Question

You have just been appointed the cost accountant of AMINIYA MANUFACTURING LTD. The management of the company, prior to your appointment have always resorted to the work of consultants in costing and pricing products. At your interview, you had indicated to management the importance of cost and the various classifications of costs. The interview panel, very enthused with your explanations decided to engage your services as an employee- thus, your appointment as a cost accountant.

Required:
Write a memo to management detailing the various classifications of costs and provide two reasons for which it is important to classify cost.
Note: The memo should contain at most 200 words.

Answer 1

Costs can be classified in more than 12 different ways, but the most important classifications are:

1. Classification of cost according to the element : direct costs (labor, materials and overhead) and indirect costs (factory overhead, selling and administration).
2. Cost classification according to function : prime cost (direct labor, materials and overhead), product cost (selling and administrative) and factory cost (factory overhead).
3. Depending on behavior : variable (changes according to the output), fixed (does not change according to the output) or mixed.
4. According to relevancy : relevant, opportunity, standard, controllable and sunk.
5. According to management: manufacturing and non-manufacturing costs.

It is virtually impossible to manage and operate a company without properly and exactly knowing the costs of producing and selling a product or service. Classifying costs helps management to control how the company is spending its money and it also helps to budget future production and selling cycles.