Costing systems & classification

Costing Systems &

Classification of Cost

Lincy Rinil

Costing Systems

The most popular systems of costing that are used by the organizations are:• Absorption Costing• Marginal Costing• Standard Costing• Activity-based Costing• Uniform Costing

Absorption Costing

• It is a costing system which recognizes all costs that have actually been incurred in producing a product.

• The system, in fact considers both fixed as well as variable cost while ascertaining the cost of the product.

Marginal Costing

• It is the ascertainment of marginal cost by differentiating between fixed and variable cost.

• It is used to ascertain the effect of changes in volume or type of output on profit.

Standard Costing

• A comparison is made of the actual cost with a pre-arranged standard and the cost of any variation (called variances) is analysed by causes.

• This permits the management to investigate the reasons for these variances and to take suitable corrective action.

Activity-Based Costing

• The Activity-Based Costing (ABC) system is a system based on activities linking spending on resources to the products/ services produced delivered to customers.

• The ABC system, first accumulates indirect costs for each of the activities of a particular plant, department of an organisation and then assigns costs of activities to the products, services and other cost objects that require the activity.

Uniform Costing

• It is the use of same costing methods, techniques, principles and practices by several undertakings for common control and comparison of costs.

• Such an arrangement, in fact, encourages the member organisations to use the performance of different units/firms within the industry as a benchmark for the purpose of having comparative study of their performance.

Classification of cost

According to:1. Nature/ Elements2. Function 3. Degree of traceability to product4. Change in Activity / Volume5. Controllability6. Normality

Classification of cost contd….

7. In relationship with accounting period8. Time9. Planning & control10. Association with the product11. Managerial decisions

The Product

MaterialsMaterials LabourLabour ExpenseExpense

1. Elements of Costs

Direct Materials

Those materials that become an integral part of the product and that can be conveniently traced

directly to it.

Example: A radio installed in an automobileExample: A radio installed in an automobile

Indirect Material

Those materials that do not become an integral part of the product but which helps in

production.

Example: indirect materialsExample: indirect materials

Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Direct LaborThose labor costs that can be easily traced to

individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers

Indirect Labour

Those labor costs that cannot be easily traced to individual units of product.

Examples: Indirect labor Examples: Indirect labor

Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards.

Expense

• The cost of services provided to an undertaking and the notional cost of the use of owned asset.

• Expenses are of two types: Direct expense Indirect expense

Expense

• Direct expense is an expense which is incurred with manufacture of a product.

Eg: Purchase of raw materials, factory labour, factory wages, electricity

• Indirect expense also called as overhead are additional expenses which are incurred on bringing a product to final customer.

Eg: Sales and Distribution, Office Salary, office electricity, office water, printing and stationery, outsourcing expenses, advertising expenses etc.

2. Function

i. Manufacturing & Production Costii. Commercial Cost

a. Administrative Costb. Selling & Distribution Cost

3. Degree of traceability to product

Direct costsCosts that can beeasily and conveniently traced to a unit of product or other cost objective.

Examples: direct material and direct labor

Indirect costsCosts cannot be easily and conveniently traced to a unit of product or other cost object.

Example: manufacturing overheads like oil, cotton, etc.

4. Change in volume

How a cost will react to changes in the level of business activity.

– Total fixed costs remain unchanged when activity changes.

– Total variable costs change when activity changes.

– Semi-variable costs are those which are partly fixed and partly variable

How a cost will react to changes in the level of business activity.

– Total fixed costs remain unchanged when activity changes.

– Total variable costs change when activity changes.

– Semi-variable costs are those which are partly fixed and partly variable

5. Controllability

Controllability

Uncontrollable Cost

Controllable Cost

6. Normality

Normality

Normal cost Abnormal cost

7. In relationship with accounting period

• Capital Expenditure• Revenue Expenditue

8. Time

Time

Historical cost Predetermined cost

9. Planning & Control

Planning & Control

Standard cost Budgeted Cost

10. Association with the product

Product costs include direct materials, direct

labor, and manufacturing

overhead.

Period costs are not included in product

costs. They are expensed on the

income statement.

11. For Managerial decisions

• Marginal Cost• Out of Pocket Cost • Differential Cost• Opportunity Cost• Sunk Cost

Opportunity Costs

The potential benefit that is given up when one alternative is selected over another.

Example: If you werenot attending college,you could be earning$15,000 per year. Your opportunity costof attending college for one year is $15,000.

Sunk Costs Sunk costs cannot be changed by any decision. They are not

differential costs and should be ignored when making decisions.

Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.