Cost Classification

This blog is dedicated to C1 students of Cima and for all those who want to refresh their sporadic memories of cost classification and its behavior.

So let’s talk about cost classification for product behavior. As later on knowledge of cost behavior is tested in cima exams and in practical life one gets to make better and effective decisions.

Cost classification for Product behavior:

In the management focus nature of expense is important whether a cost is variable or fixed. Hence decision are taken based on the classification

There are three major types of cost

1.     Fixed cost

2.     Variable cost

3.     Semi variable/fixed cost

·        Fixed cost:

It the one that remains constant and it doesn’t change in total and it has nothing to do with the change in volume. However in case of average fixed cost it drops with the level of activity

Example:

Rent in a factory remains the same despite the number of units produced in it. If we analyze this in the average fixed cost/unit then with the larger number of units produced we are in a better position to exploit the rental premises.

 ·        Variable cost

Variable cost is the one that changes in total in relation to the change in volume. It includes direct material, direct labor, direct expense and variable overheads. Variable cost in average remains constant with the number of units produced.

Example:

In any pizza joint, the higher the number of pizza’s produced will result in higher total variable cost due to the increase in the material ( pizza ingredients) ,labor ( cook) variable overheads( increase in customer care staff, increase in ordering cost of raw materials)

·        Semi variable/fixed cost

Its part variable and part fixed.

Example:

Electricity bills where ascertain charge (line rent) is to be paid irrespective of the number of calls made. This is fixed cost

And the cost per calls made is known as the variable cost. So the total bill contains

Total bill= fixed cost + variable cost

Cost classification for assigning cost to cost objects

   Costs are assigned to objects for the purpose of profitability study, pricing and cost control so they are thus classified as direct or indirect cost.

Direct cost:

It’s the one that can be easily traced to its cost object.

Example:

The cost of flour, yeast or chicken will be a direct cost for the Chicken pizza as it is the constituent of the product.

Indirect cost:

It’s the one that can’t be traced easily for the particular cost object or in other words does not play active part in the product and is just a compliment to the product.

Example:

The cost of waiter in the Pizza Joint will be an indirect cost as he/she is not fully committed to serve the customers just ordering pizza but they gladly serve customers who orders pasta etc other  dishes available

Common cost:

It’s a cost that is common to the number of cost objects but can’t be traced individually. It’s a particular type of indirect cost.