In this assignment I will be discussing how costs incurred in any organization may be classified in a number of different ways for a number of different purposes. I will also be looking to find companies that use a variety of different costing techniques and methods. I will also be discussing the comparisons between marginal and absorption costing and how the concept of activity based costing can also be compared with these. To complete the assignment I will be using a combination of lectures notes, text books and the internet to research the various ways of cost classification, and how different companies use these, to enable me to answer the assignment question.
Cost classification is the breakdown of costs in to similar categories and sub-categories. Cost classification can be done with various methods and for different reasons, depending upon the reason for use. For example, a management may use controllable and uncontrollable cost classification, to identify which costs are controlled by management and which are not. The main areas in which costs can be classified are decision making, planning, control and stock valuation. (Management Accounting Techniques, 1994, Pg1).
Cost can classify in many different ways. So considering all classification of cost with brief description is discussed below under respective heads:
Direct v Indirect Costs:
The expenses incurred on material and labor which are economically and easily traceable for a product, service or job is considered as Direct costs. Direct costs are those which can be identified with the end product. This includes raw materials used in manufacturing the product (direct material); machine operators who make the product (direct labour), royalties paid or special plant hire (direct expenses). These costs are generally allocated to products or cost units. They do not take into account costs such as admin expenses or electricity used. An example of a direct cost would be in the production of leather sofas or other related manufacturing industries. The direct cost is the actual leather which is used to make the sofa. Indirect costs are those that cannot be identified with, or traced to the end product and include the following: scrap material (indirect material): the salaries of factory supervisors (indirect labour): rent, rate and depreciation (indirect expenses). Indirect costs are often called overheads. The expenses incurred on those items which are not directly chargeable to production are known as indirect costs. For example, salaries of timekeepers, storekeepers and foremen. Also certain expenses incurred for running the administration are the indirect costs. All of these cannot be conveniently allocated to production and hence are called indirect costs. Again taking the leather sofa example to illustrate indirect costs, the salaries that are paid to the management do not affect the cost of producing the sofa itself even though they are associated with the production of the sofa. Cost behaviour:
Cost behaviour is the way in which costs per unit of output are affected by fluctuations in the level of activity. The level of activity refers to the amount of work done, or the number of events that have occurred.
Fixed v Variable costs:
The costs of expenses whose total does not change in proportion to the activity of a business, within the relevant time period or scale of production in spite of the fluctuations in production is known as fixed cost. Examples: For a business, fixed costs might be business rates, overheads (rent, insurance etc), salary of the managing director (per month or per annum), and straight line deprecation of a single machine (per month or per annum). Fixed costs are irrelevant for short-term decisions, as fixed costs do not change...