Chapter-2: Classification of Cost and Preparation of Cost Sheet
Introduction
Cost classification is the process of grouping
costs based on their nature, behavior, or function. This helps in analyzing
costs for effective management and decisionmaking. Understanding different
classifications of costs is crucial for accurate costing and financial
planning.
i)
ElementBased Classification
This classification is based on the nature of
costs. It includes raw materials, labor, other expenses, and overheads.
1. Raw Materials Cost: The cost of materials
used in the production process. For example, in a garment factory, the cost of
fabric is a raw material cost.
2. Labour Cost: The cost of wages and salaries
paid to employees involved in production. For example, the wages of workers in
a factory.
3. Other Expenses: Any other expenses directly
related to the production process but not included in raw materials or labor.
For example, the cost of electricity used in manufacturing.
4. Overhead: Indirect costs related to
production. This includes factory rent, depreciation of machinery, and
utilities.
5. Prime Cost: The sum of raw materials cost and
labor cost. It represents the direct costs of production.
ii)
FunctionBased Classification
This classification is based on the function or
activity for which the costs are incurred.
1. Factory Cost: All costs incurred within the
factory for production. This includes raw materials, labor, and factory
overheads. For example, the cost of machinery maintenance in a factory.
2. Administration Cost: Costs related to the
administration and management of the business. For example, office salaries,
rent, and utilities.
3. Selling Cost: Costs incurred to promote and
sell products. This includes advertising, sales salaries, and commissions. For
example, the cost of a TV commercial for a product.
4. Distribution Cost: Costs associated with
delivering products to customers. This includes packaging, transportation, and
warehousing. For example, the cost of shipping goods to retailers.
5. Research and Development Cost: Costs incurred
for developing new products or improving existing ones. For example, expenses
for research labs and salaries of research staff.
iii)
BehaviourBased Classification
This classification is based on how costs behave
with changes in the level of production or activity.
1. Fixed Cost: Costs that remain constant
regardless of the level of production. For example, factory rent and salaries
of permanent staff.
2. Variable Cost: Costs that vary directly with
the level of production. For example, raw materials cost and wages of temporary
workers.
3. Semivariable / Semifixed Cost: Costs that
have both fixed and variable components. For example, electricity charges that
have a fixed monthly fee plus a variable charge based on usage.
Distinctions between Fixed Cost and Variable
Cost
Fixed costs remain
constant regardless of the production level. Examples of fixed costs include
rent and salaries of permanent staff. These costs are not affected by
short-term production changes and are useful for long-term planning.
On the other hand,
variable costs vary directly with the production level. Examples of variable
costs include raw materials and wages of temporary workers. These costs change
with every unit of production and are useful for short-term decision-making.
iv)
Preparation of Cost Sheet
Definition of Cost Sheet: A cost sheet is a
statement that shows the detailed costs incurred in producing a product or
service. It helps in understanding the total cost of production and setting the
selling price.
Basic Components of Cost Sheet:
1. Prime Cost: Sum of raw materials cost and
labor cost.
2. Factory Cost: Prime cost plus factory
overheads.
3. Total Cost of Production: Factory cost plus
administration and selling costs.
4. Total Cost: Total cost of production plus
distribution costs.
Practical Problems on Cost Sheet:
Example 1:
A manufacturing company has the following costs:
Raw
Materials: ₹50,000
Labor: ₹30,000
Factory
Overheads: ₹10,000
Administration Costs: ₹5,000
Selling
Costs: ₹3,000
Distribution Costs: ₹2,000
x
Prime Cost:
Raw Materials Cost: ₹50,000
Labor Cost: ₹30,000
Total Prime Cost: ₹80,000
Factory Cost:
Prime Cost: ₹80,000
Factory Overheads: ₹10,000
Total Factory Cost: ₹90,000
Total Cost of Production:
Factory Cost: ₹90,000
Administration Costs: ₹5,000
Selling Costs: ₹3,000
Total Cost of Production: ₹98,000
Total Cost:
Total Cost of Production: ₹98,000
Distribution Costs: ₹2,000
Total Cost: ₹100,000
References
1. Arora, M.N. (2019). A Textbook of Cost and
Management Accounting. Vikas Publishing House.
2. Tulsian, P.C. (2014). Cost Accounting: A
Practical Approach. S. Chand Publishing.
3. Horngren, C.T., Datar, S.M., & Rajan,
M.V. (2015). Cost Accounting: A Managerial Emphasis. Pearson Education India.
4. ICWA (2020). Study Material for Intermediate. The Institute of Cost Accountants of India.
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