2.1 Cost Classifications and Types

Cost classifications help businesses understand and manage expenses effectively. Direct costs are easily traced to products, while indirect costs benefit multiple areas. Knowing the difference aids in accurate cost allocation and pricing decisions.

Cost behavior patterns are crucial for budgeting and forecasting. Variable costs change with activity levels, fixed costs remain constant, and mixed costs have both components. Understanding these patterns helps managers predict and control costs as production volumes fluctuate.

Cost Classifications and Types

Direct vs indirect costs

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• Direct costs traced to specific cost object easily identified with product, service, or department (raw materials, labor costs for assembly, packaging materials)
• Indirect costs benefit multiple products, services, or departments not directly traceable (factory rent, utilities, supervisor salaries)

Cost classification by behavior

• Variable costs change proportionally with activity level (direct materials, sales commissions)
• Fixed costs remain constant regardless of activity (rent, insurance premiums)
• Mixed costs contain variable and fixed components (telephone bills with fixed charge and per-minute rate, maintenance costs with inspections and usage-based repairs)

Opportunity cost in decision-making

• Value of next best alternative foregone when making choice represents potential benefit given up
• Evaluates true cost of decisions considering implicit costs aids resource allocation
• Applied when choosing investments outsourcing vs in-house production allocating limited capacity

Manufacturing cost categories

• Direct materials become integral part of finished product easily traced (wood for furniture, fabric for clothing)
• Direct labor wages for workers involved in manufacturing attributable to specific units (assembly line workers, machine operators)
• Manufacturing overhead indirect costs necessary for production not easily traceable (indirect materials like lubricants, indirect labor like supervisors, factory utilities, equipment depreciation)