Cost classification refers to the process of grouping costs according to their common characteristics, such as nature of expense, function, variability, controllability and normality. Cost classification can be done on the basis of time, their relation with the product and accounting period. Cost classification is also made for planning and control and decision making. Thus, classification is essential for identifying costs with cost centers or cost units for the purpose of determination and control of cost:
By nature of expenses: Costs can be classified into material, labour and expenses as explained earlier.
By function: Costs are classified, as explained earlier, into production or manufacturing cost, administration cost, selling and distribution cost, research and development cost.
By variability: Costs are classified into fixed, variable and semi-fixed / semi-variable costs according to their tendency to vary with the volume of output.
By controllability: Costs can be classified under controllable cost and uncontrollable cost.
By normality: Costs can be divided into normal cost and abnormal cost.
Normal cost refers to the cost, at a given level of output in the conditions in which that level of output is normally attained.
Abnormal cost is a cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained.
On the basis of time: Costs may be classified into historical or actual cost and predetermined or future cost.
Historical cost relates to the usual method of determining actual cost of operation based on actual expenses incurred during the period. Such evaluation of costs takes longer time, till the accounts are closed and finalized, and figures are ready for use in cost calculations.
Predetermined cost as the name signifies is prepared in advance before the actual operation starts on the basis of specifications and historical cost data of the earlier period and all factors affecting cost. Predetermined cost is the cost determined in advance and may be either estimated or standard.
Estimated cost is prepared before accepting an order for submitting price quotation. It is also used for comparing actual performance.
Standard cost is scientifically predetermined cost of a product or service applicable during a specific period of immediate future under current or anticipated operating conditions.
In relation to the product: Costs may be classified into direct and indirect costs.
Direct costs are those which are incurred for a particular cost unit and can be conveniently linked with that cost unit. Direct costs are termed as product cost.
Indirect costs are those which are incurred for a number of cost units and also include costs which though incurred for a particular cost unit are not linked with the cost unit. Since such costs are incurred over a period and the benefit is mostly derived within the same period, they are called period costs.