Cost Classification
Cost classification is the process of categorizing expenditures in order to better understand the cost structure of a company. This system is critical for effective decision making, planning and control, as well as to meet various compliance requirements. The primary focus of cost classification is to identify the organization’s cost structure and categorize it by function (e.g. Marketing, Production, etc.) and by cost type (e.g. Raw Materials, Labour, etc), based on the activities undertaken.
Cost classification is often used in conjunction with budgeting and forecasting activities. The information obtained from cost classifying a companys costs and expenses allows the organization to assess how much is being spent on each activity or in each category, as well as how effective their cost control efforts are. This information can then be used for decision making purposes, such as determining where to prune expenses or where to concentrate resources for improved efficiencies.
Additionally, by classifying costs by groupings, such as production costs or administrative expenses, the organization is better able to see the overall cost structure of their business. This allows them to identify which categories of spending are disproportionately high or low and make changes accordingly in order to create a more efficient cost structure. This is especially useful when setting budgets and forecasts.
When classifying costs, it is important to use a consistent system and structure to ensure accuracy. In most companies, cost classification is structured around the various functions that make up the cost structure, such as raw materials, labour and overhead costs. The same classification scheme should be applied across the organization in order to ensure that the data is comparable between different departments.
The cost classification process also has implications for taxation, as certain costs may be eligible for tax relief or deductions. Companies with well-documented cost classification systems will be in a better position to take advantage of these opportunities and ensure that their taxes are calculated correctly.
Overall, cost classification is an important part of the financial management of any business, as it provides a clearer understanding of the cost structure and allows the organization to make more effective decisions about how the company’s resources should be allocated. By having a systematic way of collecting and classifying costs, organizations will be in a better position to forecast and manage their budgets effectively.
