Cost Classifications

Chapter 1
Classification of cost
According to:
1. Elements
2. Nature
3. Function
4. Normality
5. Control-ability
6. Time
7. Decision making

The Product
Materials Labour
Expense
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 automobile
Indirect Material
Those materials that do not become an
integral part of the product but which
helps in production.

Example: indirect materials
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
Direct Labor
Those labor costs that can be easily traced to
individual units of product.
Example: Wages paid to automobile assembly workers
Indirect Labour
Those labor costs that cannot be easily
traced to individual units of product.

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

Direct and Indirect cots
Direct costs
Costs that can be
easily and conveniently
traced to a unit of
product or other cost
objective.
Examples: direct
material and direct labor
Indirect costs
Costs cannot be easily
and conveniently traced
to a unit of product or
other cost object.
Example:
manufacturing
overhead
Cost Behavior( nature)- fixed/
variable
How a cost will react to changes in the level of
business activity.
Total variable costs change when activity changes.
Total fixed costs remain unchanged when activity
changes.

Cost Classifications by
Predicting Cost Behaviour
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Variable Cost Per Unit
Per KBs used
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The cost per KB of DATA is constant. For
example, Re.5 per KB.

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Total Variable Cost
Your total DATA cost is based on how
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DATA used
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Total Fixed Cost
Your monthly basic cellphone bill does not
change when you make more calls.
Number of Local Calls
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NTT DoCoMo's wristwatch-style
cellphone
Fixed Cost Per Unit
Number of Local Calls
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The average cost per call decreases as more
local calls are made.
Quick Check Variable/Fixed Costs
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of Tissue for customers.
E. Rent of the store
F. Cost of Chocolate sauce

Quick Check Variable/Fixed Costs
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of tissue for customers.
E. Rent of the store
F. Cost of Chocolate sauce


Quick Check Variable/Fixed Costs
Which of the following costs would be variable
with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
Quick Check Variable/Fixed Costs
Which of the following costs would be variable
with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
The royalties on ticket sales is directly related to the number of
tickets sold.
The cost of cleaning up MAY also be variable if the theater pays
cleaning crews by the hour. The more tickets sold would
increase the time it would take to clean up the theater.
By Function
Marketing and
Selling Cost
Costs necessary to get the
order and deliver the
product.
Administrative
Cost
All executive,
organizational, and
clerical costs.
On the basis of normality
Normality
Normal cost Abnormal cost
On the basis of control- ability
Controllability
Controllable cost Uncontrollable cost
On the basis of time/ period
Time
Historical cost Predetermined cost
Product Costs Versus Period
Costs


Product costs include
direct materials, direct
labour, and
manufacturing
overhead.


Period costs are not
included in product
costs. They are
expensed on the
income statement.
Quick Check Period vs. Product Costs
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
Quick Check Period vs. Product Costs
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
On the basis of decision
making
Planning & Control
Standard cost Budgeted Cost
Differential Costs and
Revenues
Costs and revenues that differ among
alternatives.
Example: You have a job paying Rs1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays Rs 2,000 per month. The commuting
cost to the city is $300 per month.
Differential revenue is:
Rs2,000 Rs1,500 = Rs500
Differential cost is:
Rs300
Decision-making-
Opportunity Costs
The potential benefit that is
given up when one alternative
is selected over another.

Example: If you were
not attending college,
you could be earning
Rs15,000 per year.
Your opportunity cost
of attending college for
one year is Rs15,000.
The McGraw-Hill Companies, Inc., 2003
McGraw-Hill/Irwin
Decision making-
Marginal cost
Marginal cost cost of producing an
additional unit or output or service
Marginal costing differentiates the fixed
and variable costs


The McGraw-Hill Companies, Inc., 2003
McGraw-Hill/Irwin
Decision making-
Replacement cost
Cost of replacing an asset
At current market price
Replacement Cost value is the amount
it would cost to repair or replace an item
with one of the same kind and quality as
the original in todays market.
Quick Check -Relevant -Irrelevant Cost
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly.
Is the cost of the pizza you ate last night relevant
in this decision? In other words, should the cost
of the pizza affect the decision of whether you
drive or take the train to Chenna?
A. Yes, the cost of the pizza is relevant.
B. No, the cost of the pizza is not relevant.
Quick Check Relevant -Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the cost of the pizza you ate last night relevant
in this decision? In other words, should the cost
of the pizza affect the decision of whether you
drive or take the train to Chenna?
A. Yes, the cost of the pizza is relevant.
B. No, the cost of the pizza is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Chenna?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Chennai?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the depreciation on your car relevant in this
decision?
A. Yes, the depreciation is relevant.
B. No, the depreciation is not relevant.
Quick Check Relevant Irrelevant Costs
Suppose you are trying to decide whether to
drive or take the train to Chennai to attend a
concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the depreciation on your car relevant in this
decision?
A. Yes, the depreciation is relevant.
B. No, the depreciation is not relevant.
Depreciation that
is a function of miles driven
would be relevant.

Depreciation that is a
function of the passage of
time would not be relevant.

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
Rs100,000 two years ago. The Rs100,000 cost
is sunk because whether you drive it, park it,
trade it, or sell it, you cannot change the
Rs100,000 spent
Quick Check Sunk Costs
Suppose that your car could be sold now for
Rs50,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
Quick Check Sunk Costs
Suppose that your car could be sold now for
Rs.50,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.