Cost Classification

By Function

Classifies costs by their ease of traceability to a cost object.

Direct Cost

Cost that can be specifically and exclusively identified with a particular cost object.

Examples:

• Direct material cost
  Steel sheets used per unit of car body pressed.
• Direct labour cost
  Piece-rate wages for assembly technicians paid per unit assembled.
• Direct other cost
  Royalty fee paid to a patent holder per unit produced.

Indirect Cost

Aka. overhead. Cost that cannot be specifically and exclusively identified with a cost object. The term “overhead” is used more often.

Production Overhead

Aka. factory overhead or manufacturing overhead. All manufacturing costs other than direct costs, incurred inside the factory to support the production process.

Comprises the indirect materials, indirect labour, and indirect expenses of production.

Examples:

• Indirect labour
  Wages paid to employees not directly involved in production work, e.g. maintenance workers, janitors, security guards.
• Indirect materials
  Materials used to support the production process, e.g. lubricants and cleaning supplies used in an assembly plant.

Non-Production Overhead

Indirect cost incurred outside the manufacturing process, not for producing a unit.

• Administrative overhead
  Cost of managing and running the business, e.g. office staff salaries, office supplies.
• Selling and distribution overhead
  Cost of marketing, selling, and delivering the product, e.g. sales commission, advertising, delivery vehicle running costs.
• Finance overhead
  Cost of financing the business, e.g. loan interest, bank charges.

By Element

Classifies costs by the type of resource consumed.

Material Cost

Materials that become an integral part of the product and can be conveniently traced directly to it.

Examples:

• Steel sheets used per unit of car body pressed.
• Wood and upholstery used to make a chair.

Labour Cost

Cost of remunerating employees for effort spent producing a good or service, and traceable directly to individual units of product.

Examples:

• Welders.
• CNC machine operators.
• Assembly technicians.
• Painters.
• Machinists.

Other Cost

Costs other than material and labour.

Examples:

• Royalty fee.
• Production license fee.
• Special design consultancy fees.

Prime Cost

Aggregate of all direct costs, computed by summing the 3 cost elements.

Each component is specifically and exclusively identifiable with the cost object.

Total Production Cost

Aka. works cost or factory cost. Prime cost plus production overhead.

Production overhead covers all manufacturing costs other than the 3 direct elements.

Worked Example

Cost object: an electric car.

• Direct material cost
  8,000, for the battery pack, motor, and body panels.
• Direct labour cost
  1,200, for assembly and battery installation technicians.
• Direct other cost
  300.

• Variable manufacturing overhead
  450, electricity for robotic assembly lines and welding gas.
• Fixed manufacturing overhead
  850, factory rent and the production manager’s salary.

Variable non-manufacturing overhead (admin office electricity, sales commission) and fixed non-manufacturing overhead (administrative salaries, office depreciation) are excluded, since they’re incurred after production or not for production.

By Behavior

Classifies costs by how they respond to changes in activity level.

Variable Cost

• In total
  Total variable cost changes as the activity level changes.
• Per unit
  Variable cost per unit remains the same over wide ranges of activity.

Examples:

• Steel sheets, whose cost varies with the number of car bodies pressed.
• Piece-rate wages for assembly technicians, paid per unit assembled.

Fixed Cost

• In total
  Total fixed cost remains the same even when the activity level changes.
• Per unit
  Fixed cost per unit goes down as the activity level goes up.

Examples:

• Fixed monthly factory rent.
• Fixed monthly wages for security guards.

Semi-Variable Cost

Aka. a step cost. An expense containing both a fixed-cost component and a variable-cost component.

Examples:

• Electricity expenses.
• Telephone expenses.

Example