Classification of Cost

The same total expenditure of a business can be sorted, or classified, in several different ways depending on the purpose the classification is meant to serve. The main bases of classifying cost are the following.

1. By nature or element — the most basic classification, into:

• Material cost — the cost of the physical substances used, further split into direct material (which becomes part of the product and can be traced to it, e.g. leather in shoes) and indirect material (which cannot conveniently be traced to a unit, e.g. glue, thread, lubricants).
• Labour cost — the cost of human effort, split into direct labour (workers who actually work on the product, e.g. a machine operator) and indirect labour (supervisors, cleaners, storekeepers).
• Expenses — all costs other than material and labour, split into direct expenses (traceable to a unit, e.g. hire of a special machine for one job) and indirect expenses (e.g. factory rent, depreciation).

2. By traceability (direct or indirect) — whether a cost can be conveniently traced to a particular cost unit (direct cost) or not (indirect cost). All indirect costs together — indirect material, indirect labour and indirect expenses — are collectively called overheads.

3. By function — according to the business function to which the cost relates: production (or factory/works) cost, administration (office) cost, selling cost and distribution cost.

4. By behaviour (variability) — according to how a cost behaves when the level of output changes:

• Fixed cost — remains the same in total regardless of output within a range (e.g. factory rent, salary of the works manager); the fixed cost per unit falls as output rises.
• Variable cost — changes in total in direct proportion to output (e.g. direct material, direct wages); the variable cost per unit stays roughly constant.
• Semi-variable (semi-fixed) cost — has both a fixed and a variable part (e.g. a telephone bill with a fixed rental plus a charge per call; electricity with a fixed minimum plus a per-unit charge).

5. By controllability — controllable cost (which the manager of a cost centre can influence) versus uncontrollable cost (which he cannot, at his level, influence). …