Classification of costs Looks at the purpose and types of costs incurred by an organisation

Classification costs Bookkeeping system classifies costs as PEARLS Financial accounting classifies costs as Capital and revenue expenditure Management accounting classifies costs as – Function (costs incurred in production or administration) – Element (materials, labour and expenses) – Nature (directly involved in the production & indirectly, in management, selling and administration)

Function cost classification FunctionLedger accounts Production costsMaterials Employees used in the production Machine running costs (fuel, depreciation) Supervision/ Selling & distribution costsAdvertising Delivery costs Staff salaries (sales person) Administration costsSecretarial and accounting costs General management salaries Rent of office building Finance costsInterest on a loan or overdraft Fees for arranging a loan

Element cost classification ElementLedger accounts MaterialsMaterials used in production Machine running costs (fuel, parts & depreciation) LabourWages of employees used in production Wages of supervision & sales staff General management salaries Expenses or overheadsAdvertising Delivery costs to Secretarial and accounting costs Rent of office Interest on a loan or overdraft Fees for arranging a loan

Nature cost classification NatureLedger accounts Direct costsMaterials used in production Wages of employees used in production Indirect costsMachine running costs (fuel, parts & depreciation) Wages – employees supervising the production Sales staff salaries General management salaries Advertising Delivery costs Secretarial & accounting costs Rent of building Interest on a loan or overdraft Fee for arranging a loan

2 stage cost classification ElementNatureExamples MaterialsDirect materialsMaterials incorporated in the finished product Indirect materialsMaterials used in the production process but not incorporated in the product Insignificant costs attributable to each product are sometimes included in indirect materials for convenience LabourDirect labourWages paid to workers in the production process or perform the service in a service business Indirect labourWages and salaries of other staff involved indirectly in the production process (supervisors, storekeeper Expenses/ overhead Indirect expense/ overhead Expenses not spent on the production or service provided – rent, rates, electricity & telephone costs

Cost Centres We classify costs as function, area or department – Production – Administration – Assembly/finishing area – Human resources – Marketing These can be called a Cost Centres Financial documents are analysed to the relevant cost centre Helps to determine the total cost incurred by a centre

Elements & cost centres Materials – Materials could be analysed to different departments meaning the costs will be analysed to more than one cost centre – The stores department need to record the quantity of new materials coming to the business (inventory) – The bookkeeping system will record the materials to the ledger account materials and analyse values to the relevant cost centre

Element & cost centre Labour – Bookkeeping records the cost of wages and salaries to the ledger account (Gross Wages) and then analyses to the relevant cost centre – Management accounting will break it down to Basic wage, overtime and bonus – Basic wages is the amount paid for normal hours – Data will be taken from Clock card (mechanical device on factory floor) Time sheet (employee fills in detailed hours worked and where) Job card (used in large manufacturing businesses for individual products)

Overtime – Additional hours paid over and above employee’s contracted hours – Expressed as: Time and a half ( 1 ½ times normal hourly rate) Double time (2 times normal hourly rate) – The additional hours would be analysed to the relevant cost centre where known – If not known the overtime would be apportioned to the basic wages cost centres

Bonus payments – To increase productivity employers will set up bonus scheme – Employees will earn additional pay if they work more efficiently – Bonus scheme can be set as individual or group basis – Bonus charges can be analysed as direct cost relating to the production costs or as an indirect cost analysed to expenses

Expenses All cost centres incur expenses also called overheads Some costs can be analysed to more than one cost centre Where costs have to be split between centres known as Apportionment of costs, common costs are: rent, power & wages Where costs are split they can be apportioned as square footage or percentages

Service organisations Highest cost for most service organisation is labour costs This can be recorded on a timesheet As a service organisation, items purchased for the service will not be raw materials but consumables, examples are: – Stationery – Printing costs All will be analysed to a cost centre as with the manufacturing organisation