Cost Classification | Sahithyan's Notes

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.

Direct material cost.
Direct labour cost.
Direct other cost.

Indirect Cost

Cost that cannot be specifically and exclusively identified with a cost object.

Production Overhead

Manufacturing costs that cannot be traced directly to specific units produced.

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

Administrative expenses, selling and distribution expenses, finance and other expenses.

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.

\begin{aligned} \text{Cost of Material} = \ &\text{Invoice Price} \\ - \ &\text{Trade Discount} \\ + \ &\text{Freight Charges} \\ + \ &\text{Excise Duty} \\ + \ &\text{Non-refundable VAT} \\ + \ &\text{Non-returnable Container Charges} \end{aligned}

Labour Cost

Labour costs that can be easily traced to individual units of product.

Examples:

Welders, CNC machine operators, assembly technicians, painters, machinists.

Other Cost

Costs that can be easily traced to individual units of product, other than material and labour.

Examples:

Royalty fee, production license fee, special design consultancy fees.

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.

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.

Semi-variable Cost

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

Examples:

Electricity expenses.
Telephone expenses.

Example

Function	Element	Behavior	Example
Direct	Material	Variable	Steel sheets used per unit of car body pressed.
Direct	Material	Fixed	Special alloy bought at a fixed lump sum for one job, regardless of units produced.
Direct	Material	Semi-variable	Supply contract with a fixed minimum charge plus a per-unit charge above the minimum.
Direct	Labour	Variable	Piece-rate wages for assembly technicians paid per unit assembled.
Direct	Labour	Fixed	CNC operator on a fixed monthly salary, dedicated to one product line.
Direct	Labour	Semi-variable	Welders paid a fixed base wage plus a per-unit bonus above a production threshold.
Direct	Other	Variable	Royalty fee paid to a patent holder per unit produced.
Direct	Other	Fixed	Fixed annual design consultancy fee for one product line.
Direct	Other	Semi-variable	Production license with a fixed annual fee plus a per-unit royalty.
Indirect	Material	Variable	Lubricants and cleaning supplies consumed in an assembly plant.
Indirect	Material	Fixed	Workshop supplies budgeted at a fixed monthly amount.
Indirect	Material	Semi-variable	Fixed monthly stock replenishment cost plus variable cost for extra consumption.
Indirect	Labour	Variable	Overtime wages for maintenance workers, rising with production activity.
Indirect	Labour	Fixed	Fixed monthly wages for security guards.
Indirect	Labour	Semi-variable	Supervisor’s fixed monthly salary plus a bonus tied to units produced.
Indirect	Other	Variable	Sales commission rising and falling with sales volume.
Indirect	Other	Fixed	Fixed monthly factory rent.
Indirect	Other	Semi-variable	Electricity expenses: fixed standing charge plus a variable usage charge.