Accounting Lecture: Cost Classification

Introduction

• Cost Classification: Arrangement of cost items logically based on nature, characteristics, and their purposes. Grouping of similar cost items.

Cost Classification Based on Behavior

1. Variable Costs
   • Increase or decrease proportionately with activity level.
   • No cost if no activity. Cost increases as activity increases.
   • Graph shows direct proportional increase.
2. Fixed Costs
   • Constant within a relevant range regardless of output level.
   • Graph shows a horizontal line within the relevant range.
3. Semi-Variable (Mixed) Costs
   • Combine fixed and variable components.
   • Example: Electricity bill with a fixed rate and a variable rate based on usage.
   • Graph starts above zero due to fixed component.
4. Semi-Fixed (Step Fixed) Costs
   • Fixed cost that steps up to a new level after exceeding a certain activity level.
   • Graph shows horizontal steps as activity level increases.

Cost Classification Based on Traceability

1. Direct Costs
   • Can be directly traced to the final product (e.g., direct materials, direct labor).
2. Indirect Costs
   • Cannot be directly attributed to specific products (e.g., supervisor salary, electricity for general operations).

Cost Classification Based on Function

1. Manufacturing Costs
   • Incurred in production (e.g., direct materials, labor, manufacturing overheads).
2. Non-Manufacturing Costs
   • Not related to production (e.g., administration, selling, distribution, finance, and R&D costs).

Cost Classification Based on Controllability

1. Controllable Costs
   • Costs influenced by managerial actions (e.g., labor costs through remuneration methods).
2. Non-Controllable Costs
   • Costs not influenced by managerial actions (e.g., taxes, mandated wage increases).

Cost Classification Based on Association with Products

1. Product Costs
   • Incurred to produce or acquire products, included in inventory value.
2. Period Costs
   • Incurred over time, not directly tied to products (e.g., rent).

Cost Classification Based on Relevance to Decision-Making

1. Relevant Costs
   • Future costs differing among decision alternatives.
2. Irrelevant Costs
   • Costs that don't change between alternatives.
3. Sunk Costs
   • Past costs, already committed, not changed by future decisions.
4. Standard Costs
   • Predetermined unit cost based on operational analysis.
5. Avoidable Costs
   • Can be eliminated by not adopting a decision (e.g., variable manufacturing costs when buying externally).
6. Unavoidable Costs
   • Cannot be avoided regardless of decisions.
7. Incremental (Differential) Costs
   • Difference in cost between alternatives.
8. Marginal Costs
   • Cost of one additional unit.

Cost Classification Based on Cash Flow

1. Implicit Costs
   • No actual cash movement (e.g., depreciation).
2. Explicit Costs
   • Actual cash outflows (e.g., rent, salaries, advertising).

Conclusion

• Understanding cost classifications helps in accounting and decision-making processes.

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