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In accounting, cost is the monetary value paid to finance functional areas in business. In the manufacturing of products and services, the cost of factors of production will be calculated, where they may either be fixed or variable costs. Simply put, any expense incurred by a business in producing products and services is referred to as cost.
1. Fixed Cost
Fixed cost do not change regardless of an increase or a decrease in the production volume of products and services. A company must pay fixed cost on time regardless of the quantity produced.
Examples of Fixed Cost
1. Rent and lease payments
These are charged as per the period in the use of the land owned by a landlord. Salaries are also periodic payments paid to employees irrespective of the time put into work.
It is a reimbursement contract in case of risk such as damages. When taken, the insured (company) is required to pay a fixed premium over time.
3. Loan repayments
Businesses commonly take up loans to either start or boost their business. After a loan is taken, the company must pay off the principal and interest in equal installments. The amount paid off is often fixed and calculated by the rates given.
Amortization is an accounting technique where interest and principal pay off debt or loans over a scheduled period. It is used to evaluate intangible assets such as copyrights and patents.
Depreciation is the amount charged to the gradual wear and tear of assets in their useful life.
2. Variable Cost
Unlike fixed cost, variable cost changes based on the production volume of products manufactured by the company. Therefore, as production increases, the variable cost will increase proportionally.
In the same way, if the volume of production decreases, then the variable cost will decrease in the same proportion. Any material used in the production of goods is a variable cost. They directly affect the number of units that the company can produce.
Examples of Variable Cost
1. Direct materials
All raw materials used in producing products in a company are known as direct materials. Direct materials affect the number of units to be produced in the company. If the raw materials are in plenty, then the units produced will be in plenty, and if the raw materials are few, then the units produced will be few.
2. Piece rate labor
Unlike salaries, this is the amount workers earn for every unit they produce. Therefore, the payment will significantly depend on the number of units each worker produces, not a fixed rate.
3. Production supplies
Include the machinery oil. The machinery oil usage will significantly affect how much a machine is used in production. Therefore, the more a machine is in usage, the more it will require its oil and vice versa.
It is payable to salespeople based on the products they can sell. It is, therefore, a variable cost because the more products sold, the more the commission; when no products are sold, no commission is given.
5. Freight out
These are the costs incurred by a business when shipping out a product. So it is dependent on whether the product is shipped or not.
3. Direct Cost
It is the cost that a businesses can easily trace directly to the production of a specific product. It can either be raw materials, labor or software. An example is an employee assigned to work a specific task for a specified number of hours.
The labor, in this sense, will be treated as direct labor since it will directly affect the output produced. Most direct cost are variable cost, except labor which is a direct cost.
Examples of Direct Cost
1. Direct materials
Include raw materials used in producing the goods and services.
2. Freight in and freight out
These are shipping cost that will be incurred by the company in either shipping product out or shipping raw materials for manufacturing.
Commissions are considered direct cost because the price sold is directly connected to the sold item.
Supplies are considered direct cost because they are consumable and connect specifically with the cost of the products. Transportation and fuel are considered direct cost because products will be moved from one place to another to be sold, and the cost incurred is closely related to the products manufactured.
4. Indirect Cost
Indirect cost represent the multiple activities involved in a business that are not directly identified with cost objects. In simple terms, we can say that indirect cost are the expenses used by a company in its day-to-day running of the business. They are not affected by the manufacturing of products; therefore, they are mainly fixed and semi-variable cost.
Examples of Indirect Cost
Are legal fees incurred when a business faces a court case. It is not an everyday thing, so you’ll hire an attorney to represent the business in the court of law, and after the case is finished, normalcy will resume in the business. It is, therefore, a challenge to connect.
2. Salaries and wages
When a business hires temporary contract employees, this will be considered an indirect cost because the employees are hired once in a while. It will be challenging to connect these cost with the cost object.
3. Office supplies
Office supplies are an essential expense in a business. However, they do not take a considerable proportion of the expenses. In addition, they are not bought every other day since they are bought to last for a certain period.
It is a monthly cost that renting businesses must pay regardless of the product volume.
5. Security cost
Businesses are more likely to invest in security to protect company assets and information. It is a fixed cost used regardless of the product volume.
5. Period Cost
Period cost is the cost that cannot be capitalized into a balance sheet; they can, however, be found in an income statement. Businesses can identify these costs with the passage of time rather than a transactional event.
Examples of Period Cost
Some examples of period cost include; interests, travel, administrative, advertising, insurance, and maintenance and repairs cost, among others.
6. Sunk Cost
Sunk cost is the kind of cost that have been spent and cannot be recovered under any circumstance. Sunk costs are caused by uninformed expenditure decisions motivated by human emotions. These costs are excluded from any business plans and decisions since they will not change regardless of the outcome.
Examples of Sunk Cost
Some sunk cost include; unnecessary software upgrades and installation cost, unnecessary marketing cost, and unnecessary salary benefits.