What is Cost Classification?
Types of Cost Classification
Let us discuss some types of cost classification.
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#1 – Fixed and Variable Cost
These are the two primary categories to segregate the costs; fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more can be accounted for during the start of any project, and a part of variable expenses can be anticipated too. However, variable cost accounts for the cost associated with the units produced and any unaccounted cost.
#2 – Distribution Channel Cost
These expenses are channeled into retail, wholesale, and the internet. Revenues from each of the channels come after deducting the cost from sales.
#3 – Customer Cost
These are the costs a company gets involved in to maintain its reputation and after-sale service for the customers. This cost includes returns, warranties, or customer service. The company then evaluates this information about the individual consumers to increaseProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more and customer targeting.
#4 – Departmental Cost
Expenses related to individual departments are assigned to respective departmental managers, which are then used to analyze the manager’s performance and develop trend analysisTrend AnalysisTrend analysis is an analysis of the company’s trend by comparing its financial statements to analyze the market trend or analysis of the future based on past performance results, and it is an attempt to make the best decisions based on the results of the analysis done.read more to identify the potential of the manager.
Basis of Cost Classification
Now since we have seen the categories of the cost classification briefly, let us examine the basis on which the costs are segregated:
As the category suggests that this is the expense to be recorded in how the company bears it and for its use. Some major categories can be material and labor. For instance, raw material costs and other costs related to the procurement of the raw material will fall under Material charges. Similarly, salary and wages will belong to labor costsLabor CostsCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more.
Here the costs are divided as they are allocated to different functions in the company, like production, commercial, administration Distribution CostsDistribution CostsDistribution cost is the total of all expenses incurred by the producer to make possible the delivery of the product from its location to the location of the end customer.read more, and Research and Development costs. All the categories include the costs of their nature of occurrence throughout the whole production cycle.
It depends on the nature of the cost, like whether it is a fixed, variable, or, semi-variable costSemi-variable CostFixed and variable costs combine to form semi-variable costs. Because semi variable costs are influenced by both fixed and variable costs, they are also referred to as mixed costs.read more. Rent, Lease, and salary come under Fixed expenses; Packaging and commission fall under the variable head; lastly, management, power consumption, and maintenance costs come under semi-variable costs.
As we know, costs to the company are not only a number but also a tool to make managerial decisions. So, management decides how to distinguish the costs and what categories they should be bifurcated into Marginal Cost,, Differential cost, Sunk Cost, Abnormal Cost, Replacement cost, and so on.
This type of category is generally used by the companies involved in the manufacturing business where there are a lot of processes to be followed by the product to become a finished product. Some examples of this cost may be Batch cost Process costProcess CostProcess costing is a method of costing wherein the products go through two or more processes and the costs are assigned/charged to individual operations averaged over the number of units produced during that time. It is used commonly in manufacturing units like paper, steel, soaps, medicines, vegetable oils, paints, rubber, and chemicals.read more, Contract cost, Joint cost, and so on.
The cost comes to the company as it depends on the time frame the cost has occurred. The expense of today’s importance may not hold any value tomorrow, so the basic categories in this can be Historical, pre-Determined, Standard, and Estimated costsEstimated CostsCost estimate is the preliminary stage for any project, operation, or program in which a reasonable calculation of all project costs is performed and thus requires precise judgement, experience, and accuracy.read more. Based on these subcategories helps the management to effectively distribute the costs per their occurrence time, which eventually leads to a broader picture of cost evaluation.
Conclusion
As much as cost is an expense to the company, it is also considered a tool for future evaluations. Categorizing the costs into appropriate categories gives us a clear picture of the whole business model and gives the management an eagle-eye view of the entire process.
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