Cost Accounting and Types of Cost
Cost accounting helps a manufacturing firm work out the cost of making a product. Costs are classified in two main ways: by their relationship to the product (direct or indirect) and by their behaviour (fixed or variable).
Direct and Indirect Costs
Direct costs can be traced straight to the product, namely direct materials, direct labour and direct expenses. Indirect costs (factory overheads) cannot be traced to a single unit — for example factory rent, machine depreciation and supervisors' salaries.
Key idea
Direct costs can be traced to the product; indirect costs are shared by many products. The total of direct costs is the prime cost.
Fixed and Variable Costs
Fixed costs do not change with output within a certain range — for example factory rent of RM5,000 a month. Variable costs change with the level of output — for example raw materials that rise as more units are made.
| Type of cost | Example |
| Fixed cost | Factory rent, supervisor's salary |
| Variable cost | Direct materials, wages per unit |
Work in Progress
Work in progress (WIP) is units still partly finished at the end of the period — started but not yet finished goods. Opening WIP is added when computing production cost while closing WIP is deducted.
Example
Jaya Factory uses direct materials RM40,000, direct labour RM25,000 and factory overhead RM15,000. Opening WIP is RM6,000 and closing WIP is RM4,000. Production cost = (40,000 + 25,000 + 15,000) + 6,000 - 4,000 = RM82,000.
Why Cost Classification Matters
Some costs are semi-variable: they have a fixed part and a variable part, such as an electricity bill with a fixed monthly charge plus a rate per unit used. Classifying costs correctly lets managers work out the cost of one unit, set a selling price and plan a budget. Direct costs make up the prime cost, while indirect costs are gathered as factory overhead. Understanding fixed and variable behaviour also helps predict how total cost will change if output rises or falls, which is the foundation of break-even and profit planning.
Remember
A cost can be both direct and variable at the same time, such as raw materials. The classification depends on the angle from which it is viewed.