Chapter 3 Cost Classification - Ibrahim Sameer · PDF fileChapter 3 Cost Classification Ibrahim Sameer (MBA ... Total Cost / Service Costs ... Types of Codes

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


• Analysis of total cost


• Direct Materials

• Direct materials is all material becoming part of

the product.

• For eg: component part, part finished product,

primary packing materials.


• Direct Labour

• Direct wages are all wages paid for labour

expended on work on the product itself.


• 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.


• 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


• A variable cost is a cost which tends to vary with

level of activity.

• Eg: Direct materials, sales commission


• 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.


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, direct labour and manufacturing

overheads.


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: 1 Nails

• 2 Screws

• 3 Bolts

• The 2nd digit: 1 Steel

• 2 Brass

• 3 Copper

Types of Codes

• The 3rd digit: 1 50mm

• 2 60mm

• 3 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 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 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.



• 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.



• 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



• 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.



• Investment centre

• An investment centre is a profit centre whose

performance is measured by its return on

capital employed.



• 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

Chapter 3 Cost Classification - Ibrahim Sameer · PDF fileChapter 3 Cost Classification Ibrahim Sameer (MBA ... Total Cost / Service Costs ... Types of Codes

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