Classification of Cost Cost AccountIng-I Classification of Cost

Classification of Cost The term cost itself is without any significant meaning and therefore, it is always advisable to use it with an adjective or phrase such as prime, direct, indirect, fixed, variable, controllable, opportunity cost and the like.

Classification of Cost In order to ascertain, control, manage, forecast and interpret cost, the elements of cost must be classified. The elements of cost are; Material Labor and Other Expenses

Classification of Costs According to Nature and Function Nature Material Labor Other Expenses (Wages, Salaries, Depreciation, Utility, etc.) Function Production Costs Selling Costs Administrative Costs Research and Development Costs According to the Identifiable (Cost Center and Production) Direct Costs Indirect Costs According to Behavior (Variability) Fixed Costs Variable Costs

Classification of Cost According to Nature and Function This classification is the basis of the recording system (Uniform Accounting System). According to Uniform Accounting System the costs are to be recorded on the basis of function (7/A) and nature (7/B). Uniform Accounting System (Uniform Chart of Accounts) Balance Sheet Accounts (1-5) Cost Accounts (7/A-7/B) Other Accounts Income Statement Accounts (6)

Other Expenses (Wages, Salaries, Depreciation, Utility etc.) Classification of Cost According to Nature Material Cost Labor Cost Other Expenses (Wages, Salaries, Depreciation, Utility etc.)

Classification of Cost According to Nature Material Costs Cost of materials used for the manufacture of a product, a particular work order, or provision of a service. All raw materials are material costs. Example: Cloth for making a dress or wood in furniture or desk, cotton in textiles etc.

Classification of Cost According to Nature Material Costs Material costs involve not only raw material costs but also the material used for a service is called material costs. Example: Cooking material for catering or stationary and office supplies, cleaning materials, material for repairs and lubricant.

Classification of Cost According to Nature Labor Costs Labor cost is defined as the total expenditure incurred from employers in order to employ workers. Labor cost is all labor expended in altering the construction or composition of the product.

Classification of Cost According to Nature Labor Costs Direct wages means the wages of labor which can be identified wholly to a particular job, product or process in converting raw materials into finished goods. It may also be defined as prime labor cost, process labor cost, operating labor cost, manufacturing labor cost etc.

Classification of Cost According to Nature Labor Costs Labor costs include the direct costs linked to work carried out such as wages, salaries, vocation payments, or other benefits. Labor costs also include indirect costs such as social benefits, vocational and training costs.

Classification of Cost According to Nature Other Expenses Expense is defined as money expended or cost incurred in a firm's efforts to generate revenue, representing cost of doing business. They may be in the form of actual cash payments (such as wages and salaries) or a computed 'expired' portion (depreciation) of an asset.

Classification of Cost According to Nature Other Expenses Example: Rent, telephone expenses, insurance, lightening, oil and gas, fees paid to consultants, depreciation, Other Expenses involve overheads such as manufacturing overhead, administration overhead, selling overhead, etc.

Classification of Cost According to Function Functional Classification Production Costs Research and Development Costs Selling and Distribution Costs Administrative Costs Functional classification of costs defines how the cost was applied (manufacturing, administration or selling). A functional classification expresses that the business performs various functions for which costs are incurred.

Classification of Cost According to Function Functional Classification Production Costs Research and Development Costs Selling and Distribution Costs Administrative Costs Functional classification is also important in giving an opportunity to the management to calculate the efficiency of departments performing various functions in the firm.

Classification of Cost According to Function Production or Manufacturing costs are all production cost incurred to manufacture the products and to bring them to a saleable condition, including direct materials, direct labor and indirect manufacturing (or factory overhead) costs.

Classification of Cost According to Function Selling costs are the costs of marketing function. Distribution costs include expenditure incurred in packing, unpacking, and transporting activities.

Classification of Cost According to Function Administrative Cost is the cost of formulating the policy, directing and controlling the business activities which is not related directly to a production, selling & distribution, research or development activity or function.

