Classification of Costs: Elements, Functions, Behaviour and Cost Unit/Cost Centre Questions

Question 1

What is cost classification?

Accepted Answer

Cost classification is the process of grouping costs into suitable categories for analysis, control and decision-making.

Question 2

State the three elements of cost.

Accepted Answer

The three elements of cost are material, labour and expenses.

Question 3

Define cost centre.

Accepted Answer

A cost centre is a location, person or equipment for which costs are collected and controlled.

Question 4

Define cost unit.

Accepted Answer

A cost unit is a unit of product or service in which cost is measured and expressed.

Question 5

What is a sunk cost?

Accepted Answer

A sunk cost is a past cost already incurred which cannot be changed by present or future decisions.

Question 6

Give one example of variable cost.

Accepted Answer

Direct material cost is a common example of variable cost.

Question 7

Explain classification of costs by elements with examples.

Accepted Answer

Classification by elements groups costs into material, labour and expenses.

- Material: cost of raw materials and consumables used (e.g., steel, chemicals).
- Labour: wages/salaries for work done (e.g., direct wages of workers, indirect wages of helpers).
- Expenses: other costs excluding material and labour (e.g., royalty, special hire charges).

Question 8

Differentiate between cost centre and cost unit.

Accepted Answer

A cost centre is the place/person/equipment for which costs are collected for control (e.g., machining department, canteen).

A cost unit is the unit of output/service for which cost is expressed (e.g., per kg, per litre, per passenger-km).

In short: cost centre helps in cost collection and responsibility, while cost unit helps in measuring unit cost.

Question 9

Explain fixed, variable and semi-variable costs with examples.

Accepted Answer

Fixed cost remains constant in total within a relevant range (e.g., rent).

Variable cost changes in total in proportion to output (e.g., raw materials).

Semi-variable cost has both fixed and variable parts (e.g., electricity/telephone bill with a minimum charge plus usage).

Question 10

What is classification by function? Give examples of any three functional costs.

Accepted Answer

Classification by function groups costs according to the activity performed in the organisation.

Examples: (i) Production/Factory costs like power, factory rent and supervisor salary, (ii) Administration costs like office salaries and audit fees, (iii) Selling costs like advertising and sales commission (distribution costs like packing and freight are also included separately).

Question 11

Differentiate between normal cost and abnormal cost.

Accepted Answer

Normal cost is the cost expected under normal operating conditions, such as normal material loss.

Abnormal cost arises due to unusual or abnormal reasons and is not expected in normal operations, such as loss due to fire or major breakdown.

Abnormal costs are generally shown separately to avoid distortion in performance evaluation.

Question 12

Explain relevant cost and sunk cost for decision-making.

Accepted Answer

Relevant cost is a future cost that differs between alternatives and therefore affects the decision (e.g., extra material cost for a special order).

Sunk cost is a past cost already incurred which does not change with a decision and is therefore ignored in decision-making (e.g., book value of old machinery).

Question 13

Explain the various methods of classifying costs.

Accepted Answer

Costs can be classified in several ways depending on the purpose of analysis, control and decision-making. The major methods are:

1) By elements (nature): Material, Labour and Expenses. This helps in preparing cost sheets and tracking resource consumption.

2) By function (activity): Production/Factory, Administration, Selling and Distribution. This helps in knowing where the cost is incurred and in overhead analysis.

3) By behaviour (variability): Fixed, Variable and Semi-variable. This is useful for marginal costing, budgeting and CVP analysis.

4) By controllability: Controllable and Uncontrollable costs. It helps in responsibility accounting by fixing accountability to managers.

5) By normality: Normal and Abnormal costs. Abnormal costs are shown separately to avoid distortion in cost and performance.

6) By time: Historical (actual) and Estimated/Standard costs. Standards and estimates support planning and control.

7) By relevance for decisions: Relevant/Irrelevant, including concepts like sunk cost (irrelevant) and opportunity cost (relevant).

A good answer should include short definitions and examples under each method to clearly show understanding.

Question 14

Distinguish between cost centre, profit centre and cost unit with examples.

Accepted Answer

These terms are related but serve different purposes in cost accounting.

| Basis | Cost centre | Profit centre | Cost unit |
|---|---|---|---|
| Meaning | unit for which costs are collected | unit responsible for cost and revenue | unit in which cost is expressed |
| Focus | cost control and responsibility | profitability and performance | measurement of unit cost |
| Examples | machining dept, canteen, machine no. 5 | a branch, a product division | per kg, per litre, per passenger-km |

Explanation: A cost centre may not directly generate revenue but is used to collect and control costs. A profit centre is evaluated on both revenue and cost, hence profit. A cost unit is not a department; it is simply the unit of output/service used to compute and report cost per unit.

Question 15

Why is cost classification necessary? Explain with practical points.

Accepted Answer

Cost classification is necessary because management needs cost information in different forms for different purposes. The key reasons are:

1) Correct cost ascertainment: Classification helps in preparing a proper cost sheet and calculating cost per unit accurately.

2) Effective control: By collecting costs under cost centres and classifying controllable/uncontrollable costs, responsibility can be fixed and wastage can be reduced.

3) Better budgeting and standards: Behaviour-wise classification (fixed/variable/semi-variable) is essential for preparing flexible budgets and for CVP analysis.

4) Decision-making: Decision-based classification highlights relevant costs and ignores sunk/irrelevant costs, leading to better decisions like make-or-buy, pricing of special orders, and product mix.

5) Performance evaluation: Functional classification (production/admin/selling/distribution) helps compare departmental performance and identify areas where costs are rising.

Thus, cost classification converts raw expense data into meaningful information that supports planning, control and decision-making.

Classification of Costs: Elements, Functions, Behaviour and Cost Unit/Cost Centre

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