For us to understand costs incurred by our businesses we should be able to classify them, otherwise it would be difficult to control them to within a reasonable level. There are, actually, several ways in which costs could be classified. For instance, we could classify costs according to their elements, behaviour or function.
In terms of elements, costs could be looked at in terms of whether they are material, labour or expenses. However, this classification does not end here. We need to go further and ascertain whether these are direct (prime costs) or indirect (overheads). If we are in manufacturing or service industries, it is relatively easier to deal with the direct costs since we can trace them to the product or service we have provided, otherwise known as cost units.
The overheads on the contrary, are hard to deal with. This is because overheads can not be directly linked with any cost unit. Under traditional costing systems, the solution to the overheads problem is to: Firstly, allocate or apportion them to cost centres e.g. production department, purchasing department, engineering department etc. After this initial allocation and apportionment, we then re-apportion all overheads to those cost centres, which we can categorise as production cost centres. The reason being that if there was no production then other departments would not have incurred any overheads.
When this re-apportionment is over, we then need to find a suitable basis for absorption. This basis could be labour hours, machine hours, a proportion of material costs, a proportion of labour costs, a proportion of prime costs etc. The choice depends on which basis management feels would provide more accuracy in costing products. After this, we would then come up with an absorption rate, for overheads recovery.
The other classification of costs could be based on behaviour. This is because costs have been found to be either variable, semi-variable or fixed; that is, if we try to be simplistic. This type of classification has several uses in Cost or Management Accounting. For example, we could do a Cost-Volume-Profit (CVP) analysis only if we know the behaviour of costs. The CVP analysis, by the way, is a technique we use to try to figure out how profit would change, say, if we change costs by a certain proportion etc.
And, we could also classify costs on the basis of whether they are production, marketing, purchasing, distribution, financial etc. This type of classification, by function, is most common when we prepare Financial Accounts.
In terms of elements, costs could be looked at in terms of whether they are material, labour or expenses. However, this classification does not end here. We need to go further and ascertain whether these are direct (prime costs) or indirect (overheads). If we are in manufacturing or service industries, it is relatively easier to deal with the direct costs since we can trace them to the product or service we have provided, otherwise known as cost units.
The overheads on the contrary, are hard to deal with. This is because overheads can not be directly linked with any cost unit. Under traditional costing systems, the solution to the overheads problem is to: Firstly, allocate or apportion them to cost centres e.g. production department, purchasing department, engineering department etc. After this initial allocation and apportionment, we then re-apportion all overheads to those cost centres, which we can categorise as production cost centres. The reason being that if there was no production then other departments would not have incurred any overheads.
When this re-apportionment is over, we then need to find a suitable basis for absorption. This basis could be labour hours, machine hours, a proportion of material costs, a proportion of labour costs, a proportion of prime costs etc. The choice depends on which basis management feels would provide more accuracy in costing products. After this, we would then come up with an absorption rate, for overheads recovery.
The other classification of costs could be based on behaviour. This is because costs have been found to be either variable, semi-variable or fixed; that is, if we try to be simplistic. This type of classification has several uses in Cost or Management Accounting. For example, we could do a Cost-Volume-Profit (CVP) analysis only if we know the behaviour of costs. The CVP analysis, by the way, is a technique we use to try to figure out how profit would change, say, if we change costs by a certain proportion etc.
And, we could also classify costs on the basis of whether they are production, marketing, purchasing, distribution, financial etc. This type of classification, by function, is most common when we prepare Financial Accounts.
No comments:
Post a Comment