In my last blog we discussed why no cost is "fixed". This immediately raises the question " Ok then how do we categorise costs?". This blog explores that question.
Consider this daunting lexicon of costing terms, it's a confusion of terminology.
Fixed, Variable, Semi-fixed, Overhead, Burden, Manufacturing, Absorbed, Activity Based, Opportunity, Batch, Incremental, Sunk, Contract, Specific Order, Service, Product, Attributable, Actual, Non-Manufacturing, Direct, Indirect, Standard, Job, Order, Marginal, Allowable, Average, Cost of Goods Sold, Cost of Sales, Target, Operating, Past, Replacement, Historical, Unit, Process, Value Stream, Back-flushed…etc. and I'm sure this list is not exhaustive.
What chance do non-accounting managers have of understanding which costs are actually included in any of these categories? Even text books don't provide definitive answers and even accountants would disagree about it. Much of this proliferation of terms is unnecessary and as accountants we should be ashamed of it. We do after all have a responsibility to managers to provide them with accurate and informative financial information.
Under the above titles we also mix costs in our financial reports that behave differently when sales volumes, value or mix vary from that expected. This disguises whether any cost variations from budget or forecasts are reasonable and/or proportionate.
For example: "Marketing Costs" may include advertising, sales literature, sales salaries and sales commission. In the event of actual sales income/volume being significantly below or above that budgeted or forecast it is clear that each of these costs will behave differently, indeed one of them may have no direct connection with volume or income at all.
We need to start thinking more clearly about the 'nature' of costs and 'organisational cost structures' in our reporting.
Here's an alternative way to classify costs:
1) Start Up – EG initiating a new product, idea, research programme etc. Not a cost linked to the present turnover of the business. Optional?
2) Once off – Not related to the sales or volume of turnover. It might be the costs of a reorganisation, a refurbishment, redundancies etc. Optional? Forced upon the organisation?
3) Speculative – This might be corporate advertising. Optional?
4) Temporary – Typically a cost of short term employed staff or short term rental of plant or facilities for a particular project. Linked to turnover?
5) Consequential – Not optional but a cost which arises as a result of an unexpected happening. EG a major product or plant failure. Perhaps only loosely connected with turnover.
6) Compulsory – Could be tax change or a cost imposed upon an organisation by external sources.
7) Base Correlative – A cost that changes with the level of volume in a business.
8) Base Structural – might be termed ‘overheads’, or misleadingly 'fixed cost', in the USA sometimes known as ‘burden’ when relating to production overhead. They are costs considered essential to the running of the organisation and its turnover. Not usually thought of as directly proportional to volume of sales. But, as discussed in the last blog, not fixed either.
It is essential that accountants recognise the 'nature' of a cost when reporting and separate those costs such as 1,2,3,5 & 6 from those that have direct links to turnover.
In Part Three of this blog (next month) we will examine how this approach can be used to better monitor changes in organisational cost structure and why this matters to the way in which we present our financial reports.