Classification of Costs and Costing Methods

Classification of Costs

Direct costs are costs directly attributable to specific cost objects such as products, services, and departments. Materials used in production, direct labour, and direct expenses fall under this category.
Indirect costs cannot be directly linked to specific cost objects. Indirect costs include salaries of administrative staff, rent, and depreciation of buildings and equipment. They are also known as overhead costs.
Fixed costs do not change with variations in output levels within a certain range and for a certain period of time. They are incurred irrespective of whether production takes place or not. Examples include rent, business rates, and salaries.
Variable costs change proportionately with changes in the level of output. They rise with increase in production and fall when production level drops. Examples include direct materials, direct labour, fuel, and commission on sales.
Semi-variable costs have characteristics of both fixed and variable costs. They remain constant up to a certain level of activity and after this level, they start behaving as variable costs. For example, a salesperson’s salary might have a fixed basic wage plus a commission that varies with the level of sales.

Absorption costing involves assigning all production costs, both variable and fixed, to individual units of product.
Marginal costing only takes into account the variable cost of each unit of production in valuing inventory and calculating the profit figure. The fixed costs are treated as period costs and are fully written off against the profit of the period in which they are incurred.
Activity Based Costing (ABC) assigns costs to products and services (cost objects) based on activities that the products or services require. It is based on the premise that activities consume resources, and products or services consume activities.
Standard costing involves setting predetermined costs for activities and resources, and comparing these predetermined costs with actual costs to measure performance.
Job costing is the process of tracking the costs incurred on a specific job against the revenue produced by that job. This method is suitable for businesses that provide tailored goods or services to customers.
Process costing is used when mass quantities of identical products are produced. The cost of the process is averaged over all units produced during a period which gives a cost per unit.