The Four Major Categories Of Costs
Costs is defined as the total of amount of money, time, and resources associated with a purchase of goods or a service. There are four major categories of costs that will be discussed as follows.
Direct costs are expenses that are directly relevant and chargeable to a particular sponsored project, process or program relatively easily and with a high degree of accuracy. Examples of direct costs are includes salaries, travel, equipment and supplies directly benefiting the supported project or activity. Direct costing is very effective for controlling variable costs, because it can create a variance analysis report that compares the actual variable cost to what the variable cost per unit should have been. Direct costing is useful for plotting changes in profit levels as sales volumes change. It is relatively simple to create a direct costing table that points out the volume levels at which additional direct costs will be incurred, so that management can estimate the amount of profit at different levels of corporate activity. Direct costing is also useful for deciding whether to manufacture an item in-house or maintain a capability in-house, or whether to outsource it. If the decision involves manufacturing in-house or elsewhere, it is crucial to determine how many staff and which machines will actually be eliminated; in many cases, these resources are simply shifted elsewhere within the company, so there is no net profit improvement by shifting production to a supplier. A direct costing analysis is usually only valid within the constraints of the current capacity level. It requires a more sophisticated form of direct costing analysis to account for changes in costs as sales volumes or production volumes increase. Direct costing is an excellent analysis tool. It is almost always used to create a model to answer a question about what actions management should take.
Indirect costs are those costs that are incurred for common or joint objectives, and cannot be easily and specifically determined with a particular sponsored project, an instructional activity, or any institutional activity [federal Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards issued by the Office of Management and Budget (Uniform Guidance)]. Indirect cost are often identified as “facilities and administrative costs” or “overhead.” Example of Indirect costs are salaries to clerical and administrative assistants, secretaries or director, office supplies such as pens and papers, and facilities like building and maintenance.
Variable costs are cost that changes with the quantity of output produced. Variable cost directly affected by the fluctuations in the activity levels of the enterprise. Variable cost varies with the variations in the volume, i.e. when there is an increase in the production, variable cost will also increase proportionately with the same percentage and when there is no production there will be no variable cost. The Variable cost is directly proportional to the units produced by the enterprise.
Fixed costs are the cost which remains constant at different levels of output produced by an enterprise is known as Fixed Cost. They are not affected by the momentary fluctuations in the activity levels of the organization. Fixed Cost remains constant does not mean that they are not going to change in future, but they tend to be fixed in the short run. This can be explained with an example, If your company is operating the business in a rented building, so whether you produce tons of output, or you produce nothing, you have to pay the rent of the building, so this is a fixed expense which is constant over a period until the rent of the building increases or decreases.
