COSTS, CONCEPTS

&CLASSIFICATION OF COSTS
 COSTS
• Cost refers to the value sacrificed with the aim of
gaining something in return.
• Every BUSINESS process involves some costs.
• It is the basis of profit determination for an
organization.

• Basic cost elements are:

Material
Labour
Expenses and other overheads

• MATERIAL
(INVENTORY)
• Any wages paid to workers or a group of
• The materials directly contributed to a
product and those easily identifiable in the
finished product are called direct materials.
For example, paper in books, wood in
furniture.
COSTS
LABOR
workers which may directly co-relate to any
specific activity of production, maintenance,
transportation of material, or product, and
directly associate in the conversion of raw
material into finished goods are called labor .

• Other, usually lower cost items or supporting

material used in the production of in a finished
product are called indirect materials . For
example, the length of thread used in a
garment.

• These can be categorized into three different

types of inventories that must be accounted
for in different ways; raw materials, work-in-
progress, and finished goods
 COSTS
OVERHEADS
• Overhead refers to the ongoing costs to operate a business but excludes the
direct costs associated with creating a product or service. A company must pay
overhead on an ongoing basis, regardless of how much or how little the
company sells.
•  
• Overhead can be fixed, variable, or a hybrid of both.

• Overheads include:
Production or works overhead including factory staff
Administration overhead including office staff
Sales overhead including production and maintenance of catalogues,
advertising (development and purchases), exhibitions, sales staff, cost of money
Distribution overhead
Maintenance and repair including office equipment and factory machinery
Supplies
Utilities including gas, electric, water, sewer, and municipal assessments
Salaries/payroll including wages, pensions, and paycheck deductions 
 COST DATA & ITS USES
Cost data means factual information concerning the cost of
labor, material, overhead, and other cost elements which are
expected to be incurred or which have been actually incurred
by the contractor in performing the contract.

Uses - The collection, presentation, and analysis  should serve the

following essential uses of cost data:

• Planning profit by means of budgets

• Controlling costs via responsibility accounting
• Measuring annual or periodic profit, including inventory costing
• Assisting in establishing selling prices and a pricing policy
• Furnishing relevant cost data for analytical processes for
decision making
 CLASSIFICATION OF
COSTS
• Cost classification is the logical process of categorizing
the different costs involved in a business process
according to their type, nature, frequency and other
features to fulfil accounting objectives and facilitate
economic analysis. 
 CLASSIFICATION OF COST
ACCORDING TO NATURAL
CHARACTERISTICS:
a. Manufacturing and Production Cost:
• This is the total of costs involved in manufacture,
construction and fabrication of units of production.
A manufacturer's product costs are;
• The materials
• labor
• manufacturing overhead
 CLASSIFICATION OF COST
ACCORDING TO NATURAL
CHARACTERISTICS:
b. Commercial Cost:
• This is the total of costs incurred in the operation of a
business undertaking other than the cost of
manufacturing and production. Commercial cost may
further be sub-divided into
• (a) administrative cost and
• (b) (marketing costs) costs of selling and distribution
product cost.
 CLASSIFICATION OF COSTS IN
RELATION TO THE PRODUCT
• Direct materials: Represents the
cost of the materials that can be
identified directly with the
product at reasonable cost. For
example, cost of paper in
newspaper printing, etc.
• Direct labor: Represents the cost
of the labor time spent on that
product, for example cost of the
time spent by a petroleum
engineer on an oil rig, etc.
• Manufacturing overhead costs:
 Represents all production costs
except those for direct labor and
direct materials, for example the
cost of an accountant's time in
an organization, depreciation on
equipment, electricity, fuel, etc.
• Indirect labor is the cost of any labor that
supports the production process, but which is
not directly involved in the active conversion of
materials into finished products. Examples of
indirect labor positions are:
• Production supervisor
• Purchasing staff
Materials handling staff
•
• Materials management staff
• Quality control staff
• Indirect Materi al : Indirect Material are those
materials which cannot be conveniently
identified & allocated to the cost centre or cost
unit. It  does also not form part of the finished
product. Example of indirect material are
bottom in case of shirt making, Thread in case of
shirt making, pin & paste in case of furniture
making etc. are those materials which cannot
be conveniently identified not form part of the
finished product.
 CLASSIFICATION OF COST W.R.T THE
ACCOUNTING PERIOD IN WHICH
THEY ARE APPLIED
capital expenditure
• An expenditure is a capital expenditure if the benefit of the expenditure
extends to several trading years. Capital expenditure may include the
following expenditures.
• Expenditure incurred on the acquisition of fixed assets, (tangible or
intangible) which are related to the business for the purpose of earning
profit and not for resale such as land and building, plant and machinery,
furniture & fixture, goodwill, patent rights and copyrights etc.
• Expenditure which results in an increase in the earning capacity of a
business. 
• Money spent on the improvement of existing assets so as to increase their
life or reduce the cost of production.
• Expenditure incurred on the extension and addition of existing fixed assets,
for instance.
• Any expenditure which is incurred for raising capital money for business.
• The total amount spent on capital expenditures during an accounting
year is reported under investment activities on the statement of cash
flows.
 (CONTD…)
REVENUE EXPENDITURE
• An item of expenditure whose benefit expires within the year is revenue
expenditure.
• Revenue expenditure incurred on fixed assets include costs that are aimed at
'maintaining' rather than enhancing the earning capacity of the assets. These
are costs that are incurred on a regular basis and the benefit from these costs
is obtained over a relatively short period of time.
• All establishment and other day-to-day expenses incurred in the conduct and
administration of the business such as salaries, rent, taxes, postage, stationery,
bank charges, insurance, advertisement charges etc.
• Expenditure incurred to maintain the fixed assets in proper working condition
such as repair, replacement and renewals of building, furniture, machinery etc.
• For example, a company buys a machine for the production of biscuits.
Whereas the initial purchase and installation costs would be classified as
capital expenditure, any subsequent repair and maintenance charges
incurred in the future will be classified as revenue expenditure. This is so
because repair and maintenance costs do not increase the earning capacity
of the machine but only maintains it.
 BY FUNCTIONS (I.E.,
FUNCTIONAL
CLASSIFICATION):
• According to this classification costs are divided in the
light of the different aspects of basic managerial
activities involved in the operation of a business
undertaking. It leads to grouping of costs according to
the broad divisions or functions of a business
undertaking i.e., production, administration, selling and
distribution.
 CLASSIFICATION ACCORDING
TO ASSOCIATION WITH
PRODUCT OR PERIOD
• Costs related to time periods are:

