The Chartered Institute of Management Accountants has defined a code as ” a system of symbols designed to be applied to a classified set of items to give a brief account reference , facilitating entry collation and analysis”
Hence cost classification forms the basis of any cost coding. It helps us understand the characteristic of any cost through a short symbolized form.
Let us consider the following example
A company has devised a system of codification in which the first three digits indicate the nature of the expenditure and the last three digits the cost centre or cost unit to be charged e.g. if the first digit is 1, the system implies that it refers to raw material and if the number is 2 it represents a labour cost. The second and third numbers relating to 1 i.e., raw material, provide details of the type e.g., whether the raw material is an electronic component (number 4), mechanical component (number 1) consumables(number 2) or packing (number 3) and the name respectively. Hence the description of a cost with a code 146.729 shall be understood as follows:
Since the first number is 1 the cost refers to raw material cost
The second number being 4 indicates that the raw material is an electronic component.
The third number 6 refers to the description which according to the company’s codification refers to Diodes.
The last three numbers provide details of the cost centre e.g. the first number provides details of the location of the plant, the second number gives detail of the department (machining or assembly or something else) and the third number indicates whether the cost is direct or indirect.
Advantages of a coding system
The following are some of the advantages of a well-designed coding system:
(a) Since the code is, most of the times, briefer than a description, it saves time when systems are worked upon manually and in case the system is computerized it reduces the data storage capacity. The illustration above demonstrates this advantage very clearly.
(b) A code helps in reducing ambiguity. In case two professionals understand the same item differently a code will help them objectively.
(c) Unlike detailed descriptions, a code facilitates data processing in computerized systems.
The requirements for an efficient coding system
(a) Every number used in the code should be unique and certain, i.e. it should be easily identified from the structure of the code.
(b) Elasticity and comprehensiveness is an absolute must for a well designed coding system. It should be possible to identify a code for every item and the coding system should be capable of expanding to accommodate new items.
(c) The code should be brief and meaningful.
(d) The maintenance of the coding system should be centrally controlled. It should not be possible for individuals to independently add new codes to the existing coding system.
(e) Codification systems should be of the same length. This makes errors easier to spot and it assists computerized data processing.