Cost (Favorable and Normal Expenditures and Expired Costs) Manufacturing Costs Direct Material Direct Labor Factory Overhead (Indirect Material, Indirect Labor, factory and machinery depreciation etc.) Research and Development Costs Material, Labor and Other Expenses Related with Research Function Administrative Costs Material, Labor and Other Expenses Related with Administrative Function Selling and Distribution Costs Material, Labor and Other Expenses Related with Selling Function

Classification of Cost Example The economic events that ABC Company met in December 2015 are as follows: Date Events Classification Nature Function 1st December Woods priced at 1.000 TL has been used in manufacturing furniture. 5th December The wages of manufacturing employee 800 TL has been paid. 10th December The factory electricity invoice has been paid with a total price of 200 TL. 11th December The factory depreciation cost is 200 TL, the fixture cost of Sales Department is 100 TL. 15th December The wages of general administration personnel 250 TL and sales department 100 TL have been paid. 20th December The catering cost has been paid as 1200 TL 25th December Estimated factory building depreciation is 350 TL.

Classification of Costs According to Nature and Function Nature Material Labor Other Expenses (Wages, Salaries, Depreciation, Utility, etc.) Function Production Costs Selling Costs Administrative Costs Research and Development Costs According to the Identifiable (Cost Center and Production) Direct Costs Indirect Costs According to Volume (Variability) Fixed Costs Variable Costs Semi-Variable Costs

Direct Cost Indirect Cost Classification of Cost According to Identifiable (Relation Between Product and Cost Center) Direct Cost Indirect Cost

Direct Costs Classification of Cost According to Identifiable (Direct-Indirect Costs) Direct Costs The expenses that can be completely attributed to the production or cost center. In the process of production of articles, material cost, labor cost and other expenses incurred directly related with manufacturing activity.

Direct Costs Classification of Cost According to Identifiable (Direct-Indirect Costs) Direct Costs For example in producing furniture the cost of wood and the cost of labor (converting wood to future) is directly related with manufacturing activity and will be defied as direct costs.

Classification of Cost According to Identifiable (Direct-Indirect Costs) Cutting& Molding Department Assembly Department Polishing Department For example in manufacturing furniture, the cost of wood is directly traceable to Cutting & Molding Cost Center, and the cos of wood is directly attributable to cost of production activity.

Classification of Cost According to Identifiable (Direct-Indirect Costs) Indirect Costs Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and therefore are considered indirect costs.

Classification of Cost According to Identifiable (Direct-Indirect Costs) The expenses incurred on those items which are not directly chargeable to production or cost center are indirect costs. Example: In production, salaries of timekeepers, storekeepers, are indirect costs.

Classification of Cost According to Identifiable (Direct-Indirect Costs) The costs that cannot be conveniently allocated to production are called indirect costs.

Classification of Cost Material Direct Indirect Labor Expenses Selling & Distribution Overheads Administration Overheads Factory / Works Overheads

Classification of Cost According to Behavior Fixed Cost Variable Cost

Classification of Cost According to Behavior In this classification, costs are classified by their behavior to changes in the level of activity. This is the analysis of how cost or profits change as volume changes.

Classification of Cost According to Behavior In this context volume might be an activity such as the number of machine hours, the number of units produced, the number of pounds processed, the number of units sold, or the TL of goods sold.

Classification of Cost According to Behavior- Fixed Costs The cost which does not vary but remains constant within a given period of time or range of activity is called fixed costs. Example: Rent, insurance of factory buildings, depreciation etc. remain the same for different levels of production.

Classification of Cost According to Behavior- Variable Costs The costs tend to vary with the volume of output called variable costs . Any increase in the volume of production results in an increase in the variable cost. Example: cost of material, cost of labor etc.

