Cost 

Classification and
Cost Behavior
Prepared by: Muzzamil Malik
What is cost?
n In business and accounting, cost is the monetary
value that a company has spent in order to produce
something.

Cost of making a chair Cost of making a car
Cost classification
Classification by
Element Nature Function Behavior

Non Semi
Material Indirect Production Variable Stepped
Labour cost Expenses Direct cost production Fixed cost Variable
cost cost cost cost Fixed cost
Cost Cost
Cost classification by element
n Material cost
This includes all costs of materials purchased for
production or non‐production activities, e.g. raw
materials and components.

n Labour cost
This includes all staff costs relating to employees.

n Expenses
This include all other costs which are not materials or
labour. These include rent, telephone, and depreciation of
equipment.
Cost classification by element
Cost classification by element
Material cost Labour cost Expenses
Steel Production line workers Rent
Plastic Assembler Rates
Leather Painter Depreciation
Electrical wires Supporting staff Insurance
Glass Machine operators Light
Screw and bolts Test drivers Heat
Tires Supervisor Power
Lubricant Managers Royalties
Purchased components Security guards
Cost classification by element
Cost classification by element
Material cost Labour cost Expenses

Wood Carpenter Rent

Foam Assemblers Depreciation

Nails and screw Machine operator heat

Fabric Painter Light

Paint Supporting staff Insurance

Cost classification by nature
• Direct cost:
Cost that can be traceable for one unit of product

• Indirect cost:
Cost which can not be traceable for one unit of product
Cost classification by nature

Cost

Material Labour
cost Expenses
cost

Direct Indirect Direct Indirect Direct Indirect

material material Labour Labour expense expense
 Examples
Direct Inirect Direct Indirect Direct Indirect
Material Material Labour Labour Expense Expense
Wood Salt Line workers Supervisor Royalties Rent
Plastic Buttons Assembler Manager Sub Rates
contractors
Steel Screw & Nails Machine Helpers Special tools Depreciation
operator
Glass Lubricant of Carpenter Supporting Insurance
Machine staff
Fabric Cleaning Plumber Security Light
Material guards
Leather Glue Bricklayer Store staff Heat
Cement Tape Painter Quality Power
Controller
Paper Clips Electrician IT staff
Paint Food colour Teachers Canteen staff
Cost classification by nature
Cost classification by nature
Direct Indirect Direct Indirect Direct Indirect
material material labour labour expense expense
Flour Salt Baker Supervisor Royalties Rent
Eggs Food color Chef Supporting Special Light
staff tools
Butter Food Line Production Heat
essence workers manager
Sugar Cleaning Packaging Depreciation
material staff
Cream Insurance
Cost classification by nature
 Cost classification by nature
Direct Indirect Direct Indirect Direct Indirect
material material labour labour expense expense
Cement Nails Bricklayer Supporting Royalties Rent
staff
Steel Screws Plumbers Supervisor Special Depreciation
tools
Bricks Lubricant Electrician Site Sub Insurance
of machine manager contractor
cost
Paint Water Carpenter
Fittings architect
Cost classification by function
Cost
Production Non production cost or
cost period cost

Research and
Administration Distribution
Material Labour Expenses Selling cost Finance cost development
 cost cost
cost
Cost classification by function
Administration Selling cost Distribution Finance cost R&D cost
 cost  cost
Rent of office Free samples Warehouse Interest on Chemical
cost loan compound
Director salaries Selling staff Driver Interest on Test
commission salaries bank equipment
overdraft cost
Manager salaries Promotional Lorries fuel Research
cost cost material
Office insurance Lorries Scientist
running cost salaries
Office supplies
Costing Terminologies
n Prime cost
All direct cost (Direct material + Direct labour + Direct expense)

n Factory overhead, Production overhead or Manufacturing overhead
All indirect cost (Indirect material + Indirect labour + indirect expense)

n Production cost, Factory cost or Manufacturing Cost
Prime cost + Factory overhead

n Total cost
Production cost + Non production cost

n Conversion cost
Direct labour cost + Production Overhead
Cost classification by behavior

Cost

Semi
Stepped
Variable cost Fixed cost variable cost
fixed cost
or Mix cost
 Variable cost
n A cost that varies in total with the level of activity but
remains constant per unit.

n Examples
Direct material (fabric wood leather etc.)
Direct labour (carpenter tailor assembly line workers
etc)
Variable cost
Units Total Cost Cost per unit
5,000 $100,000 $20
10,000 $200,000 $20
15,000 $300,000 $20
20,000 $400,000 $20
 Fixed cost
n A cost that remains fix in total with the level of activity
level (with a specific range) but changes per unit is
called fixed cost”. Fixed cost does not depend on the
activity level, it relates with the passage of time

n Examples
Rent
Rates
Depreciation
Insurance
Fixed cost
units Total cost Cost per unit
5,000 $400,000 $80
10,000 $400,000 $40
15,000 $400,000 $26.67
20,000 $400,000 $20
 Semi Variable cost or Mix cost
n A cost which has both elements fixed and variable is
called semi‐variable cost.

n Examples
Gas bill
Car running cost
Telephone bill
Semi Variable cost
Units Total semi variable cost
1000 1000×$0.5+$300=$800 $0.8
2000 2000×$0.5+$300=$1300 $0.65
3000 3000×$0.5+$300=$1800 $0.6
4000 4000×$0.5+$300=$2300 $0.575
 Stepped fixed cost
n A cost that fixed for a certain level of activity, will
increase and will then remain fix again until another
production level.

