- Types of Cost Classifications
- Define and show examples of Direct Cost
- Define and show examples of Indirect Cost


[SLIDE 1]

There are many different types of costs used in managerial accounting.  The reason is costs are classified differently depending on the immediate needs of management.  Cost classifications for different purposes is a very important part of managerial accounting.  The main purposes of cost classification include:<ul>
<li>Assigning costs to cost objects (Cost Traceability)</li>
<li>Accounting for costs in a manufacturing company</li>
<li>Preparing financial statements</li>
<li>Predicting cost behavior in response to changes in activity</li>
<li>Making decisions (Value added or Non-value added)</li>
</ul>
We will learn about each of these purposes in greater depth as we move through the lessons.  We will first look at assigning cost to cost objects.


[SLIDE 2]

The purpose for assigning costs to cost objects is to classify data for some purpose.  A cost object is anything for which cost data is desired.  This could include customers, jobs, organizational subunits, and products.  

There are two classifications for assigning cost to cost objects:<ol>
<li>Direct Costs</li>
<li>Indirect Costs</li>
</ol>
One important thought to remember is that the cost object will determine whether a cost is classified as a direct or indirect cost.  Let's look at these two costs in more detail and how the cost object will determine how to classify the cost.


[SLIDE 3]

Direct Costs are costs that can be easily traced to a unit of product or other specific cost object.  Examples of these include materials and labor.  

For example, if a company has several offices, then the salary of the sales manager in one of its locations would be a direct cost of that office or location.  

Another example might be a company that prints paper cartons for a specific customer. The cost of the paper used to make the paper carton is a direct cost.   Another item in this example would be the labor to produce those printed cartons for the customer.  Since the labor is specific and traceable to the specific customer and product, it is a direct cost.

As you can see these costs are easily traced to a specific product or cost object.  


[SLIDE 4]

Indirect Costs are costs that cannot be easily traced to a unit of product or other specific cost object.  Examples of these include overhead and common costs.  

For example, if a company produces several varieties of ice cream, the plant manager's salary would be an indirect cost of a specific flavor of ice cream.  The reason is because the cost is incurred as a consequence of running the entire plant and not incurred specifically for that one flavor.  In this case the cost object is a specific flavor of ice cream.  Another example here would be the utilities, as they are not easily traced to a specific flavor of ice cream but to the entire plant.

The plant manager's salary is also called a common cost of producing the various products of the plant.  A common cost is cost that is incurred to support a number of cost objects but cannot be traced to them specifically.  

As you can see these costs are not easily traced to a specific product or cost object.  


[SLIDE 5]

In some instances, a cost can be both direct and indirect depending on the specified cost object. 

In the example of a plant manager's salary, while it is an indirect cost to a specific product, it is a direct cost to the manufacturing division. 

With regard to the indirect cost, the cost object is a specific product such as Vanilla ice cream in a plant that makes several varieties.  As a direct cost, the cost object is the entire manufacturing division, which is an organizational subunit specific to the company.

This may seem confusing so you always have to keep in mind what the cost object is for the cost; the cost object is what will determine whether a cost is direct or indirect.