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The process of categorising a company’s expenses for the decision-maker to have a clearer understanding defines the cost classification. Seamless execution allows various teams to use data for financial modelling and other accounting purposes.
To get a better understanding of this process, keep reading!
The list below highlights the four different types of cost classification.
To understand what cost classification is, one must go through the basics of those classifications. There are six classifications in total, some of which also have sub-parts.
The analytic classification depends on its nature. Hence there are three categories, material cost, labour cost and other expenses. In addition, categorising in this manner helps monitor specific expenses of any work still in progress.
As the name suggests, this categorisation checks the basic administrative actions of any organisation.
Cost classification is also done by segregating them as the following:
In every company, those in managerial positions use money as a tool for their business growth. Hence this category of cost classification is solely dependent on management's decision. It is up to them how they want to distinguish or divide the expenses.
This may include differential cost, sunk cost, abnormal cost, marginal cost, replacement cost, etc.
Companies that manufacture businesses use this technique. However, such companies need to follow specific processes to launch their final product ultimately.
For example:
There is a dependency on cost over time. For example, it is quite common that an expense of today may have no value tomorrow. Therefore, the managers categorise costs depending on time so that they can effectively distribute costs according to their occurrence.
Hence, the sub-division can be like this:
Every company needs unique costing strategies to demonstrate its expenses. Here is a list of some popular methods of cost classification.
Typically, all firms have a business rationale that allows them to manage the flow of their work process. For example, they allocate a certain cost to a particular job or assignment. The increase in profit depends on the accurate application of this strategy.
A prominent characteristic of job costing is that it applies to every particular order costing irrespective of the duration it needs to complete the job. Generally, job costing is employable for works that take a shorter period to complete.
This method only applies if there is any involvement of a contract between a client and a contractor. However, employing this strategy benefits the contractee as it helps track all the expenses.
Primarily construction companies use the method of contract costing. For example, the construction of dams, railways, building complexes, highways, etc., are somewhere contract costing is implemented. Some may confuse this with job costing, but they differ in one aspect. Projects that take longer periods use contract costing, whereas works that take a shorter period for completion use job costing.
Batch costing is applicable when the production of goods does not meet the demand. In such cases, they replicate the products. Nevertheless, the strategy remains persistent, and it is done in batches. These batches contain uniform products that may fulfil one order or meet the predetermined quantity requirements.
In this system, the expenditure during these batches of products is further divided by the total number of produced units. This results in the cost per unit. For example, companies that produce electronic goods like television or dryers use batch costing strategies.
This is another popular strategy of costing. Here numerous products are manufactured at the same time, and all of them are similar. Companies use this strategy to know the production cost of single units.
To determine this, first, they find the production cost of every process and then divide it by the manufactured units. Those who manufacture salt, sugar, other chemicals, or edible oil use this strategy.
Another method of cost classification is operating costing. This is an ideal strategy for service sectors. These companies use this method to evaluate the cost of services.
However, to employ this method, companies should ensure certain formalities. Firstly, all of the services must be uniform. Secondly, they cannot be any of those specialised services.
Till now, we explained the cost classification, its types and different strategic methods. Now for a quick recap, maintaining the costs in a running business is essential as it acts as a tool for future evaluations. Therefore, we can say that by classifying costs into separate categories, one can clarify their entire business model.
To track various costs in any business, a proprietor can appoint an accountant or handle the costing themselves. Accountants are responsible for maintaining the expenditures' records and other associated tasks.
Unit costing, also known as outcome costing, is a procedure to demonstrate the cost of every output unit.
A life insurance plan it’s a recurring expense. You pay premiums regularly, and unless it has investment value (like whole life plans), it doesn’t build wealth. Think of it as a safety tool rather than something that grows in value like land or gold.
Term insurance premium is usually a fixed cost because you pay the same amount monthly or yearly, regardless of your income or spending. It's predictable, just like rent or EMIs. This helps you budget better, especially if you’re planning long-term financial goals for your family.
Health insurance reduces variable medical costs, like hospital bills, surgeries, and medicines, which would otherwise hit your pocket suddenly. Instead of unexpected huge expenses, you pay a fixed premium and let the insurer cover major health risks. It makes your budget more stable.