Classification of Cost Summary According to Nature and Function Nature Function According to the Identifiable (Cost Center and Production) Direct Costs Indirect Costs According to Volume (Variability) Fixed Costs Variable Costs

Classification of Cost Function and Nature A. Production Costs Direct Material (Variable) Prime Cost Direct Labor (Fixed or Variable) Factory Overheads (Fixed or Variable) Indirect Material Indirect Labor Rent, Utility Costs, Repairs, Depreciation etc. Indirect Cost B. General Administrative Costs (Fixed or Variable) Material Reported in Income Statement Labor (Wages and Salaries) Other Expenses Rent, Utility Costs, Repairs, Depreciation etc. C. Selling and Distribution Costs (Fixed or Variable) Material Reported in Income Statement Labor (Wages and Salaries) Other Expenses Rent, Utility Costs, Repairs, Depreciation etc.

Classification of Cost Production Costs The cost of inventory will be reported in balance sheet. The categories of inventory are as follows: Raw Material Work-in-progress Finished Goods The cost of product will be reported as Work-in-Progress (Process). The cost of finished goods will be reported as finished goods in Balance Sheet.

Cost of Raw Material (Direct Cost) = Classification of Cost Production Costs The cost of Raw Materials involves acquisition costs. The cost of consumed raw material will be a part of production cost and will be reported as Work-in-progress or Finished Goods in Balance Sheet. The cost of raw material will be ascertained as; Cost of Raw Material (Direct Cost) = Beginning Inventory of Raw Material + Net Purchases Ending Inventory of Raw Materials - Total Cost of Raw Material

Cost of Ending Work-in Progress Inventory Classification of Cost Production Costs Work-in-progress is semi finished goods at the time of finding of Total Cost of Production. Work- in-progress consists of : Cost of Direct Material Cost of Direct Labor and Factory Overheads Cost of Ending Work-in Progress Inventory Beginning Inventory of Work-in Progress + Current Period Production Costs Total Cost of Production xx Cost of Finished Goods -

Classification of Cost Production Costs The cost of finished goods consists of : Cost of Beginning Finished Goods Cost of Direct Material Cost of Direct Labor and Factory Overheads Cost of Finished Goods Beginning Inventory of Work-in Progress + Current Production Costs Ending Inventory of Work-in Progress - Total Cost of Current Period’s Finished Goods xx

Classification of Cost Production Costs Cost of Goods Sold consist of Cost of Beginning Finished Goods Total Cost of Current Period (Direct Material, Direct Labor and Factory Overhead) Cost of Goods Sold Cost of Beginning Finished Goods (Involve: Direct Material, Direct Labor and Factory Overhead) + Current Period’s Production Costs (Involve: Direct Material, Direct Labor and Factory Overhead) Cost of Ending Finished Goods (Involve: Direct Material, Direct Labor and Factory Overhead) - Cost of Goods Sold (Involve: Direct Material, Direct Labor and Factory Overhead) xx

Statement of Cost / Cost Sheet Cost Of Direct Material (+)   Cost Of Beginning Raw Material (+) Net Purchases (+) Cost Of Ending Raw Material (-) Direct Labor Wages (+) Factory Overheads (+) Indirect Materials Indirect Labor Depreciation On Factory Building Depreciation On Factory Equipment Insurance Repairs And Maintenance Other Factory Overheads  Current Period’s Total Cost Work-in-progress (Beginning) (+) Work-in-progress (Ending) (-) Current Period’s Cost of Finished Goods Finished Goods (Beginning) (+) Finished Goods (Ending) (-) Cost of Goods Sold General Administrative Expenses Office Material, Wages, Rents, Insurance, Depreciation etc. Selling And Distribution Expenses

Classification of Cost Production Costs Example: The cost of beginning raw material is 400 TL, work-in progress is 350 TL, finished goods is 600 TL. The economic events occurred in October are as follows: Purchased raw material costs 800 TL, The direct labor cost 300 TL and indirect labor cost 100 TL paid. Depreciation cost is 150 TL, fuel-oil cost is 75 TL, factory building rent is 125 TL. The cost of ending raw material is 500 TL, work-in progress is 750 TL and finished goods is 450 TL Sales incurred in October are 1.700 TL. Required: Ascertain the current period’s total cost, cost of finished goods, cost of goods sold and gross sales profit.