9_Types of Costs

8/13/2019 9_Types of Costs

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Classification of Costs


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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.


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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?


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Variable Costs

Variable Cost

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2040

60

80

100

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Units of Activity

Cost Total Cost

Cost per Unit

Cost per unit remains constantTotal cost varies directly with activity


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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 atthe 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


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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?


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Fixed Costs

Total cost remains constantCost per unit varies inversely with activity

Fixed Cost

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20

40

60

80

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1 2 3 4 5 6 7 8 9 10

Units of activity

Cost Total Cos

Cost per


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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


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Opportunity Cost

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

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


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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 costand will not effect the decision to buy the new car


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Shut Down Costs

Shutdown Costs occur when a firm suspends its activities temporarily orpermanently.

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


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Direct and Indirect Costs

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

Direct costs are often, but not always, variable costs. Eg., the salary of a managerwho 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 oneproduct.

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.


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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)


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Relevant and Irrelevant Costs

Relevant Costs: Those costs which relate to the situation requiringmanagements decision

Irrelevant Costs: Represents a cost, either positive or negative, that does notrelate to a situation requiring management's decision. Eg. fixed overheads,

sunk costs


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Conversion Costs

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

These costs do not include the costs of raw materials


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Controllable Cost and Uncontrollable

Cost

Controllable Costcan be influenced by the action of a specified member ofthe undertaking (normally by the action of the executive heading a

responsibility centre). Eg: Direct labour cost, direct material cost

Uncontrollable Costcannot be influenced by the action of a specified

member of the undertaking. Eg. an employee's rate of pay that they cannotchange themselves or the rent that a landlord charges for use of the

company's premises.

9_Types of Costs

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