TECHNOLOGICAL UNIVERSITY OF THE PHILIPPINES

Km. 14 East Service Road Western Bicutan, Taguig Taguig, 1630 Metro Manila

Costing Classification and Procedure:

A written report

Bachelor of Engineering Technology: Major in Mechanical Engineering Technology

Rosalijos, Reyman M.

June 18, 2020

Cost is a very generic term, it needs to be classified to be of further use. Cost accounting

involves the recording and classification of such costs. Some costs are prime cost, direct cost,

factory cost, selling cost etc. Such classification allows the management to control the costs and

ascertain the profitability of any such processes and activities. It also helps in calculating

efficiency. The cost information system plays an important role in every organization within the

decision-making process. An important task of management is to ensure the control over

operations, processes, activity sectors, and not ultimately on costs. Although in reaching the

goals of an organization compete many control systems (production control, quality control and

stocks control), the cost information system is important because it monitors the results of the

others. The detailed analysis of costs, the calculation of production cost, the loss quantification,

the estimating of work efficiency provides a solid basis for the financial control.

I. Introduction

Costing is the classifying, recording and appropriate allocation of expenditure for the

determination of the costs of products or services, and for presentation of suitably arranged data

for the purposes of control, and guidance of management. The Chartered Institute of

Management Accounts (CIMA), London has defined costing as “the techniques and processes of

ascertaining costs.” Costing is concerned with determining the costs of products and also

planning and controlling such costs. Wheldon has defined costing as, "the proper allocation of

expenditure and involves the collection of costs for every order, job, process, service or unit.”

Costing is determine the exact cost of each article. To determine the cost incurred during each

operation to keep control over workers’ wages. To provide information to ascertain the selling

price of the product. To supply information for detection of wastage. It helps in reducing the total
cost of manufacture. It suggests changes in design when the cost is higher. To help in

formulating the policies for charging the prices of the product. To facilitate preparation of

estimate for submitting the rates in tenders or quotations. To compare the actual cost with the

estimated cost of the component.

II. Discussion

There are different classification of costing, Classification of Costs essentially means the

grouping of costs according to their similar characteristics. Now, in costing there are a dozen

ways to classify costs as per their nature, functions, traceability etc.

Variable Cost: A cost that changes with the change in the level of activity is called

variable cost.

Fixed Cost: A cost that does not change, in total, with the change in activity is called

fixed cost.

Mixed or Semi-Variable Cost: A cost that has the characteristics of both variable and

fixed cost is called mixed or semi-variable cost.

Direct Cost: A cost that is easily traceable to a particular cost object is known as direct

cost. Every cost that can be easily and conveniently traced to a particular product, customer,

branch, plant or any other cost object is a direct cost.

Indirect Cost: A cost that is not easily traceable to a particular cost object is called

indirect cost.

Quality Cost: It refers to the costs that are incurred to prevent, detect and remove defects

from products. Quality costs are categorized into four main types.
  Prevention costs (to avoid or minimize the number of defects).

 Appraisal costs (to identify defective products).

 Internal failure costs (to remove defects from the products).

 External failure costs (include warranties, replacements, lost sales because of bad

reputation, payment for damages arising from the use of defective products).

Product Costs: Product costs (also known as inventoriable costs) are those costs that are

incurred to acquire or manufacture a product.

Period Costs: The costs that are not included in product costs are known as period costs.

Usually, these costs are not part of the manufacturing process and are therefore treated as

expense for the period in which they arise. Period costs are not attached to products.

Decision-Making Costs: Special purpose costs that are applicable only in the situation in

which they are compiled. They have no universal application. They need not tie into routine-

financial accounts. They do not and should not conform the accounting rules.

Accounting Costs: Are compiled primarily from financial statements. They have to be

altered before they can be used for decision-making. Moreover, they are historical costs and

show what has happened under an existing set of circumstances.

Relevant Costs: are those which change by managerial decision.

Irrelevant Costs: are those which do not get affected by the decision.

