TOPIC TWO

CLASSIFACATION OF COSTS

What is a Cost centre?

A cost centre is a location, a person, an item of equipment (or a group of
these in relation to which cost are ascertained and further related to cost
units. For example, the factory, canteen, maintenance section, the foreman,
managing director, the plant, the pool of computers etc.

What is a cost unit?

A cost unit is a quantitative unit of a product or service in relation to which
costs are ascertained. For example, tonnes of cocoa, bags of maize, bags of
rice, barrels of beer or cartons of minerals, kilowatt hours, passenger per
mile, ton per mile etc.

What is Cost allocation?

Occurs when overheads and expenses are charged directly to the cost
center. Assigning specific overheads to a production or service cost centre or
cost unit on an appropriate basis. For example, the cost of direct labour
(such as labour cost per unit produced) is directly allocated to the specific
cost center.
Cost tracing is the process of directly matching a cost with a product being
produced.

CLASSIFICATION OF COST

There are different costs for different purposes and no single cost concept is
relevant in all situations. Cost can be classified variously for different
objectives.

A.CLASSIFICATION ACCORDING TO ELEMENT/NATURE OF COST

Costs can be classified by element. There are three basic elements of cost.
These are materials, labour and expenses. Thus when classified according to
elements, these are materials cost, labour cost and expenses cost

a. Material Costs.
These are the costs of materials or commodity other than fixed assets,
introduced into product or consumed in the operations of an organisation. In
other words, they are the cost of materials input into the production of goods
and services. For example, the cost of: raw materials, component parts,
Primary packing materials, cleaning materials
b. Labour Cost

These are the cost of employee remuneration. In other words, payments

made to and on behalf of employees for offering labour services in the
production function.

c. Expenses
These are all other costs other than material cost and labour costs. For
example the cost of: - Hiring special equipment and maintaining such
equipment, Royalty payments, Copyrights and patent payments, Utilities
such as electricity and water, Rent etc.

B. CLASSIFICATION ACCORDING TO PURPOSE

Cost can also be classified either as direct cost or as indirect costs.

i. Direct Cost
These are cost that can be directly identified and charged to a cost unit
without apportioning. Direct costs comprises of direct material cost,
direct labour cost and direct expenses

a. Direct material cost

These are the costs of material that can be physically identified with a
specific cost unit.
The following groups of materials are examples of direct materials:
-Materials specifically purchased for a particular job order or process.
-Materials requisitioned from store for a particular production order
-Primary packing materials e.g. cartons, wrapping materials etc

b. Direct labour or wages cost

These are the cost of remuneration for employees‟ efforts and skill applied
directly to a product or saleable service. Such wages are allocated directly to
cost units. Examples of direct labour cost are:
- Wages of production operatives who are involved in transforming the raw
materials into finished goods.

- Wages of waiters who serve meals at a hotel

- Wages of sales assistants involved in selling goods in a retailing shop etc.

c. Direct Expenses
These are costs other than material cost, labour cost which can be identified
with and charged or allocated to a cost unit. In other wards they are costs
other than material cost and labour cost which are incurred for a specific
product or saleable service.
Examples of direct expenses are:
- The cost of hiring special equipment for a particular production order

- The maintenance cost of special equipments hired for particular production

orders

- Royalty payments , Traveling expenses to site of contracts etc.

NOTE: The sum of all direct costs is prime cost.

ii. Indirect Cost
All costs that cannot be identified with and allocated to a cost unit but that
has to be apportioned to a number of cost centres and further absorbed by
cost units are described as indirect cost. Another term for all indirect costs is
Overhead costs.

Indirect costs comprise of: a. indirect material cost b. indirect labour cost c.
indirect expenses

a. Indirect Material Cost

These are the cost of material items that cannot be identified with any one
product because they are used for the benefit of all products rather than for
any one specific product. examples of Indirect Material Cost are;

 The cost of materials required for operating and maintaining plant &
equipment such as - lubricating oil , consumable tools
 cost of stationary

 cost of cleaning materials such as- soap and detergents, rugs and
dusters, brooms and brushes etc

b. Indirect labour cost

These are wages of employees who do not work on the product itself but who
assist in the manufacturing process. For example: salaries of factory
supervisors, wages of the stores dept employees, wages of cleaners etc

c. Indirect Expenses
These are expenses incurred in general and not for the production of a
specific cost unit. For example
 Selling and distribution expenses i.e. i.advertising ii. Sales promotion
etc
  Administrative expenses i.e. i. stationery ii. Audit & consultancy
fees iii. Secretarial charges
 Production expenses i.e. i. rent ii. Insurance iii. Electricity

