Classification of Costs in Cost Accounting – Explained with Examples and Categories

Types of Costs in Business

In any organization, understanding how to classify and manage different types of costs is crucial for financial planning, pricing, and profitability. All costs must be assigned to a specific category to ensure accurate budgeting and decision-making.

1. Direct Costs

Direct costs are clearly traceable to a specific product, service, or job. These costs vary directly with the level of production.

Examples:

• Raw materials used in manufacturing

• Wages of workers directly involved in production

• Parts and components used in assembly

Example: In a car manufacturing company, the cost of steel used to build the car and the wages paid to assembly line workers are direct costs.

2. Indirect Costs

Indirect costs are not directly attributable to a specific product but are necessary for the production process or overall business operation. These are also called overheads.

Types of Indirect Costs:

• Indirect Materials: Materials used in production but not directly traceable to a product (e.g., lubricants, cleaning supplies)

• Indirect Labor: Wages of personnel not directly involved in production (e.g., maintenance staff, supervisors)

• Indirect Expenses: General expenses not linked to specific products (e.g., rent, utilities, depreciation)

3. Fixed Costs

Fixed costs remain constant regardless of production volume. They do not change with the level of goods or services produced within a certain range.

Examples:

• Rent or lease payments

• Insurance premiums

• Depreciation

• Property taxes

4. Variable Costs

Variable costs change in direct proportion to production or sales volume. As production increases, these costs rise.

Examples:

• Raw material costs

• Packaging costs

• Sales commissions

• Shipping and delivery expenses

5. Semi-Variable Costs

Also called mixed costs, these include a fixed component and a variable component.

Example:

• Utility bills (fixed monthly charge + variable amount based on usage)

• Maintenance contracts with a base fee plus additional charges based on service calls

Overheads

Overheads refer to ongoing expenses not directly attributed to a specific product or service. These are necessary to run the business but do not directly generate revenue.

Overheads can be categorized into the following types:

1. Factory Overheads (Also called Manufacturing or Production Overheads)

These are indirect costs incurred within the production facility, not directly linked to a specific product.

Includes:

• Indirect materials (e.g., lubricants, cleaning supplies)

• Indirect labor (e.g., supervisors, janitors)

• Factory rent and utilities

• Maintenance of machinery

• Depreciation of factory equipment

2. Office and Administration Overheads

These are costs associated with the general administration of the business.

Includes:

• Salaries of administrative staff

• Office rent and utilities

• Stationery and office supplies

• Legal and accounting services

• Depreciation on office equipment

3. Selling and Distribution Overheads

These are costs related to marketing, selling, and delivering products to customers.

Includes:

• Advertising and promotional expenses

• Salaries of sales staff

• Sales commissions

• Delivery vehicle costs and fuel

• Freight and shipping charges

• Warehousing

Summary Table