Nature and Classification of Costs

Cost accounting may be defined as the process of measuring, analyzing, computing and reporting the cost, profitability and performance of operations in manufacturing. This can be contrasted to earlier definitions which limited cost accounting to “obtaining a figure representing the cost of a manufactured product.”

The nature of modern business is such that all enterprises-whether large or small, manufacturing or non-manufacturing, public or private, profit or nonprofit-require a wide variety of cost data in making day-to-day operating decisions. Thus, for the modern cost accountant, the positive emphasis on analysis and interpretation (managerial cost accounting) requires involvement in the dynamic phase of business-the current period and the future. The dynamic phase is concerned primarily with planning (i.e., selecting objectives and the means for their attainment) and controlling (i.e., achieving conformity to established plans).

cost accounting structure

Cost Accounting Concepts

Classification of Costs

Classification of costs is necessary in order to determine the most suitable method of accumulating and allocating cost data. The principal methods of accumulating costs are described below.

Functions of Cost accounting

  • Manufacturing: Costs applied to producing a product.
  • Marketing: Costs incurred in selling a product or service.
  • Administrative: Costs incurred in policy-making activities.
  • Financial: Costs related to financial activities.

Elements in cost accounting

  • Direct material: Material which is an integral part of the finished product.
  • Direct labor: Labor applied directly to components of the finished product.
  • Factory overhead: Indirect materials, indirect labor, and the manufacturing expenses that cannot logically be charged directly to specific units, jobs, or products.


  • Direct: Costs which are charged to the product and require no further allocation
  • Indirect: Costs which are allocated


  • Production: A unit in which operations are performed on the part or  product and whose costs are not further allocated
  • Services: A unit not directly engaged in production and whose costs are ultimately allocated to a production unit When Charged to Income
  • Product Costs: included when product costs, as defined above, are computed. Product costs are included in inventory and in cost of sales when the product is sold
  • Period Costs: associated with the passage of time rather than with the product. These are closed out to the income summary each period since no future benefits are expected relation to Volume
  • Variable Costs: which change in total in direct proportion to changes in related activity. The unit cost remains the same regardless of volume.
  • Fixed Costs: which do not change in total over wide ranges of volume. The unit costs decrease as volume increases

Period Covered Capital. Costs which are expected to benefit future periods and are classed as assets.

Revenue. Costs which benefit only the current period and are thus expenses.

Degree of Averaging

  • Total: The cumulative cost for the established category
  • Unit: The total cost divided by the number of units of activity or volume

Next Page:  Cost Systems