit

represents a classification, and each digit further to


the right represents a smaller subset than those to
the left. For example
3 = Screws
31 = flat headed screws

Advantages of Coding
A code usually briefer than a description, thereby
saving clerical time in a manual system & storage
space in a computerized system.
A code is more precise than a description and
therefore reduce ambiguity.
Coding facilitates data processing.

Cost unit, Cost object &


Responsibility centres
Cost centres
Cost centres are collecting places for costs

before they are further analysed. Cost are further


analysed into cost units once they have been
traced to cost centres.
Cost centres may include a department, a
machine, a project.

Cost unit, Cost object &


Responsibility centres
Cost units
A cost unit is a unit of product or service to

which cost can be related. The cost unit is the


basic control unit for costing purpose.
Eg: room (in hotel), Barrel (in the brewing industry)

Cost unit, Cost object &


Responsibility centres
Cost objects
If the user of management information wish to

know the cost of something, this something is


called a cost object.
Eg: the cost of product, the cost of service, the
cost of operating a department.

Cost unit, Cost object &


Responsibility centres
Profit centres
A profit centre is any section of an organization to

which both revenues and costs are assigned, so


that the profitability of the section may be
measured.
Remember that there can be several cost centres
within a profit centre.

Cost unit, Cost object &


Responsibility centres
Some examples of profit centre:
A sales division selling products to customers.

A service division providing after sales service.


Individual shop in a retail chain.

Local branches in a regional or nationwide


distribution business.
A geographical region. Eg: a country

Cost unit, Cost object &


Responsibility centres
Revenue centre
Revenue centres are similar to cost centres and

profit centres but are accountable for revenue


only.
Revenue centre managers should normally have
control over how revenues are raised.

Cost unit, Cost object &


Responsibility centres
Investment centre
An investment centre is a profit centre whose

performance is measured by its return on


capital employed.

Cost unit, Cost object &


Responsibility centres
Responsibility centre
A responsibility centre is a function or department

of an organization that is headed by a manager


who

has

direct

responsibility

for

its

performance. (OR)
It is an organization unit for which a manager is
made responsible.

Questions & Answers

Thank You

Ibrahim Sameer
Seek knowledge from cradle to grave

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