Classification of Costs

Variable Costs

Change in proportion to the activity of a business Those costs that directly vary/change with the number of units sold Also called marginal costs Examples - sales commissions, shipping charges, delivery charges, costs of direct materials or supplies, wages of part-time or temporary employees etc.

Variable Costs

Labour Cost : Rs. 10 per unit Material Cost: Rs. 20 per unit Variable overhead: Rs. 5 per unit

What is the cost to produce 10 units? What is the cost to produce 20 units? What is the per unit cost?

Variable Costs
Cost per unit remains constant Total cost varies directly with activity
Variable Cost
120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 9 10

Cost

Total Cost Cost per Unit

Units of Activity

Fixed Costs

Remain the same regardless of level of sales. Examples: rent, insurance, business licenses, salary of permanent full-time workers etc Relevant range of activity

It's important to realize that fixed costs are "fixed" only within a certain range of activity or over a certain period of time.

For example, rent is a constant amount per month until the landlord raises it at the end of the year unless your sales increase to the point where you need to rent an additional workplace, in which case it might double

Fixed Costs

Rent for a month is Rs. 10,000 Units produced in a year are Rs. 100,000 What is the total rent paid in a year? What is the per unit fixed cost? What is the total rent paid in a year if the units produced in a year increases to Rs. 200,000 What is the new per unit fixed cost?

Fixed Costs
Total cost remains constant
Cost per unit varies inversely with activity
Fixed Cost
120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 9 10 Units of activity

Cost

Total Cost Cost per Unit

Combination Costs / Semi-Variable Costs

Some costs are a combination of fixed and variable A certain minimum level will be incurred regardless of the sales levels, but the costs rise as your volume increases. Example: Phone bill- Monthly fix charge + Variable depending on the usage, Power Costs

Opportunity Cost

The cost of next best alternative or the benefits you could have received by taking an alternative action

Eg. An entrepreneurs opportunity cost is the salary that he could have earned had he not pursued his own business and would have worked in a corporation

Sunk Costs

Cost that has already been incurred and thus cannot be recovered. These costs do no effect the future decisions since such costs cannot be recovered. Eg. While buying a new car, the cost of existing car is a sunk cost and will not effect the decision to buy the new car

Shut Down Costs

Shutdown Costs occur when a firm suspends its activities temporarily or permanently.

Shut Down costs include only those costs that would not occur if the firm continued its operations.

Direct and Indirect Costs

Direct costs: Can be easily traced to a particular object (also called a cost object)

Direct costs are often, but not always, variable costs. Eg., the salary of a manager who oversees production of only one product of a company is a direct cost of that product inspite it being a fixed cost.

Indirect costs are those which affect the entire company, not just one product.

Eg. advertising, depreciation, legal services, administrative services, etc. Can't be associated with just one product or service. Indirect costs can be fixed or variable costs. Often, they are fixed costs with an example being the rent you pay on your building.

Product Costs and Period Costs

2 types of expenses in every accounting period

Linked with revenues earned in that period (Product Costs), Can be easily matched with the revenues Linked with time period itself (Period Costs)

Relevant and Irrelevant Costs

Relevant Costs: Those costs which relate to the situation requiring managements decision

Irrelevant Costs: Represents a cost, either positive or negative, that does not relate to a situation requiring management's decision. Eg. fixed overheads, sunk costs

Conversion Costs

Manufacturing or production costs necessary to convert raw materials into finished products. Eg. Labour, overheads

These costs do not include the costs of raw materials

Controllable Cost and Uncontrollable Cost

Controllable Cost can be influenced by the action of a specified member of the undertaking (normally by the action of the executive heading a responsibility centre). Eg: Direct labour cost, direct material cost Uncontrollable Cost cannot be influenced by the action of a specified member of the undertaking. Eg. an employee's rate of pay that they cannot change themselves or the rent that a landlord charges for use of the company's premises.