COST CLASIFFICATION

OBJECTIVES
After studying this chapter, you should be able to:
• Define cost classification and understand the basis of cost classification, especially the 
cost objectives
• Classify a specific cost as either manufacturing or non-manufacturing and whether 
direct or indirect.
• Understand the behavioral classification of costs and be able to classify various costs 
according to their behavior, either variable or fixed, and draw cost graphs for the various 
costs
• Understand the controllable and non-controllable costs and their relevance in cost 
decision making.
• Classify costs according to their functions. 
• Explain the difference between product and period costs.
INTRODUCTION
This chapter is aimed at introducing the most important concepts applicable in all the other chapters. 
We look at the various cost classifications based on the various basis of classification. 
DEFINITION OF KEY TERMS
Prime cost: this is a summation of all direct costs incurred in production. It comprises direct 
material and direct labour costs and direct expenses.
Variable cost: a cost that changes in direct proportion to changes in the level of activity.
Fixed cost: a cost that does not change with the level of output - also called autonomous cost
Direct costs: are costs that can be traced specifically and identified to the end product of the 
production process without any extra cost or inconvenience
Download more free notes at www.kasnebnotes.co.ke
2 4 COST ACCOUNTING
STUDY TEXT
Indirect costs: are costs that will not be directly attributable to a specific product. They are 
regarded as overheads.
Marginal cost: it represents the additional cost of producing an extra unit of output.
EXAM CONTEXT
This topic is normally examined because it is the basis on which flexible budgets, among 
other statements, are prepared. It provides the ground on which to understand various costing 
techniques. The examiner may not set questions directly from this topic but from topics that 
borrow significantly from cost classification topic.
INDUSTRY CONTEXT
Cost classification is important as management accountants apply it when preparing budgets 
and carrying out sensitivity analysis. The above are just but a few applications. 
Fast forward:
Costs are classified for various purposes or reasons. There is an objective for each classification. 
A cost can fall into more than one classification based on the objective.
Cost classification may be defined as ‘the arrangement of cost items in a logical sequence having 
regard to their nature and purpose to be fulfilled’. Costs are classified according to the cost 
objectives. Cost objective is the activity for which a separate measure of cost is desired. They 
include, cost stock valuation, cost for decision-making and cost for control purposes. The table 
below shows a summary of cost classifications given cost objectives:
Cost objective Possible classification
1. Stock valuation • Manufacturing and non-manufacturing costs 
• Period and product costs
• Direct and indirect costs
2. Decision making • Cost behavior: Variable, fixed, semi variable, 
• Relevance: opportunity, sunk cost, historical cost, 
 standard costs
3. Control purposes • Controllable and non-controllable
• Avoidable and non avoidabl