Cost classification may be defined as ‘the arrangement of cost items in a logical sequence having regard to their nature and purpose to be fulfilled’. The term cost must be qualified when in use in order that its precise meaning is established in a particular situation; however, cost refers to the amount of resources that have been diverted from other uses or sacrificed so as to achieve the desired objective. But the term is used to refer to various aspects of cost, depending on the base of argument that one is approaching the issue from.
These different bases of cost classification are summarized in the diagram below: Manufacturing/ Non-manufacturing
Cost Behaviour Functional Classification Avoidable/unavoidable Controllable/
2.2 Importance of cost classification
Analysis of cost behaviour is important to all organizations for effective management. This is because many organizations have a unique cost structure. For example, fixed costs account for 60 – 80% of all hospital costs. However, unlike many organizations of this type, labour costs largely comprise the hospital’s fixed costs.
Labour costs unlike depreciation require a cash outflow. This is characteristic of labour intensive organizations. Capital-intensive organizations, on the other hand, have low labour costs, e.g. computerized manufacturing organizations.
Some organizations e.g. hospitals allocate 10 –15% of their space for standby emergency events giving them built in idle capacity. This prevents them from enjoying advantages of higher profits that a capital-intensive organization realizes at higher volumes beyond the break-even volume.