CLASSIFICATION OF COSTS (BY COSTS FOR MANAGERIAL DECISION MAKING)

CLASSIFICATION OF COSTS

 By Costs for Managerial Decision Making
According to this basis cost may be categorised as follows:

(a) Pre-determined Cost - A cost which is computed in advance before production or operations start, on the basis of specification of all the factors affecting cost, is known as a pre-determined cost.

(b) Standard Cost - A pre-determined cost, which is calculated from managements ‘expected standard of efficient operation’ and the relevant necessary expenditure. It may be used as a basis for price fixation and for cost control through variance analysis.

(c) Marginal Cost -The amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit.

(d) Estimated Cost - Kohler defines estimated cost as “the expected cost of manufacture, or acquisition, often in terms of a unit of product computed on the basis of information available in advance of actual production or purchase”. Estimated costs are prospective costs since they refer to prediction of costs.

(e) Differential Cost - (Incremental and decremental costs). It represents the change (increase or decrease) in total cost (variable as well as fixed) due to change in activity level, technology, process or method of production, etc. For example, if any change is proposed in the existing level or in the existing method of production, the increase or decrease in total cost or in specific elements of cost as a result of this decision will be known as incremental cost or decremental cost.

(f) Imputed Costs - These costs are notional costs which do not involve any cash outlay. Interest on capital, the payment for which is not actually made, is an example of imputed cost. These costs are similar to opportunity costs.

(g) Capitalised Costs -These are costs which are initially recorded as assets and subsequently treated as expenses.

(h) Product Costs - These are the costs which are associated with the purchase and sale of goods (in the case of merchandise inventory). In the production scenario, such costs are associated with the acquisition and conversion of materials and all other manufacturing inputs into finished product for sale. Hence, under marginal costing, variable manufacturing costs and under absorption costing, total manufacturing costs (variable and fixed) constitute inventoriable or product costs. 

(i) Opportunity Cost - This cost refers to the value of sacrifice made or benefit of opportunity foregone in accepting an alterna¬tive course of action. For example, a firm financing its expansion plan by withdrawing money from its bank deposits. In such a case the loss of interest on the bank deposit is the opportunity cost for carrying out the expansion plan.

(j) ) Out-of-pocket Cost - It is that portion of total cost, which involves cash outflow. This cost concept is a short-run concept and is used in decisions relating to fixation of selling price in recession, make or buy, etc. Out–of–pocket costs can be avoided or saved if a particular proposal under consideration is not accepted.

(k) Shut down Costs - Those costs, which continue to be, incurred even when a plant is temporarily shut-downe.g. rent, rates, depreciation, etc. These costs cannot be eliminated with the closure of the plant. In other words, all fixed costs, which cannot be avoided during the temporary closure of a plant, will be known as shut down costs.

(l) Sunk Costs - Historical costs incurred in the past are known as sunk costs. They play no role in decision making in the current period.For example, in the case of a decision relating to the replacement of a machine, the written down value of the existing machine is a sunk cost and therefore, not considered.

(m) Absolute Cost - These costs refer to the cost of any product, process or unit in its totality. When costs are presented in a statement form, various cost components may be shown in absolute amount or as a percentage of total cost or as per unit cost or all together. Here the costs depicted in absolute amount may be called absolute costs and are base costs on which further analysis and decisions are based.

(n) Discretionary Costs – Such costs are not tied to a clear cause and effect relationship between inputs and outputs. They usually arise from periodic decisions regarding the maximum outlay to be incurred.Examples include advertising, public relations, executive training etc.

(o) Period Costs - These are the costs, which are not assigned to the products but are charged as expenses against the revenue of the period in which they are incurred. All non-manufacturing costs such as general &administrative expenses, selling and distribution expenses are recognised as period costs.

(p) Engineered Costs - These are costs that result specifically from a clear cause and effect relationship between inputs and outputs. The relationship is usually personally observable.Examples of inputs are direct material costs, direct labour costs etc.Examples of output are cars, computers etc.

(q) Explicit Costs - These costs are also known as out of pocket costs and refer to costs involving immediate payment of cash.Salaries, wages, postage and telegram, printing and stationery, interest on loan etc. are some examples of explicit costs involving immediate cash payment.