Shutdown Cost: A manufacturer or an organization may have to suspend its operations

for a period on account of some temporary difficulties, e.g., shortage of raw material, non-

availability of requisite labour etc.

decision that was made in the past and cannot be changed by any decision that will be made in

the future. Since sunk costs cannot be altered by decisions made at the later stage, they are

irrelevant for decision-making.

Controllable And Uncontrollable Costs: Controllable costs are those costs which can

be influenced by the action of a specified member of the undertaking. The costs that cannot be

influenced like this are termed as uncontrollable costs.

Avoidable Costs: Those which will be eliminated if a segment of a business (e.g., a

product or department) with which they are directly related is discontinued.

Unavoidable Costs: Those which will not be eliminated with the segment. Such costs are

merely reallocated if the segment is discontinued. For example, in case a product is discontinued,

the salary of a factory manager or factory rent cannot be eliminated. It will simply mean that

certain other products will have to absorb a large amount of such overheads.

Expired Costs or Expenses: The used up value of assets. Expired costs are always

shown on the income statement as deductions from revenue.

Expired Costs: May be thought of as that portion of the asset value benefitting current

operations. Unexpired cost is the unused part of the economic benefit of an expenditure that

remains as an asset for future use

Differentials, Incremental or Decrement Cost: The difference in total cost between

two alternatives is termed as differential cost. In case the choice of an alternative results in an

increase in total cost, such increased costs are known as incremental costs. While assessing the

profitability of a proposed change, the Incremental costs are matched with incremental revenue.
 Traceable Costs: The costs that can be easily identified with a department, process or

product. For example, the cost of direct material, direct labour etc.

Untraceable or Common Costs: The costs that cannot be identified. In other words,

common costs are the costs incurred collectively for a number of cost centers and are to be

suitably apportioned for determining the cost of individual cost centers.

PRODUCTION, ADMINISTRATION AND SELLING AND DISTRIBUTION COSTS

 Production Cost: The cost of sequence of operations which begins with supplying

materials, labour and services and ends with the primary packing of the product. Thus, it

includes the cost of direct material, direct labour, direct expenses and factory overheads.

 Administration Cost: The cost of formulating the policy, directing the organization and

controlling the operations of an undertaking which is not related directly to a production,

selling, distribution, research or development activity or function.

 Selling Cost: It is the cost of selling to create and stimulate demand.

 Distribution Cost : It is the cost of sequence of operations beginning with making the

packed product available for dispatch and ending with making the reconditioned returned

empty package, if any, available for reuse.

 Research Cost: It is the cost of searching for new or improved products, new

application of materials, or new or improved methods.

 Development Cost: The cost of process which begins with the implementation of the

decision to produce a new or improved product or employ a new or improved method and

ends with the commencement of formal production of that product or by the method.
  Pre-Production Cost: The part of development cost incurred in making a trial

production as preliminary to formal production is called pre-production cost

MISCELLANEOUS COST

 Conversion Cost: The cost of transforming direct materials into finished products

excluding direct material cost is known as conversion cost.

 Opportunity Cost: It refers to an advantage in measurable terms that have foregone on

account of not using the facilities in the manner originally planned.

 Out-Of-Pocket Cost: It means the present or future cash expenditure regarding a certain

decision that will vary depending upon the nature of the decision made.

 Imputed or (Hypothetical) Costs: These are the costs which do not involve cash outlay.

They are not included in cost accounts but are important for taking into consideration

while making management decisions.

COSTING PROCEDURE

Elements of Cost: A cost is composed of three elements, i.e., Material, labour, and

expense. Each of these elements is direct or indirect.

1. Material Cost: This is the cost of material or the commodity used by the

organisation for its production purpose

 Direct Material Cost: Forms an integral part of the. finished

product and is identified with the individual cost center. Example:

Raw materials purchased or purchased primary packing material,

etc.
  Indirect Material Cost: Is used for ancillary purposes of the

business and cannot be conveniently identified with the individual

cost centre. Example: Consumable stores, oil and waste, printing

and stationery material etc.