C. CLASSIFICATION ACCORDING TO BEHAVIOR

Costs may be classified according to the way the cost behaves in relation to
activity level. In this regard, cost may be classified as:
a) Fixed cost

b) Variable cost

c) Semi-fixed, semi-variable or mixed cost

d) Stepped fixed cost

a. Fixed Cost

These are costs that do not vary with changes in activity levels. They usually
change with the passage of time. For example, rent and rates, the managing
director’s salary etc.

b. Variable Cost: These are costs which vary in direct proportion with
changes in activity levels. For example, the cost of raw materials, direct
wages and direct expenses such as royalties.

c. Semi-fixed\semi-variable or mixed cost

These are costs which contain fixed and variable elements. That is, for a
given range of activity level. The cost may remain constant and beyond the
relevant ranges, costs may then vary in direct proportion with changes in
activity level. For example, the cost of utilities such as electricity, water and
telephone.

d. Stepped fixed cost

These are costs which are fixed for a given range of activity level but which
change discretely for ranges of activity levels beyond the given ranges.

D. CLASSIFICATION AS PRODUCT COSTS OR PERIOD COSTS

a. Product Costs
These are the costs that are identified with goods produced or purchased for
resale. These usually are the production or manufacturing costs.
Examples of product costs are:
- cost of raw materials, production wages ,Production overheads such as
electricity, depreciation of plant, rent of factory premises etc.

b. Expired Product Cost

These are the portion of product cost which relate to products that have
already realised revenues and do not have future revenue generating
potential.

c. Unexpired Product Costs

These are the cost of resources acquired which are expected to contribute to
future revenue. They are recorded in the statement of financial position, e.g.
stock of materials not yet sold.

NOTE:

Product costs can be analysed as expired costs or unexpired costs

d. Period Costs

These are the costs incurred and charged against profit for a period, and not
included in cost for stock valuation purposes. These usually are non-
manufacturing costs. Examples are selling and distribution overheads and
administrative overheads.
E. CLASSIFICATION OF COSTS AS RELEVANT AND IRRELEVANT COSTS

a. Relevant Costs/Revenue

These are those future costs and revenues that can be altered by a given
decision. Examples of Relevant Costs include: Future costs, Opportunity
costs Avoidable costs, Incremental costs etc.

b. Irrelevant Costs/Revenues

These are those costs/revenues that will not be affected by a given decision.
Irrespective of what decision is taken, the cost will not alter. Examples of
Irrelevant Costs include: Past costs, Sunk costs , Unavoidable costs

F.CLASSIFICATION OF COSTS ACCORDING TO NORMAL AND

ABNORMAL COSTS

Normal Costs: These are costs planned for and expected at given levels of
activity under specified conditions. For example, normal scrap and loss of
materials cost of expected idle time etc.

Abnormal Costs

These are costs not planned for and therefore not expected to be incurred at
a given level of activity under conditions in which that level of activity is
normally achieved, e.g. cost of excessive scrap and abnormal idle time pay
etc.

G. CLASSIFICATION OF COSTS ACCORDING TO AVOIDABLE AND NON-

AVOIDABLE COSTS
 a. Avoidable Costs

These are costs that may be saved by the adoption of a given alternative
option.

b. Non-Avoidable Costs

These are costs that cannot be saved or eliminated by the adoption of a

given alternative line of action.

H. CLASSIFICATION ACCORDING TO CONTROLLABLE AND

UNCONTROLLABLE

Cost Controllable Costs/Revenue

These are costs/revenues that are reasonably subject to regulation by a

given responsibility centre manager. In other words, they are costs/revenue
whose amounts are influenced by the actions or inactions of a given
responsibility centre manager. All costs/revenues are controllable at some
level of management. However, some costs/revenues are not
controllable. In preparing control reports, it is very necessary to
have cost/revenue classified as controllable and non-controllable.

