Explain the classification of costs

Explain the classification of costs

The Analysis and Classification of Expenditure

The main classifications of business expenditure are:

• Materials
• Wages
• Expenses

However there are, two broad divisions to be noted, namely: Direct Expenditure and Indirect Expenditure

Direct materials means the cost of materials which enter into and become part of the product, e.g. the flour in bread, the clay in bricks, the leather in shoes and the wood in furniture. In some cases, however, it is not so easy to determine whether a material is to be regarded as direct or not, and the custom of the trade has to be taken into account or a decision which appears fair and reasonable in the circumstances has to be made.

Direct wages means the cost of wages paid to operatives who are immediately concerned with the manufacture of a product. That is to say, who “does” something to the raw material? If the concern is not a manufacturing business, but instead renders a service, then the term is related to those employees who directly carry out that service. Example of direct wages would be those paid to bakers, clay getters, shoemakers, cabinet-makers, and in the second category, to bus drivers and conductors and to postmen.

Direct expenses means those expenses incurred which without doubt are as much a cost of the product as are direct materials. Such might be the provision of special drawings or the cost of a special pattern. The amount of such expenses is likely to be relatively small, and the heading is often ignored with no great disadvantage. The sum of direct materials, direct wages and direct expenses is known as the prime cost.

Indirect materials, wages, and expenses may be simply be defined as all expenditure other than that regarded as direct. Although in accountancy the term “Indirect” expenses” is a common one, and is used in a general sense. Cost accountants have sought for a term which would definitelybe understood to be embracive of indirect materials, wages and expenses. This they have found in the word “overhead”

Subdivision of Overhead

For the sake of classifying overhead suitably, it is sub-divided into:

• Production overhead
• Administrative overhead
• Selling overhead
• Distribution overhead

Production Overhead

This refers to the indirect works expenditure incurred, and it consists of the three elements i.e indirect materials, indirect labour and indirect expenses.

• Indirect materials

Any materials used in the course of manufacture which either cannot be traced as part of the product or which are too small in value to be conveniently measured. Examples of indirect materials are:

1. Dustbins
2. Soap
3. Oil and grease

• Indirect labour

The cost of labour employed in the works or factory which is ancillary to production. Examples are:

1. Inspectors
2. Supervisors
3. Workshop cleaners
4. Internal transport staff

• Indirect expenses

Expenses incurred by the undertaking which may be either allocated to the factory or partially apportioned to it. Examples are:

1. Power, lighting and heating
2. Rent and rates
3. Water
4. Insurance
5. Depreciation

It will also include services such as:

1. Work canteen
2. Industrial nurse
3. Fire precautions
4. Research

Administration Overhead

This refers to the expense incurred in the direction, control, and administration of an undertaking. The same elements of material, labour, and expenses permeate the headings under this and the remaining two classifications, but it is not usually necessary to consider them in those separate categories. Examples of administration overhead are:

1. Salaries and wages of executives and clerks on the administrative staff, rent and
2. Lighting and
3. Insurance
4. Office printing and stationery.

Selling Overhead

This classification comprises the costs incurred in securing orders from customers for the products dealt in by the concern. Examples are:

1. Staff
2. Advertising
3. Sales department expenses
4. Samples displays
5. Catalogues

Distribution Overhead

This consists of all expenditure incurred in handling the product from the time it is completed in the works until it reaches its destination. Examples of such expenditure are:

1. Warehouse wage and salaries
2. Packing cases
3. Loading expenses
4. Upkeep and running charges of delivery vans

 

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