CHAPTER 2 COST CLASSIFICATION Flashcards
what types of cost summaries do management often require
- management require a variety of different cost summaries, including
o costs for a particular product – a cost unit or cost object
o costs for use in the preparation of external financial reports
o costs for a particular department – a cost centre
o costs to be used for decision making
o costs that are useful for planning and control - to be able to produce these summaries the type of cost and the cost behaviour will need to be analysed
what are cost objects
cost objects
- a cost object is any activity for which a separate measurement of cost is undertaken
- examples include cost of a product, cost of a service, cost of running a department, cost of running a regional office
what are cost units
cost units
- is a unit of product or service in relation to which costs are ascertained
- examples include a room in a hotel, an in patient in a hospital
what are cost centres
cost centres
- a production or service location, function, activity or item of equipment for which costs can be ascertained
- examples include a department, a project etc
what are cost cards
cost cards
- used to show the breakdown of the costs of producing output based on the classification of each cost.
- Can be produced for one unit or a planned level of production
what are the costs brought together and recorded on a cost card
- The following costs are brought together and recorded on a cost card
o Direct materials
o Direct labour
o Direct expenses
o Prime cost
o Variable production overheads
o Fixed production overheads
o Non production overheads
what are the 4 ways which costs are classified
costs can be classified in a number of ways
- Element
o Whether they relate to material, labour or expenses, useful for cost control
- Nature
o How they relate to production – are they directly involved in the production of the product/service or indirectly involved in production, useful for cost accounting
- Function
o Based on whether they are production costs or non production costs, useful for financial accounts
- Behaviour
o Based on how they change in relation to levels of output or activity, useful for budgeting and decision making
how are cost classified by element
To classify by element it must be decided if a cost is material, labour or an expense
- Materials
o All costs of materials purchased fr production or non production activities e.g. raw materials, maintenance, stationary
- Labour
o All staff costs relating to employees on the payroll
- Expenses
o Other costs which are not material or labour, includes rent, bought in services, depreciation of equipment
how are costs classified by nature
Direct costs
- Can be directly identified with a specific cost unit or cost centre
o 3 main types
Direct materials – cloth for making shirts
Direct labour – the wages of the workers stitching the cloth to make the shirts
Direct expenses – the royalties paid to a designer
- The total of direct costs is known as the prime cost
Indirect costs
- Costs which cannot be identified with a specific cost unit or cost centre
- 3 indirect costs include
o Indirect materials – cannot be traced to an individual item for example cleaning fluids for machinery
o Indirect labour – for example a supervisor who supervises the shirt makers
o Indirect expenses – cost of renting the factory where the shirts are manufactured
- The total of indirect costs is known as overheads
how are cost classified by function
5 classification by function
Production costs
- Costs that relate to the manufacture of a product or provision of a service
o Found in the cost of sales section of the statement of profit and loss
o Production costs, such as direct materials, direct labour, direct expenses and production overheads, are included in the ‘valuation of inventory’
Non production costs
- Costs that are not directly associated with the production of the business output
- Non production costs, such as administrative costs, selling costs and finance costs, are charged to the statement of profit and loss as expenses for the period in which they are incurred.
- Non production costs are not included in the ‘valuation of inventory’
how are costs classified by behaviour
Costs may be classified according to the way that they behave in relation to changes in levels of activity
- Cost behaviour classifies costs as one of the following
o Variable cost
o Fixed cost
o Stepped fixed cost
o Semi variable cost
what are variable costs
Variable costs
- Costs that vary in direct proportion with the level of activity. As activity levels increase then total variable costs will also increase
- Note that as total costs increase with activity levels, the cos per unit of variable costs remains constant
- Examples of variable costs include direct costs such as raw materials and direct labour
what are fixed costs
Fixed costs
- A cost which is incurred for an accounting period, and which, within certain activity levels remains constant
- The total costs will remain constant over a given level of activity but the cost per unit falls as level of activity increases
- Examples of fixed costs include rent, business rates, executive salaries
what are stepped fixed costs
- A type of fixed cost that is only fixed within certain levels of activity, once the upper limit of an activity level is reached then a new higher level of fixed cost becomes relevant
- Examples include – warehousing costs (as more space is required), supervisor wages
what are semi variable costs
- Contain both fixed and variable cost elements and are therefore partly affected by changes in the level of activity
- Examples include electricity bills (standing charge plus variable), telephone bills (fixed line rental plus variable)