I. CLASSIFICATION ACCORDING TO FUNCTION

All the indirect costs, that is, overhead cost, can also be classified according
to function. Thus, overhead can be classified as:
a) Production overheads

b) Selling overheads

c) Marketing overheads

d) Distribution overheads

e) Administrative overheads
a. Production Overheads
These are the indirect cost of manufacturing a cost unit. It comprises of
indirect materials consumed in the factory, indirect factory wages and other
indirect expenses incurred in connection with production.

b. Selling Overheads
These are marketing costs incurred in securing orders, e.g. sales promotion
cost.
c. Marketing Overheads
These are the costs incurred in publicising and presenting to customers the
products of the undertaking in suitably attractive forms at acceptable prices
together with the cost of all relevant research work, the securing of orders
and delivery of the goods to customers

d.Distribution Overheads
These are the costs incurred in making the finished goods ready for dispatch
and the delivery of the product to customers, e.g. cost of carriage outwards.
e.Administrative Overheads
These are the costs of formulating policy, directing and controlling
operations not related directly to production, selling, distribution or research
and development.

THE FORMAT OF A COST SHEET OR COST STATEMENT

COST SHEET OR COST STATEMENT FOR THE YEAR ENDED . . . . . . . . . . . . . . ...

Format
COST SHEET OR STATEMENT OF COST
Total Units………
... ... ... ... ... ...
Prime Cost →
... ...
... ... ... ... ... ...
Add: Factory overheads
... ...
... ... ...
... ... ...
Works Cost → ...
...

... ... ... ... ... ...

Add: Administration overheads
... ...
... ... ... ... ... ...
Cost of Production →
... ...
Add: Selling and distribution ... ... ... ... ... ...
overheads ... ...
... ... ... ... ... ...
Total Cost or Cost of Sale →
... ...

Illustration
The following data is extracted from a Mafiati firm.
Tshs.
(000)
Purchases 90,450
Raw materials available for use 112,672
Ending stock of WIP 34,500
Total manufacturing Overhead 18,000
Cost of goods produced 229,505
Total manufacturing costs 208,450
Cost of direct materials used 79,339

You are required to calculate the following:

a) Beginning stock of raw materials
b) Ending stock of raw materials
c) Direct labour cost
d) Beginning stock of WIP
Solution
Statements for Manufacturing
“000”
Beginning stock of raw materials 22,222.00
ADD: Purchases 90,450.00
Raw materials available for use 112,672.00
Ending stock of raw materials 33,333.00
Cost of direct materials used 79,339.00
Direct labour cost 111,111.00
Total manufacturing Overhead 18,000.00
Total manufacturing costs 208,450.00
ADD: Beginning stock of WIP 55,555.00
LESS: Ending stock of WIP (34,500.00)
Cost of goods produced 229,505.00
Format 2

Direct materials:
Opening stock of raw materials xxx
Add: purchase of raw materials xxx
Add: carriage inwards (if any) xxx
Total purchases of raw material xxx
Less: closing stock of raw materials (xxx)
Cost of direct materials used or consumed xxx
Add: direct labour xxx
Add: direct expenses (eg: royalties) xxx
Prime cost xxx
Add: works or factory overheads:
Indirect materials xxx
Indirect labour xxx
Factory rent and rates xxx
Factory lighting and heating xxx
Power and fuel xxx
Repairs and maintenance xxx
Cleaning xxx
Cost of research and equipment’s xxx
Depreciation of factory plant xxx
Factory stationery xxx
Insurance of factory xxx
Factory or work manager's salary xxx
Other factory expenses xxx
Total works or factory overheads cost xxx
Add: opening stock of work in progress xxx
Less: closing stock of work in progress (xxx)
works or factory cost xxx
Add: office & administrative overheads:
Office rent and rates xxx
Office salaries xxx
Lighting and heating xxx
Office stationery xxx
Office insurance xxx
Postage and telegrams xxx
Office cleaning xxx
Legal charges xxx
Depreciation of furniture and office equipment’s and buildings xxx
Audit fees xxx
Bank charges and commission xxx
Total office & administrative overheads xxx
Production cost or manufacturing cost xxx
Add: Opening Stock of Finished Goods xxx
Less: Closing Stock of Finished Goods (xxx)
Cost of Goods Sold xxx
Add: Selling and Distribution Overheads:
Salesmen's Salaries xxx
Salesmen's Commission xxx
Sales Office Rent and Rates xxx
Travelling Expenses of Salesmen xxx
Warehouse Rent and Rates xxx
Advertisement Expenses xxx
Warehouse Staff Salaries xxx
Carriage Outwards xxx
Sales Manager's Salaries xxx
Repairs and Depreciation of Delivery Van xxx
Bad debts, Debt Collection Expenses xxx
Total Selling and Distribution overheads xxx
Cost of sales or total cost xxx
Profit I Loss xxx
Sales xxx
Review questions
Question 01

The following particulars/projections pertain to a well-maintained medium-sized car.

