Cost classification is 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 most common cost classifications include:
Classification based on cost behavior
Cost behavior means how costs will respond or react to changes in the activity level, that is, as we increase output or sales, are the costs rising, dropping or remaining the same. Cost Behavior can be used to produce various classifications of costs such as:
These are costs that increase or decrease, in total, in direct proportion to changes in the total level of activity or number of units produced i.e. that portion of the cost of an activity that change with the level of output. Examples of variable costs include wages paid to casual employees paid on an hourly basis and fuel cost based on mileage. With variable costs, the cost level is zero when production is zero. With variable costs, the cost level is zero when production is zero. For a cost to be variable there should be an activity base which drives it. This activity base is a measure of effort that operates as a casual factor in the incurrence of variable costs. Thus to control these costs, cost accountants should be well acquainted with the various cost drivers (activity bases) within the organization.
Semi variable costs
These are costs with both a fixed and variable cost component. The fixed component is that portion which is constant irrespective of the level of activity. They are variable within certain activity levels but are fixed within other activity levels.
These are costs that do not change with the level of output. They are also called autonomous costs, as they remain the same irrespective of the activity level. Fixed costs can be taken to be either committed fixed costs or discretionary fixed costs. Fixed costs that cannot be avoided in the short run are called committed fixed costs. They sometimes are also referred to as capacity costs. Such costs concern senior managers for strategic decision making. Discretionary fixed costs are those that can entirely be avoided without having an immediate impact on the level of activity. These costs are subject to management decision e.g. advertisement costs.
Semi fixed costs
These are costs that are fixed only within a relevant range of activity level beyond which they rise to a higher fixed level. They are sometimes referred to as step costs.
Semi variable costs
These are costs that are variable only within a relevant range of activity level beyond which they may remain fixed before assuming variability again.