Cost Classification

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What is Cost Classification?

Cost Classification is the process of segregating the company's costs into different categories that gives a fair idea to the decision-maker about the spending pattern. This bifurcation allows teams to efficiently use the data for accounting purposes and financial modeling, leading the management to decide which cost is more important than others.

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Types of Cost Classification

Let us discuss some types of cost classification.

Types of Cost

#1 - Fixed and Variable Cost

These are the two primary categories to segregate the costs; fixed costs can be accounted for during the start of any project, and a part of variable expenses can be anticipated too. However, variable cost accounts for the cost associated with the units produced and any unaccounted cost.

#2 - Distribution Channel Cost

These expenses are channeled into retail, wholesale, and the internet. Revenues from each of the channels come after deducting the cost from sales.

#3 - Customer Cost

These are the costs a company gets involved in to maintain its reputation and after-sale service for the customers. This cost includes returns, warranties, or customer service. The company then evaluates this information about the individual consumers to increase profitability and customer targeting.

#4 - Departmental Cost

Expenses related to individual departments are assigned to respective departmental managers, which are then used to analyze the manager's performance and develop trend analysis to identify the potential of the manager.

Basis of Cost Classification

Now since we have seen the categories of the cost classification briefly, let us examine the basis on which the costs are segregated:

Cost Classification

#1 - By Nature

As the category suggests that this is the expense to be recorded in how the company bears it and for its use. Some major categories can be material and labor. For instance, raw material costs and other costs related to the procurement of the raw material will fall under Material charges. Similarly, salary and wages will belong to labor costs.

#2 - By Functions

Here the costs are divided as they are allocated to different functions in the company, like production, commercial, administration Distribution Costs, and Research and Development costs. All the categories include the costs of their nature of occurrence throughout the whole production cycle.

#3 - By Behaviour

It depends on the nature of the cost, like whether it is a fixed, variable, or, semi-variable cost. Rent, Lease, and salary come under Fixed expenses; Packaging and commission fall under the variable head; lastly, management, power consumption, and maintenance costs come under semi-variable costs.

#4 - By Management Decision Making

As we know, costs to the company are not only a number but also a tool to make managerial decisions. So, management decides how to distinguish the costs and what categories they should be bifurcated into Marginal Cost,, Differential cost, Sunk Cost, Abnormal Cost, Replacement cost, and so on.

#5 - By Production Process

This type of category is generally used by the companies involved in the manufacturing business where there are a lot of processes to be followed by the product to become a finished product. Some examples of this cost may be Batch cost Process cost, Contract cost, Joint cost, and so on.

#6 - By Time

The cost comes to the company as it depends on the time frame the cost has occurred. The expense of today's importance may not hold any value tomorrow, so the basic categories in this can be Historical, pre-Determined, Standard, and Estimated costs. Based on these subcategories helps the management to effectively distribute the costs per their occurrence time, which eventually leads to a broader picture of cost evaluation.

Conclusion

As much as cost is an expense to the company, it is also considered a tool for future evaluations. Categorizing the costs into appropriate categories gives us a clear picture of the whole business model and gives the management an eagle-eye view of the entire process.