Particulars Tsh
Cost of car 1,200,000
Salvage value after 100,000 kilometres (km) 300,000
Maintenance cost:
– Service after every 5,000 km 6,000
– Replacement of spares/parts (per 2,000 km) 4,000
Vehicle tax per annum (20% adjustable against income tax payable by the owner) 7,500
Insurance per annum 36,000
Cost of petrol per litre 75
Cost of tyres replacement after 25,000 km 20,000

On an average, the car consumes one litre for every 15 km.

Required:
For three different levels of use i.e. 10,000, 20,000 and 30,000 km per annum, prepare a schedule
showing:

 Variable, fixed and total costs

 Variable, fixed and total costs per km

In respect of each type of cost, give appropriate justification for treating it as a variable or a fixed
cost.

(10 marks)

Question 02
The following information is obtained from the accounts of ABB Ltd
Manufacturers Ltd for the year ended 30 November 2018 in respect of their
product Z
Direct materials 100,000,000
Direct labour 80,000,000
Direct expenses 35,000,000
Indirect factory costs 55,000,000
Administration costs 30,000,000
Distribution costs 30,000,000
Selling expenses 25,000,000
The following additional information is available
(a) During the year ending 30th November 2019 prime costs will rise by
15%
(b) Indirect factory costs will rise by 10%
(c) Administration costs ,distribution costs, and selling expenses will each
rise by 5%
(d) The company expects to make 20% profit on the selling price of
product Z

Required
Prepare a statement for the year ending 30th November 2013 to show;
i) Prime costs
ii) Overheads
iii) Total costs of product Z
iv) Selling price of product Z

Question 03
The following information relates to cost estimates for the product XP100

Tzs.
Direct materials 180,000
Direct wages 85,000
Direct expenses 75,000
Indirect factory costs ?
Administration costs 25,000
Distribution costs 15,000
Selling and distribution 20,000
Additional information:

- Profit on the product is estimated at 20%

- Overhead factory cost is 125% of direct expenses

Required

Prepare a cost statement to show:

a) Prime cost
b) Production cost
c) Total cost
d) The selling price of product

Question 04
From the following information of Munishi & Co. Ltd., for the year 2019 you are required
to prepare:
a) Prime Cost
b) Work Cost
c) Cost of Production
d) Cost of goods sold and
e) Net Profit

Tzs.
Stock of raw materials (1.1.2019) 50,000
Purchase of raw materials 170,000
Stock of raw materials (31.12.2019) 80,000
Carriage Inward 10,000
Direct Wages 150,000
Indirect Wages 20,000
Other Direct Charges 30,000
Office rent and rates 1,000
Factory rent and rates 10,000
Indirect consumption of materials 1,000
Depreciation on plant 3,000
Depreciation on office furniture 200
Salesmen salary 4,000
Salary to office supervisor 5,000
 Other factory expenses 11,400
Other office expenses 1,800
General Manager's remunerations:
Office 4,000
Factory 8,000
SeIling Dept. 12,000
Other seIling expenses 2,000
Traveling expenses of salesmen 2,200
Carriage & Freight outward 2,000
Advertisement 4,000
Margin 20%

Question 6
The accounts of the Steel Ways Engineering Co. Ltd for 2019 are as follows:
Tzs.
Materials used 180,000,000
Manual and machine labor wages directly 160,000,000
chargeable
Works overhead expenditure 40,000,000
Establishment and general expenses 19,000,000

Required

a. Show the works cost and total cost, the percentage that the works overhead cost
bears to the manual and machines labour wages and the percentage that the
establishment and general expenses bear to the works cost.
b. What price should the company quote to manufacture a machine which is
estimated to require an expenditure of Tzs. 8,000,000 on materials and Tzs.
6,000,000 on wages so that it will yield a profit of 25% on the total cost or 20% on
selling price.