period costs
product costs.
 CLASSIFICATION ACCORDING
TO ASSOCIATION WITH
PRODUCT OR PERIOD
• Period Costs: Period costs refer to those items
of cost which are recognized as expenses for
the period in which they are incurred and are
charged against the revenue for the period.
• They relate to the passage of time, rather then
being associated closely with the
manufacturing process.
• Examples of period costs are salaries of sales
personnel, sales representatives’ commission,
administrative expenses, selling expenses,
distribution expenses, depreciation of the
office equipment, and finance expenses etc.
• Product Costs: Product costs refer to those
items of cost that are included in the costs of
inventory and become expenses when the
product is sold subsequently.
• So product costs are those costs that are
assigned to inventory because they are
closely associated with production activities
rather than with the passage of time.
• It should be remembered that product costs
are considered assets when incurred,
because they are resources that are
expected to provide future economic
benefits to the organization.
• For examples, the cost of direct materials,
direct labour, and manufacturing overhead
consist product costs for manufactured goods
 CLASSIFICATION
ACCORDING TO CHANGES
IN THE VOLUME/LEVELS OF
a. Fixed Costs: ACTIVITY
• A cost that is not immediately affected by changes in the cost
driver. Activities that affect costs are often called cost driver. A
fixed cost is that which tends to remain unchanged despite
often wide changes in output or activity. On a per unit basis, a
fixed cost varies inversely with changes in the level of activity.

• The rent of buildings of an organization, supervisor’s salaries,

taxes on real estate, maintenance and repairs of buildings and
grounds, depreciation (other than that computed under the
units of production method), insurance are good examples of
fixed costs.

• Fixed costs are sometimes termed as "capacity cost" because

fixed costs are generally incurred to create facilities.
 b. Variable Costs:
(CONTD…)
• A cost that varies in total in direct proportion to changes
in activity levels, a variable cost must be a constant
amount per unit.
• The cost of raw materials, wages, sales commission, use
of machine on rental basis are the good examples of
variable costs.
• Thus, as activity changes, total variable cost increases or
decreases proportionately with the activity changes, but
unit variable cost remains the same.
 Controllable costs BY CONTROL ABILITY
Controllable costs are those which can be controlled or influenced by conscious management action.
Examples of controllable costs are
• Advertising
• Bonuses
• Direct materials
• Donations
• Dues and subscriptions
• Employee compensation
• Office supplies
• Training

Uncontrollable costs
Uncontrollable costs cannot be controlled or influenced by conscious management action.

• Examples of uncontrollable costs are:

• Rent expense
• Corporate overhead allocation
• Administrative overhead allocation
• Depreciation expense
 OTHER COSTS
cost for planning and cost for analytical purposes
control • Differential costs
• Budgets • Opportunity costs
• Standards - are a set of • Sunk costs
19 standards and rules
promulgated by the
United States
Government for use in
determining costs on
negotiated findings
 FACTORS AFFECTING COST
CONTROL AND
MANAGEMENT
• Global Competition
• Growth of the Service Industry Advances in Information
Technology.
• Advances in the Manufacturing Environment
• Customer Orientation
• New Product Development
• Total Quality Management
• Time as a Competitive Element
• Efficiency
 CASB
• In 1970, Congress established the original Cost
Accounting Standards Board (CASB) to promulgate
cost accounting standards designed to achieve
uniformity and consistency in the cost accounting
principles 
• The current CASB consists of five members: the OFPP
Administrator (who serves as Chairman) and one
member from the United States Department of
Defense (this position is held by the Director of
the Defense Contract Audit Agency), the General
Services Administration, industry, and the private sector.
• CAS applies to contracts, not contractors.
Thank you