Classification of costs
Looks at the purpose and types of
costs incurred by an organisation
Classification costs
• Bookkeeping system classifies costs as
PEARLS
• Financial accounting classifies costs as
Capital and revenue expenditure
• Management accounting classifies costs as
– Function (costs incurred in production or
administration)
– Element (materials, labour and expenses)
– Nature (directly involved in the production & indirectly,
in management, selling and administration)
Function cost classification
Function
Ledger accounts
Production costs
Materials
Employees used in the production
Machine running costs (fuel, depreciation)
Supervision/
Selling & distribution costs
Advertising
Delivery costs
Staff salaries (sales person)
Administration costs
Secretarial and accounting costs
General management salaries
Rent of office building
Finance costs
Interest on a loan or overdraft
Fees for arranging a loan
Element cost classification
Element
Ledger accounts
Materials
Materials used in production
Machine running costs (fuel, parts & depreciation)
Labour
Wages of employees used in production
Wages of supervision & sales staff
General management salaries
Expenses or overheads
Advertising
Delivery costs to
Secretarial and accounting costs
Rent of office
Interest on a loan or overdraft
Fees for arranging a loan
Nature cost classification
Nature
Ledger accounts
Direct costs
Materials used in production
Wages of employees used in production
Indirect costs
Machine running costs (fuel, parts & depreciation)
Wages – employees supervising the production
Sales staff salaries
General management salaries
Advertising
Delivery costs
Secretarial & accounting costs
Rent of building
Interest on a loan or overdraft
Fee for arranging a loan
2 stage cost classification
Element
Nature
Examples
Materials
Direct materials
Materials incorporated in the finished product
Indirect materials
Materials used in the production process but
not incorporated in the product
Insignificant costs attributable to each product
are sometimes included in indirect materials
for convenience
Labour
Expenses/
overhead
Direct labour
Wages paid to workers in the production
process or perform the service in a service
business
Indirect labour
Wages and salaries of other staff involved
indirectly in the production process
(supervisors, storekeeper
Indirect expense/
overhead
Expenses not spent on the production or
service provided – rent, rates, electricity &
telephone costs
Cost Centres
• We classify costs as function, area or department
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–
–
–
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Production
Administration
Assembly/finishing area
Human resources
Marketing
• These can be called a Cost Centres
• Financial documents are analysed to the relevant
cost centre
• Helps to determine the total cost incurred by a
centre
Elements & cost centres
• Materials
– Materials could be analysed to different
departments meaning the costs will be analysed to
more than one cost centre
– The stores department need to record the quantity
of new materials coming to the business
(inventory)
– The bookkeeping system will record the materials
to the ledger account materials and analyse values
to the relevant cost centre
Element & cost centre
• Labour
– Bookkeeping records the cost of wages and salaries to
the ledger account (Gross Wages) and then analyses
to the relevant cost centre
– Management accounting will break it down to
• Basic wage, overtime and bonus
– Basic wages is the amount paid for normal hours
– Data will be taken from
• Clock card (mechanical device on factory floor)
• Time sheet (employee fills in detailed hours worked and
where)
• Job card (used in large manufacturing businesses for
individual products)
• Overtime
– Additional hours paid over and above employee’s
contracted hours
– Expressed as:
• Time and a half ( 1 ½ times normal hourly rate)
• Double time (2 times normal hourly rate)
– The additional hours would be analysed to the
relevant cost centre where known
– If not known the overtime would be apportioned
to the basic wages cost centres
• Bonus payments
– To increase productivity employers will set up
bonus scheme
– Employees will earn additional pay if they work
more efficiently
– Bonus scheme can be set as individual or group
basis
– Bonus charges can be analysed as direct cost
relating to the production costs or as an indirect
cost analysed to expenses
• Expenses
• All cost centres incur expenses also called
overheads
• Some costs can be analysed to more than one
cost centre
• Where costs have to be split between centres
known as Apportionment of costs, common
costs are: rent, power & wages
• Where costs are split they can be apportioned
as square footage or percentages
Service organisations
• Highest cost for most service organisation is
labour costs
• This can be recorded on a timesheet
• As a service organisation, items purchased for the
service will not be raw materials but
consumables, examples are:
– Stationery
– Printing costs
• All will be analysed to a cost centre as with the
manufacturing organisation