Many start-ups often wait far too long before they introduce a clean cost accounting system and thus begin to draw real insights from their accounting data. This leaves a lot of potential unused, as on the basis of a clean cost accounting, many conclusions can be drawn that are extremely helpful for further, efficient growth. In this blog series, we offer a brief insight into cost accounting. In the following article, we will focus on the types of costs.
Cost accounting consists of three components: Cost categories (also called type of costs or cost types), cost centres and cost objects. Although cost elements, cost centres and cost objects sound similar, they refer to different things:
- Cost categories are criteria by which costs are categorised.
- Cost centres are the places where costs are incurred – usually departments in the company.
- Cost objects are a specific product, project or service for which the costs are incurred.
Why are cost categories important?
Cost categories are important analytical tools in a company. Cost categories form the basis for cost-type accounting. This is important to document and structure the tasks in a company and to provide important information.
If you choose the cost elements wisely, you can analyse your costs more precisely. This is especially important for business management. Only then can you find out why, for example, the costs of a certain raw material have increased or where there is still potential for savings and much more.
What are cost categories?
Cost categories are categories into which a company can divide its total costs. A cost category therefore includes all costs that have at least one specific characteristic – and all in the same way.
The cost categories as well as their classification and calculation belong thematically to internal accounting. This is also the basis for operational cost and activity allocation.
Principles of cost category formation
The formation of cost categories cannot simply be done arbitrarily. A company must adhere to certain principles. As a company, you must observe the following principles for the formation of cost elements:
- Principle of complete recording: Care must be taken to ensure that appropriate cost elements exist for all costs incurred. All costs in an enterprise must be assignable to a cost element.
- Principle of economic efficiency: The aim is to avoid unnecessary or superfluous allocation criteria and to pursue a cost-benefit ratio.
- Principle of subdividing costs according to their allocation: Costs must be subdivided in such a way that they are compatible with their further allocation.
- Principle of labelling imputed cost types: Imputed costs or other costs or additional costs are not based on actual payments, which is why they must also be taken into account and labelled when forming cost types.
What types of cost categories are there?
In general, a distinction is made between two types of costs:
- Primary costs
- Secondary costs
Primary cost types are those cost types that are externally sourced from the market, such as wage costs or material costs. These primary or original cost types are recorded in cost-type accounting.
Secondary cost elements, on the other hand, are the costs incurred for goods or services that are intended for the company’s own use. These costs result from internal activity allocation, which takes place within the framework of cost centre accounting.
Controlling is responsible for this. Because controlling is there to provide a good basis for management decisions and reliable data. Only then can you make fact-based decisions about when a product is no longer profitable for your company. Especially smaller companies and start-ups often do not have their own controlling department. The tasks usually fall under the table or are taken over by the accounting department, which can only deal with them in passing. This is one of the reasons why it is often advisable to use software support in this area.
How are costs classified?
There are 5 criteria by which cost types can be classified. The classification is either:
- according to the factors of production
- according to functional area
- according to the type of allocation
- according to the type of cost recording or
- according to the behaviour in the event of fluctuations in employment
Which of these 5 classification criteria of cost types are used in a company depends strongly on the industry. Some criteria are more suitable for some industries than for others.
What is meant by classification criteria of cost types?
Classification by production factors offers the possibility of allocating costs to production factors. These can be, for example, personnel or material costs.
Classification by functional areas leads to the following cost types: procurement costs, inventory costs, production/material costs, administrative costs and distribution costs. Costs are allocated to the areas in which they are incurred and for which they are used.
When classifying according to the type of allocation, a distinction is made between direct and total costs. In the case of direct costs, the costs can be assigned to a specific product, the cost object, whereas in the case of total costs they cannot.
Classification according to the type of cost recording distinguishes between costs equal to expenses and imputed costs (also other costs and additional costs).
The last possible classification of cost types is the classification according to the behaviour during fluctuations in employment. Specifically, these are fixed and variable costs. Fixed costs always remain constant, while variable costs depend on other factors. Fixed costs include, for example, rent or interest, while variable costs include expenditure on electricity.
Types of costs: Example
Let us now turn to an example of types of costs: in a tailor’s shop, there can be different types of costs:
- Material costs: costs of fabrics, sewing silk, etc.
- Personnel costs: these include wages for master craftsmen, journeymen and apprentices.
- Depreciation: for example, for tools or sewing machines.
- Rent: for the shop
- Advertising costs: costs for posters, online advertising, etc.
Implementation in practice
In practice, the accounting department, or the external tax consultant, assigns each individual booking to a cost type. The company defines which cost types are used. For start-ups in particular, however, the accounting system’s standard operating accounting sheet is usually used, which defines precisely these cost types. For example, Datev, the most widely used accounting system in Germany, defines the following cost types as standard:
- 100 Personnel costs
- 120 Occupancy costs
- 140 Operating taxes
- 150 Insurance/contributions
- 180 Vehicle costs (without tax)
- 200 Advertising/travel costs
- 220 Cost of goods sold
- 240 Depreciation and amortisation
- 250 Repair/maintenance
- 260 Other costs
The respective three-digit numbers form part of the account numbers under which the respective postings of the individual cost types are booked.
Analysis of the cost types
The consistent posting of individual bookings to the respective correct cost types allows the first analysis possibilities, especially with an individualised cost type structure. Here, a suitable software solution can offer great advantages. Pectus Finance allows companies to customise their cost category structure and to create several structures at once in order to analyse their costs in a variety of ways. Such analyses become even more informative through the additional use of cost centres. Cost centres define where in the company the cost centres originated. By combining cost types and cost centres, it is possible to determine, for example, how high the personnel costs are in production or sales. Watch this space for future articles on both cost centres, cost bearers and cost accounting in general.