January 26, 2022


Accounting + Finance Blog

Classification of cost according to its functions


In this lesson, the focus is on the classification of cost according to function. Earlier, I have dealt rigorously on other classifications of cost. Function classification is also an important criterion of cost classifications. It shows other necessary costs that are included in the cost of production as well as other costs.

What is classification of Cost according to function?

It is referred to as cost classification based on indirect costs. In addition, it is based on the business functions or activities rather than how cost behaves or its elements. Since these costs are mostly indirect, they are called overhead costs.

Types of classification of costs according to function

1. Production overheads
2. Selling overheads
3. Distribution overheads
4. Research and development overheads
5. Marketing overheads
6. Administrative overheads

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Production overheads: These are overheads or indirect costs relating to transforming raw materials to finished goods. All production costs are factory costs that are not directly attributable to the manufactured product.

Examples of this cost are depreciation of plant and machinery, wages of factory workers, factory electricity, the proportion of rent of the building apportioned to the factory, and so on.

Selling overheads: These are overheads relating to selling the product or getting orders for the goods. Selling overhead costs are part of the marketing cost. Examples are salesmen salaries, sales promotion expenses.

Distribution overheads: These overhead costs are incurred to move the product from its present location (warehouse, stores) to the consumers or customers. Examples are depreciation of delivery van, delivery men’s salaries, and repairs of a delivery van.

Research and Development overheads: This overhead is incurred to discover new product ideas, efficient production processes, and methods, better product materials as well as the design of such product, process, methods, or the use of such materials to improve an old product or create a new one.

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Research and development cost is also part of the marketing cost. It can simply be explained as the overhead cost required to enhance the quality of an old product or to formulate ideas to innovate new products.

Marketing overheads: This is the combination of selling, distribution, and research and development cost. In summary, it is the expenses for making a product attractive to the consumers.

Administrative overheads: This cost is incurred by management. It is the cost of planning, making decisions, supervision, and controlling every aspect of a business.

It includes office electricity bills, depreciation of the official car of directors, salaries paid to admin staff among others.

In the next article, we will consider the classification of cost according to behavior.