Cost management and cost control functions in an organization are primarily directed towards streamlining costs and reducing them as best possible. This is aimed to ultimately maximize the profitability of the entity. Different types of these costs are amenable to varying levels of control. Some of them may be directly controllable by individual management decisions while others may be inevitable and not amenable to control, especially via individual management decisions.
In order to maximize the efficiency of an entity’s cost management function, the appropriate bifurcation of these costs is necessary. Let’s discuss and exemplify the controllable and uncontrollable costs in this article.
Controllable costs are those costs which can be altered, especially in a shorter time frame, by individual management decisions and actions. These costs can thus be adjusted from time to time depending on business requirements of the firm. Typically, these costs are directly traceable to a product, process, cost center or some other cost object which makes it easier to control them by a relevant manager or an authorized individual.
A few examples of controllable costs are listed below:
- Direct costs like direct materials and labor etc. can be controlled by altering their quantum or upgrading the way they are used or processed. The production managers can directly control such costs by applying more efficient measures.
- Advertising and marketing costs can be controlled by marketing managers to accommodate them into budgeted costs.
- Optional costs like small donations etc. can be controlled by management decisions at individual levels.
Uncontrollable costs are costs that cannot be altered by individual management decisions, especially in a short time span. Any particular individual in the entity does not have direct control over the incurrence or nonincurrence of these costs.
This bifurcation essentially lies in how easily these costs can be altered. A cost that cannot be altered at an individual cost center level but requires long term and higher management intervention becomes an uncontrollable cost for the management of that individual cost center.
A few examples of uncontrollable costs are listed below:
Uncontrollable at individual level
Rent of factory building, for example, is a business level decision which cannot be controlled by the individual production or shop floor manager. It, however, may become controllable at some higher level management who may negotiate the amount of rent with the property owner.
Uncontrollable as imposed by an authority of a third party
Legal obligations levied by external parties such as government taxes and duties become uncontrollable as they are mandatorily applied by the government.
Some uncontrollable costs, however, can become controllable to some extent over the longer term. For example, long term contractual obligations such as rent, maintenance contracts etc. can be negotiated from time to time, especially when they are due for renewal.
Importance of classification
Two key reasons that necessitate correct classification of costs on the basis of their controllability are as follows:
Efficient cost monitoring and management
From above discussion, it is apparent that a cost is controllable or uncontrollable due to either its nature or position and role of individuals working in the organization.
When costs are correctly categorized as controllable and uncontrollable, management can more effectively monitor them. Managers can focus their attention and resources on monitoring and modifying only those costs that they are able to control. They can monitor uncontrollable costs less frequently, only when required.
This bifurcation helps understand who in the organization is responsible for what costs and to what extent. This not only aids in reducing costs but also helps assign accountability in case of overruns. It also helps construct incentive packages for responsible personnel on the basis of controlling efficiency exhibited by them.