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TYPES OF COSTS
DIRECT AND INDIRECT COSTS
A cost will be distinguished as direct or indirect depending on the cost object and its
size.
Direct costs: usually very easy to trace and allocate to a cost object. It can be divided
in:
Direct materials: raw materials and other components used to create a product.
This definition can be only applied properly in manufacturing organizations,
where costs become part of a physical product. However, this term usually
cannot be applicable to merchandising (the term will be purchase cost of items
use for resale) and service organizations (materials or parts purchase to
provide a service).
Direct labour costs are the labour used to create a specific good or service.
Indirect costs or overheads: are difficult to trace, the only way to identify them is
through estimation by using cost allocations (process use to assign a common cost to
various cost objects).
Are costs that cannot be specifically identified with a particular product, service or
department. In the case of manufacturing organization are divided in manufacturing,
administrative and marketing overheads. Examples of indirect costs are property costs
or the costs of materials use to repair machinery.
PERIOD AND PRODUCT COSTS
On an ordinary subject like a car, and relevant costs would be the petrol costs while the
insurance of the car would be irrelevant.
AVOIDABLE AND UNAVOIDABLE COSTS
They respond as an alternative name to relevant and irrelevant costs. In this case, for
the decision-making, avoidable costs are the important ones.
Avoidable costs are the costs that the may be saved by not adopting a given
alternative.
Unavoidable costs are the ones that cannot be saved.
SUNK COSTS
Irrelevant for decision-making as are created in the past and cannot be change by any
decision that will be made in the future. An example is the costs of materials that are
not used and will not be used in the future.
OPPORTUNITY COSTS
Is the cost of giving up to the alternative choice of the one choose. Usually are not
recorded in the accounting system since they dont involve cash outlays.
INCREMENTAL AND MARGINAL COSTS
Incremental costs (or differential costs) are the difference between the costs of each
alternative action, recording the additional cost resulting from a group of additional
units of output. It can include fixed and variable costs.
Marginal costs represent the additional cost of one extra unit of output.
The definition of both terms is the same; however, they are different when it comes to
measure the costs.