1. Cost accounting and cost classification
1.3Cost
The monetary value of resources sacrificed in the production and provision of goods
and services.
2.0 Cost classification
The process of grouping costs according to common characteristics so as to come
up with various cost classes.
2.1 Criteria of classifying costs
2.1.1 Behaviour
Costs are classified according to how they change in relation to changes in activity
level of the business. Using this criterion, costs are classified into:
 Variable costs
 Fixed costs
 Semi-variable costs
 Semi-fixed costs.
a)Variable costs
These costs vary in direct proportion to changes in levels of business activity eg
direct materials, direct labour etc.
b)Fixed costs
These costs remain constant despite changes in the level of business activity eg
rent. Such costs are incurred even if production is nil.
c)Semi-variable costs
These costs consist of elements of both fixed and variable costs in one cost.
Examples are labour costs paid on the basis of units produced plus a monthly
minimum salary.
d)Semi-fixed
These costs are fixed only within a given range/parameter after which they increase
with a fixed amount. They are sometimes referred to as step fixed costs as they
resemble steps when plotted on a graph.
2.1.2 By nature
Under this basis, costs are classified according to their identifiability with cost centres
or cost units. Thus costs can be grouped into:
 Direct costs
 Indirect costs
a) Direct costs
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These are costs which can be easily traced to cost units or cost centres for example
direct materials, direct labour.
b) Indirect costs
These are costs incurred generally in the firm but cannot be easily traced to
individual cost units or cost centres examples are indirect material, indirect labour
and other overheads.
2.1.3 By element
Costs are classified with reference to the factors on which costs are incurred. Thus
cost can be classified as:
 Material costs
 Labour costs
 Expenses
2.1.4 Controllability
Costs are classified according to whether or not these are influenced by the action of
a given member of an undertaking. The classes of costs are:
 Controllable costs
 Uncontrollable cost
a) Controllable costs
Are within the control of a given member within the section of a business.
b) Uncontrollable costs
Are beyond the control of a given member within the organisation or department of
an organisation eg head office costs borne by a branch or department.
2.1.5 Normality
Costs are classified according to whether these are costs which are normally
incurred at a given level of output in the conditions in which that level of output is
normally attained. According to normality, costs are classified as:
 Normal or unavoidable costs
 Abnormal or avoidable costs.
2.1.6 By function
From the view point of the purpose for which the cost is incurred, these may be
classified as:
 Production cost
 Administration cost
 Selling costs
 Distribution costs
2.1.7 Time factor
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Costs can be classified as either:
 Historic costs or
 Pre-determined costs.
a) Historical costs
Costs that are ascertained after they have been incurred. Historical costs are
ascertained after goods have been manufactured or service has been rendered.
They are ascertained so as to ascertain the profitability of the firm rather than for
cost control.
b)Predetermined costs
Refer to costs which are computed in advance of production on the basis of a
specification of all the factors affecting them.
2.1.8 Relevance to management decision making and control
Costs are classified on the basis of their relevance to decisions taken by the
management. Therefore costs are classified as either:
 Relevant or
 irrelevant costs
a) Relevant costs
These affect managerial decision making and examples include:
 Marginal cost
 Opportunity cost
 Differential costs
b) Irrelevant costs
These costs are not considered by management when taking decisions. Examples
include:
 Sunk costs
 Fixed costs when taking short run decisions.
Glossary of terms
Variable costs: costs which vary in direct proportion to the level of business activity.
Fixed costs: costs which remain constant despite changes in the level of business
activity.
Semi-variable costs: costs which consist of elements of both fixed and variable
costs.
Semi-fixed costs: costs which are only fixed within given parameters beyond which
they vary with a fixed amount. They are also known as step- fixed costs because
they resemble steps when plotted on a graph.
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Direct costs: these are costs which can be easily traced to units of production for
example direct materials and direct labour.
Indirect costs: these are costs which cannot be easily traced to individual cost
centres or cost objects.
Product costs: costs incurred in producing a good or service.
Relevant costs: costs which are taken into account in managerial decision –making.
Sunk costs: costs already incurred hence not relevant for decision making.
Chapter summary
Cost classification is the grouping of costs according to their common
characteristics so as to enable cost control as well as enabling management
decision –making. Costs can be classified according to the following
categories:
 Behaviour
 Nature
 Element
 Function
 Relevance to decision –making
 Time factor
Practice questions
Question 1: multiple choice
1.1 sunk costs are :
A fixed in nature
present decisions.
b variable in nature
c avoidable
d not relevant to
1.2 revenue from an alternative which has been foregone is:
A sunk cost b variable cost c imputed cost
d opportunity cost
1.3 aggregate of direct costs is known as:
A direct material cost
b direct wages c direct expenses d prime cost
1.4 the estimated cost which is ought to be incurred is :
A standard cost b budgeted cost c imputed cost
d indirect cost
1.5 salary paid to a factory manager is an item of :
A prime cost b factory overhead c selling overheads d office overheads
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Question 2: true or false
State whether the following statements are true or false.
2.1 cost classification is the grouping of costs having common features.
2.2 on the basis of identifiability, costs are classified into controllable and
uncontrollable costs.
2.3 indirect costs can not be identified with any particular cost unit.
2.4 fixed cost per unit is always constant.
2.5 variable cost per unit is always constant.
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