n Examples
Store rent
Supervisor salary
Oil replacement
Stepped fixed cost
units Number of stores Total rent cost
1‐ 20,000 1 $100,000
20,001 – 40,000 2 $200,000
40,001 ‐60,000 3 $300,000
60,001 – 80,000 4 $400,000
Identify cost behavior of below
mentioned costs
Cost Production

1,000 units 2,000 units 3,000 units

Cost A $100, 000 $150,000 $200,000

Cost B $200,000 $200,000 $200,000

Cost C $100,000 $200,000 $300,000

Cost D $100,000 $100,000 $200,000

Question
A product that a company manufactures requires 5 kg of material A
costing $3.60 per kg and 5 kg of material B costing $4.80 per kg. The
product requires 3 hours of labour at a cost of $6.50 per hour. The
product is sold in packs of 30 and the packaging for 30 units costs
$36. Fixed production costs are $80,000 per annum and selling,
distribution and administration costs are $24,000 per annum. The
company makes 15,000 units of the product each year.

(i) Calculate prime cost per product
(ii) Calculate production cost per product
(iii) Calculate total cost per product
Responsibility centre
Responsibility Centre: a function or department of an organization that is headed
by a manager and the manager has direct responsibility for its performance is
known as a responsibility centre.

Responsibility
Centre

Revenue Investment
Cost centre Profit centre
centre centre
Responsibility centre
Cost Centre
▪ A cost centre is a production or service location,
function, activity or item of equipment for which
costs are accumulated.
▪ If a manager is responsible for costs attributable to
his area of business, it means that the manager is
responsible for a cost centre. 
 Types of Cost Centre
Production Cost Centre
• Assembling department
• Finishing department
• Machining department
• Packaging department
Service Cost Centre
• Canteen
• Store department
• Repair & Maintenance
department
• Accounts department
 Responsibility centre
Revenue centre
n  A centre, which raises revenue and has no
responsibility for costs.
n Manager of revenue centre is accountable only for
revenues.
n For example department which obtains grants and
donations for a charity, sales department
 
Cost Unit
A unit of product or service in relation to which costs are
ascertained.

❖ Car for a car manufacturer
❖ Batch of cakes for a cake manufacturer
❖ Meal for restaurant
❖ House for a construction company
❖ Patient night for hospital
❖ Guest day for hotels
❖ Passenger kilometer for railway
❖ Tonne mile for logistic
❖ Client hour for audit firm
 Responsibility centre
Profit Centre
n If a manager is responsible for costs as well as income
attributable to his area of business, it means that the
manager is responsible for a profit centre
n A profit centre manager is likely to be a senior
person in the organization who influences over both
revenue and cost.
 Responsibility centre
Investment Centre
n  It refers to a profit centre with an additional
responsibility for capital investment.
n Manager of investment centre has the responsibility
for profit in relation to capital invested in his area.
 
High low method
A method used to determine fixed and variable elements of
semi variable cost, this method could also be used to determine
future estimated cost.

Application

1. Variable cost per unit
    Cost at high activity level – Cost at low activity level
               High activity level – Low activity level
2. Fixed cost
Total cost          xxx
‐Total variable cost (activity level × variable cost per unit)       (xxx)
      Fixed Cost        xxx
High low method
The following data relate to two activity levels of  a company:
 
Number of Units            3,000            4,500
Total Cost                         $60,000          $72,000

(a) Calculate variable cost per unit
(b) Calculate total fixed cost
High low method
The following data relate to three output levels of a department:

Production                 10,000         20,000       30,000
Overheads               $128,000     $156,000    $186,000

(a) What is the amount of variable overhead per unit?
(b) What is the amount of fixed overheads?
High low method
The following data relate to two activity levels of  a company:
 
Activity level            4,000            6,000
Total Cost                         $60,000          $80,000

(i) Calculate variable cost per unit
(ii) Calculate total fixed cost
(iii) Calculate cost of 8,900  units
High low method
The following data relate to two activity levels of  a company:
 
Activity level            10,000            15,000
Total Cost                         $150,000          $125,000

(i) Calculate variable cost per unit
(ii) Calculate total fixed cost
(iii) Calculate cost of 4,500  units
High low method
The following data relate to two activity levels of  a company:
 
Number of Units             3,000
Total Cost                                           $60,000
Fixed Cost                 $15,000
(a) Calculate variable cost per unit
(b) Calculate cost of 16,200 units
 Effect on unit cost when activity
level changes
A particular cost is fixed in total for a period
 
What is the effect on cost per unit if activity level increases by 100%?
 
n Cost per unit reduce by 50%
n Cost per unit reduce by more than 50%
n Cost per unit reduce by less than 50%
n Cost per unit is unchanged
 
 Effect on unit cost when activity
level changes
A particular cost is variable in total for a period
 
What is the effect on cost per unit if activity level increases by 50%?
 
n Cost per unit reduce by 50%
n Cost per unit reduce by more than 50%
n Cost per unit reduce by less than 50%
n Cost per unit is unchanged
Effect on unit cost when activity
level changes
A particular cost is semi variable in total for a period 

What is the effect on cost per unit if activity level increases by 100%?

n  Cost per unit reduce by 50%
n Cost per unit reduce by more than 50%
n Cost per unit reduce by less than 50%
n Cost per unit is unchanged