2. Labour Cost: This is the cost, incurred in the form of remuneration paid to

the employees of the organisation. The workforce required to convert material

into finished product is called labour. It can be direct or indirect.

 Direct Labour Cost: is the cost incurred on those

employees who directly take part in the manufacturing

process and easily identified with the individual cost centre.

 Indirect Labour Cost: is the cost incurred on those

employees who do not directly take part in the

manufacturing process and cannot identified with the

individual cost centre. Example: salary of foreman,

salesmen, director’s salary, etc.

Overheads: All indirect material cost, indirect labour cost, and indirect expenses. Overheads

may also be classified into Production or Factory Overhead, Office and Administrative

Overheads, Selling Overhead and Distribution Overhead.

 Production Overhead: Production Overhead is also termed as Factory Overhead.

Factory overhead includes indirect material, indirect labour and indirect wages which are

incurred in the factory. For example, rent of factory building, repairs, depreciation,

wages of indirect workers, etc.

indirect expenditure incurred in formulating the policies, establishment of objectives,

planning, organizing and controlling the operations of an undertaking. All office and

administrative expenses like rent, staff salaries, postage, telegram, general expenses etc.

are examples. (c)

 Selling and Distribution Overhead: It is the indirect expenses which are incurred for

promoting sales and distribution of goods until it reaches its destination. For example,

advertisement, salesmen’s commission, salaries of salesmen, Cost of warehousing, cost

of packing, transportation cost etc.

ELEMENT OF COST

ELEMENTS OF
COST

DIRECT DIRECT DIRECT

FACTORY
OVEHEADS

OFFICE
OVERHEADS

SELLING AND
DISTRIBUTION
Cost Sheet: Cost Sheet or a Cost Statement is "a document which provides for the assembly of

the estimated detailed elements of cost in respect of cost center or a cost unit." The analysis for

the different elements of cost of the product is shown in the form of a statement called "Cost

Sheet." The statement summarises the cost of manufacturing a particular list of product and

discloses for a particular period:

1. Prime Cost

2. Works Cost (or Factory Cost)

3. Cost of Production

4. Total Cost (or Cost of Sales)

Components of Cost Sheet: Elements of cost can be grouped as

1. Direct Material + Direct Labour + Direct Expenses = Prime Cost

2. Prime Cost + Production overhead = Factory (or Works) Cost

3. Works Cost + Administration Overheads = Cost of Production

4. Cost of Production + Selling & Distribution Overheads =Total Cost (or Cost of Sales)

III. Conclusion

As we will see, cost accounting has many advantages. It holds importance to many different

parties of business. Management, investors, employees, government and even consumers

themselves benefit from cost accounting. In view of the complexity of businesses and increasing

changes in industry, trade and commerce, costing is becoming very important, It assist

management to make decision for example make or buy, whether to accept a special order and
others, It assist management in planning and control, Costing assists management to appreciate

scarce resources in the increasingly complex business operations, Understanding costing assist in

cost awareness, cost control / management, Is vital to an organization’s survival re: using

marginal cost in competitive tendering and others. Cost accounting makes budgeting simple. No

business can run without a set budget in mind. Budgeting is a process which a smart entrepreneur

follows annually. Cost accounting statements of previous years help you to forecast the future

business expenses. If the costs are rising for previous years, you can make a proper estimate of

the increase in the cost for the current year. Accordingly, a firm can decide whether they need to

increase the margin or not and plus, make the necessary arrangement of funds to cater to the

increasing prices. The overhead costs refer to the indirect costs incurred by a business. Expenses

such as power, insurance, advertising, repairs, administrative expenses, etc. fall under this

category. When a cost accountant separates the direct and indirect costs, it becomes easier to find

ways to reduce the unnecessary wastage resulting due to overhead costs. Cost accounting is an

important factor in the bookkeeping process. In order to grow and develop your business, you

need to keep a check on your costs and hence, cost accounting is necessary for any business.