Question 7
A manufacturing company submits the following information on March 31, 2020:
Tzs. Tzs.
Sales for year 275,000
Inventories at the beginning of the year:
Materials 3,000
Finished goods 7,000
Work in progress 4,000
Purchase of raw materials for the year 110,000
Direct labor 65,000
Inventories at the end of the year:
Materials 4,000
Work in progress 6,000
Finished goods 8,000
Other expenses for the year
Selling expenses @10% of sales
Factory overhead @ 60% of direct labor cost
Administrative expenses @5% of sales

Required
Prepare a statement of cost showing
i. Cost of materials consumed
ii. Prime cost
iii. Factory cost
iv. Cost of goods sold
v. Total cost
vi. Profit

QUESTION 07
The following information relates to the manufacture of a product during the
month of Jan. 2003:
Direct raw materials Tzs. 160,000
Direct wages Tzs. 90,000
Machine hours worked 6,000 hours
Machine hour rate Tzs. 6
Office overhead 15% of work cost
SeIling overhead Tzs. 2 per unit
Units produced 5000 units
Units Sold 5,000 units @ Tzs. 80 each

Required
Prepare a cost sheet and show Cost per unit

QUESTION 08

Question: Preparation of Cost Statement

Tanzania Aluminium Ltd is involved in the production of cooking pans. The following
cost data has been extracted from its records for the year ended 31 December 2024:

 Opening stock of raw materials: TZS 5,000,000

 Purchases of raw materials: TZS 25,000,000
 Closing stock of raw materials: TZS 4,000,000
 Direct wages (labour): TZS 10,000,000
 Royalties (direct expenses): TZS 2,000,000

 Indirect materials: TZS 3,000,000

 Power and fuel: TZS 2,500,000
 Factory rent and rates: TZS 1,500,000
 Repairs and maintenance: TZS 1,000,000
 Opening work-in-progress: TZS 3,500,000
 Closing work-in-progress: TZS 2,000,000

 Office salaries: TZS 2,800,000

 Office rent and rates: TZS 1,200,000
 Depreciation of office equipment: TZS 500,000
 Postage and telegrams: TZS 200,000

 Salesmen’s salaries: TZS 1,500,000

 Advertisement expenses: TZS 1,000,000
 Warehouse rent: TZS 800,000
 Carriage outwards: TZS 600,000
 Opening stock of finished goods: TZS 4,500,000
 Closing stock of finished goods: TZS 3,000,000

Required:

Prepare the Cost Statement for Tanzania Aluminium Ltd for the year ended 31
December 2024, clearly showing:

 Prime cost
 Works/factory cost
 Production cost
 Cost of goods sold
 Total cost (cost of sales)
Solution to QN 05
Particulars Amount (Tzs)
Opening stock of raw materials 50,000
Add: Purchases of raw materials 170,000
Add: Carriage Inwards 10,000
Raw materials available 230,000
Less: Closing stock of raw materials (80,000)
Direct materials consumed 150,000
Add: Direct wages 150,000
Add: Direct expenses (Other direct charges) 30,000
👉 Prime Cost 330,000
20,000
Add: Indirect wages
Add: Indirect materials 1,000
Add: Factory rent and rates 10,000
Add: Depreciation on plant 3,000
Add: General Manager’s salary (factory share) 8,000
Add: Other factory expenses 11,400
👉 Works Cost 383,400

Solution to QN 07
Particulars Tzs.
Raw Materials:
Opening stock of raw materials 3,000
Add: Purchase of raw materials 110,000
113,000
(4,000)
Opening stock of raw materials 3,000
Add: Purchase of raw materials 110,000
 Particulars Tzs.
Less: Closing stock of raw materials
Cost of direct materials consumed 109,000
Add: Direct labor 65,000
Add: Other direct expenses (none given) –
Prime Cost 174,000
Add: Factory Overheads (60% of direct labor) 39,000
Factory Cost before WIP adjustment 213,000
Add: Opening stock of WIP 4,000
Less: Closing stock of WIP (6,000)
Factory / Works Cost 211,000
Add: Administrative Expenses (5% of Sales) 13,750
Cost of Production 224,750
Add: Opening stock of Finished Goods 7,000
Less: Closing stock of Finished Goods (8,000)
Cost of Goods Sold (COGS) 223,750
Add: Selling Expenses (10% of Sales) 27,500
Total Cost / Cost of Sales 251,250
Sales Revenue 275,000
Profit (Sales – Total Cost) 23,750