Unit 3 Cost and Cost Classifications

Module 8
Different Classification of Costs

PROF. ESTRELLITA R. SICLAT

Learning Objectives:

At the end of this module, the students are

expected to:
1. Identify and give examples of each classification of
costs;
2. Define and illustrate a cost object;
3. Understand the difference between/among material
costs, labor costs and expenses, production costs and
commercial costs, direct costs and indirect costs,
product costs and period costs, variable costs, fixed
costs and mixed costs;
4. Identify and differentiate costs classification by
relevance to decision making
Classification of Costs

1. According to Nature
2. According to Functions
3. According to Traceability
4. According to Normality
5. According to Timing of Charges against
Revenue
6. According to Behavior in Accordance
with Activity
7. According to Relevance to Decision
Making
Classification of Costs According to Nature

1. Material Costs: Material costs are the costs of any

materials we use in the production of goods. These costs
are further divided into raw material costs, spare parts,
costs of packaging material, etc.
2. Labor Costs: Labor costs consist of the salary and wages
paid to permanent and temporary employees in the
pursuit of the manufacturing of goods.
3. Expenses: Expenses refer to all expenses associated with
making and selling of goods or services.
Classification of Costs According to Functions

1. Production Costs: These are costs concerned

with actual manufacturing or construction of
the goods.
2. Commercial Costs: These refer to the costs of
the operation of an enterprise other than the
manufacturing costs. They include the
administrative costs, selling and distribution
costs.
 Classification of Costs According to
Traceability
1. Direct Costs: These are costs that can be traced
to a particular department or other subunit of an
organization. Examples of these are raw
materials used in manufacturing a product and
the labor involved with the production process.
2. Indirect Costs: These are costs that cannot be
traced to a particular department. Examples are
rent of the building or the salary of the manager.
 Classification of Costs According to
Normality

1. Normal Costs: These costs are the normal or regular costs

which are incurred in the normal operations of the
business organization.
2. Abnormal Costs: These costs are the cost which are
unusual or irregular and which are not incurred during the
normal operations of the business. These costs are
charged to the profit and loss account, they are not a part
of the cost of production. An example of this is a factory
loss due to fire.
Classification of Costs According to Timing of
Charges against Revenue
1. Product costs – These are costs assigned to goods
that are either purchased or manufactured. They
form part of inventory and are charged against
revenue, i.e. cost of sales, only when sold. All
manufacturing costs (direct materials, direct labor,
and factory overhead) are product costs.
2. Period Costs - are not inventoriable and are charged
against revenue immediately. Period costs include
non-manufacturing costs, i.e. selling expenses and
administrative expenses.
Classification of Costs According to Timing of
Charges against Revenue
Manufacturing Costs
➢ Direct materials – refer to the raw materials that are
used in the manufacturing process.
➢ Direct Labor – refers to the salaries, wages, and
fringe benefits of personnel who work directly in
manufacturing the product
➢ Manufacturing Overhead – refers to all other costs
of manufacturing that are not included in direct
material and direct labor.
Classification of Costs According to Timing of
Charges against Revenue
Manufacturing Overhead
➢ Indirect Materials – cost of materials required for the production
process but do not become integral part of the finished product like
oil for sewing machine.
➢ Indirect Labor –salaries, wages and fringe benefits of personnel who
do not work directly on the product but whose work is necessary for
the manufacturing process like the salary of production department
supervisor and security guard.
➢ Other Manufacturing Costs – all other manufacturing costs that are
neither material nor labor costs like depreciation of plant and
equipment, property taxes, insurance, and utilities such as electricity
of the manufacturing plant.
Classification of Costs According to Behavior
in Accordance with Activity
1. Variable costs - vary in total in proportion to changes in
activity. Examples include direct materials, direct labor,
and sales commission based on sales.
2. Fixed costs - costs that remain constant regardless of the
level of activity. Examples include rent, insurance, and
depreciation using the straight-line method.
3. Mixed costs - costs that vary in total but not in
proportion to changes in activity. These basically include
the fixed cost portion plus additional variable costs. An
example would be electricity expense that consists of a
fixed amount plus variable charges based on usage.
 Classification of Costs According to
Relevance to Decision Making
1. Mixed cost - cost that vary in total but not in
proportion to changes in activity. It basically
includes a fixed cost portion plus additional variable
costs. An example would be electricity expense that
consists of a fixed amount plus variable charges
based on usage.
2. Relevant cost - cost that will differ under alternative
courses of action. In other words, this cost refers to
the cost that will affect a decision.
 Classification of Costs According to
Relevance to Decision Making
3. Standard cost - predetermined cost based on some
reasonable basis such as past experiences, budgeted
amounts, industry standards, etc. The actual costs
incurred are compared to standard costs.
4. Opportunity cost - is a benefit forgone or given up
when an alternative is chosen over the other/s.
Example: If a business chooses to use its building
for production rather than rent it out to tenants, the
opportunity cost would be the rent income that
would be earned had the business chose to rent out.
 Classification of Costs According to
Relevance to Decision Making

5. Sunk Costs – These are historical costs that do

not make any difference in making a decision.
6. Controllable Costs – These refer to the costs
that can be influenced or controlled by the
manager.
 Thank you for
paying
attention!
God bless you and
stay safe!