Question

Write a memo to management detailing the various classification of costs and provide two reasons for which it is important to classify cost.

Answer 1

Answer: Direct or indirect cost, Fixed or variable cost, classification by nature, classification by function, it is important for the development of cost data which can help the management in the cost planning and control objectives of the organization. It is important for ascertaining the purpose for which the cost being classified is to fulfilled in the organization.

Explanation:

Cost classification can be said to be a process of grouping costs according to the characteristics which can be attributable to the cost in the organization and which determined their uses in the organization. Classification of cost can be divided into four namely.

Direct Cost or indirect cost : The direct cost is the cost which can be directly identified with a process, production, job or other business activities. In direct cost there is nothing like sharing or apportioning cost between the products. Examples are Direct materials, Direct Labour, Direct Expenses. While indirect cost are the cost which cannot be directly traced to the items being costed by the organization. It is a cost which can be incurred jointly by two or more products. Examples are indirect materials, indirect labour, and indirect expenses.

Fixed or variable cost : Fixed cost is said to be a cost which tend not to change with the level of activities such as output or turnover. Examples are rent, rates, insurance, executives salaries. While variable cost are the cost which vary with changes in the level of output or sales. It is a cost which increase or decrease in proportion to the changes in the level of activity such as Labour and materials

Classification by nature : This relates to the nature of the cost such as the materials, labour and expenses. The materials can be broken down into raw materials, while labour can be broken down into supervision, cleaning, clerical or office work. While expenses can be broken down into rent, power, depreciation and so on.

Classification by function : This is the classification of cost according to the functions to which the cost relates. Examples are production cost, selling cost,distribution cost,and so on. However, these cost classification are important for the following two reasons

(i) It is important for the development of cost data which can help the management in the cost planning and control objectives of the organization.

(ii) It is important for the ascertaining the purpose for which the cost being classified is to fulfilled in the organization