What Is Classification of Cost? Definition, Explanation and Examples

classifications of costs

If the executive, manager or department cannot change or

control the cost, it is an uncontrollable cost. An example of an

uncontrollable cost would be an allocation of administrative

expenses to each job or department. Fixed costs are not relevant because they are costs that have already been incurred. Since the money must be spent or is already spent, they are not able to be relevant. Relevant costs always occur in the future as far as planning is concerned.

Common examples of controllable costs are office supplies, advertising expenses, employee bonuses, and charitable donations. Controllable costs are categorized as short-term costs as they can be adjusted quickly. There are also mixed costs, which are a combination of fixed and variable. Utilities tend to be a mixed cost because there is a base charge that will be incurred regardless of use. The added variable comes from how much electricity is used in that period.

  • Estimated costs are costs that, according to investigation and analysis, are most likely to be incurred.
  • Guidelines for determining direct and indirect (F&A) costs charged to Federal awards are provided in this subpart.
  • Since the money must be spent or is already spent, they are not able to be relevant.
  • Direct costs would be costs that impact a single product or object such as direct labor.
  • Relevant costs always occur in the future as far as planning is concerned.

Sunk costs are also not relevant costs because they have already been spent even if their use is no longer viable with a company. Examples of costs that can be classified include raw materials, labor costs, administrative expenses, marketing expenses, overhead costs, etc. Examples of shut-down costs include rent for factory premises, salaries of top management, and so on. Production costs include the cost of materials, cost of labor, other factory expenses, and the cost of primary packing.

Having accurate knowledge of how expenses are impacting a business can allow for changes to be made for the benefit of profitability or cost savings. In making this decision, the depreciation of the vehicles is not to be considered but the management must take into account the present expenditure on fuel, maintenance, and driver salaries. Administration costs are the costs incurred in formulating business policies, directing the organization, and controlling the operations of an undertaking.

The Electronic Code of Federal Regulations

Costs can be classified based on several criteria such as nature of cost, elements of cost, controllability of cost, function or department from where the cost is incurred, etc. Thus, the replacement cost of an asset is the cost that would be incurred if the asset were purchased at the current market price and not at the original purchase price. Management decisions are directly affected by such costs because they give rise to cash expenditure.

  • A standard cost, on the other hand, is a specification of what a cost ought to be when it is incurred.
  • Administration costs are not related to research, development, production, distribution, or selling activities.
  • Investors can calculate a company’s operating expense ratio, which shows how efficient a company is in using its costs to generate sales.
  • Controllable costs

    are things the executive, manager, or department even can control

    or change.

Individually assessing a company’s cost structure allows management to improve the way it runs its business and therefore improve the value of the firm. However, the electricity used to power the plant is considered an indirect cost because the electricity is used for all the products made in the plant. Cost classification is a major driver in decision-making due to its ability to identify profitability.

What are the different categories of cost classification?

The different categories of cost classification include fixed costs, variable costs, direct costs, indirect costs, and semi-variable costs. Each category has its characteristics that help in understanding the cost structure and making more informed decisions. A direct cost is an amount that can be traced to

a specific department, process or job. Direct costs can be product

costs like direct materials or direct labor or they can be period

costs like an accountant’s salary would be traced to the accounting

department. Indirect costs is an amount that cannot be traced to a

specific department, process or job. These costs are typically

allocated (or estimated) to the departments, processes or jobs

using those items.

She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

classifications of costs

Expenses are classified by individual customer, such as the costs of warranties, returns, and customer service. This information is used on a trend line to examine the ability of each department manager to control his or her assigned costs. In this course, we will cover many cost

classifications useful for planning and control. We will introduce

the basic concepts behind these classifications but you will use

them (and get in greater depth) in other chapters.


Those expenses that can be temporarily reduced or eliminated are classified as discretionary. This approach is used to reduce costs on a temporary basis, particularly when a business anticipates having a brief decline in revenues. There are two primary types of costs that companies incur when doing business. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

When choosing an alternative increases total costs, such increased costs are known as incremental costs. A standard cost, on the other hand, is a specification of what a cost ought to be when it is incurred. The basic difference between an estimated cost and a standard cost is that an estimated cost is a more or less reasonable assessment of what a cost will be when it is incurred.

These costs depend mainly on the passage of time and do not vary directly with the changes in the volume of output or sales. Examples of variable costs are direct material cost, direct wages, direct expenses, consumable stores, and commission on sales. Cost classification involves the separation of a group of expenses into different categories. A classification system is used to bring to management’s attention certain costs that are considered more crucial than others, or to engage in financial modeling. We will analyze what is relevant to our

decision making including any opportunity costs.

Classification of Cost is the process of organizing costs into categories for better understanding and analysis. It involves dividing costs into fixed, variable, direct, indirect, and semi-variable to help in better decision-making. Abnormal or avoidable costs are costs that are not normally incurred at a given level of output under the conditions for which that level of output is attained. In this category, costs are classified based on whether they are normally incurred at a particular level of output under the conditions for which that level of output is normally attained. Direct costs are costs that can be directly and easily traced to (or identified with) a product, process, or department. The idea of cost accounting is to collect, classify, record, and suitably allocate expenditures to determine the costs of products or services.

5: Cost Classifications Used for Planning and Control

Variable costs are costs that vary in a directly proportional way to changes in the volume of output or sales. Common examples of direct costs include the materials used and labor employed in manufacturing an article or in a production process. Opportunity cost is the benefits of an alternative given up when one decision is made over another. In investing, it’s the difference in return between a chosen investment and one that is passed up. For companies, opportunity costs do not show up in the financial statements but are useful in planning by management. Fixed costs do not vary with the number of goods or services a company produces over the short term.

Operating Costs

Financial accounting is focused on reporting the financial results and financial condition of the entire business entity. For example, a company decides to buy a new piece of manufacturing equipment rather than lease it. Cost classifications help to designate various ways in which a company can account for expenses. Historical costs are costs that are identified after they have been incurred. That is to say, they are determined after goods have been manufactured or services have been rendered. Cost accounting looks to assess the different costs of a business and how they impact operations, costs, efficiency, and profits.

Controllable vs Non-controllable Costs

For example, suppose a company leases a machine for production for two years. The company has to pay $2,000 per month to cover the cost of the lease, no matter how many products that machine is used to make. Marginal cost is denoted by variable cost, and it consists of direct material cost, direct labor cost, direct expenses, and variable overheads.

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