Communication and cost classification – 1


An effective cost accounting system requires variability of costs to be known very well.

Everyone remembers that costs can be considered fixed or variable depending on the link with the number of products. If costs grow with increasing in size of an operating unit, they’ll be considered “variable” (energy for motive power, seasonal workers, raw materials); if costs remain equal, they’ll be considered “fixed” (salaries & wages for direct labor, advertising, depreciation).

This is an easy theorical example referring to fiscal year, because no costs are constant in the long run. Every cost is always going to change because of increasing production – when a very strong demand suggests managers increasing production volume, they’ll probably decide to purchase another machinery in order to have multiple production facilities: fixed expenditures will have been made double.

Moreover, some costs are fixed and variable at the same time, so we talk about semi-fixed costs or semi-variable costs according to their greater portion (lubrificant for machinery, maintenance, tools).

The second argument regards direct or indirect costs.

We consider costs “direct” when they can be easily allocated to a particular product through a cause-effect relationship, and controllers are able to measure the consumption of input in financial terms of money.

On the other side, the lack of the same relationship, or difficulties in measuring the input’s cost, make us consider the expense as “overhead”.

Raw materials are the classical example for direct costs, while amortization is often considered an indirect cost.

Be careful: ancillary materials are overheads, but machinery dedicated to a particular business line refers to direct costs. Basic operational manuals consider direct variable costs and indirect fixed costs: you must evaluate chance by chance and make sure to do the best choice.

(to be continued)

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