Types of Costs

by on February 13th, 2015
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Introduction

Costs are the required expenses that have to be paid in order to maintain a business. Eddison Electronics Company (EEC) must be vitally interested in measuring the costs associated with running the business since every factory of production will have expenses associated with it. Having knowledge of the costs of running the business is vital for the controlling and planning functions related to the business. Being the financial analyst for EEC it is my duty to explain the different costs associated with the business. Discussed below are fixed, variable, and mixed costs which are three of the main expenses associated with running the operations of EEC.

Fixed Costs

Fixed costs are the costs associated with running the business that do not vary with the changes in output. In other word, the fixed costs of the company will stay continuous whether there are alterations in the levels of production we put out or not. Also, the fixed expenses of the company will have to be paid regardless of the products we manufacture for our customers. Therefore, the level of sales we generate will not change the cost of the fixed expenses associated with running the operations of the company. The fixed costs that we may incur while running the operations of the business will include the taxes we pay, the employees who are on a salary, and the rent we pay for our facility (Accounting for Management, 2009).

Variable Costs

Variable costs are costs that will be flexible as alterations take place in running the functions of the business. In other words, the variable costs associated with running the business will vary in relation to the sales or products we directly manufacture for our customers. The variable costs will be a direct indication of the volume of products we produce. The costs associated with variable for the company will rise when production increases and fall when production decreases. The variable costs that the company may incur while operating the business include unprocessed materials and any labor that is directly tied to manufacturing our products (Accounting for Management, 2009).

Mixed Costs

Mixed costs will be a combination of both fixed and variable costs for the company. For instance, if a vehicle is needed in relation to operating the business this would be an example of mixed costs. The gas to drive the vehicle would be variable since according to how much gas was needed to get where the vehicle needed to go would be varied, but the payments and insurance on the vehicle would be fixed costs since they would be the same each time. This is where mixed costs would come in since some of the expenses associated with operating the vehicle would be fixed costs and variable costs (Accounting Coach, 2010).

EEC 2005 Journal Activity

According to the 2005 journal activity of EEC some of the areas that would be classified as fixed, variable, and mixed costs for the business will be identified. First, the fixed costs from the 2005 Journal Entry of EEC are insurance factory which is number six, factory salaries which is number eight, factory property tax which is number nine, depreciation expense factory which is number eleven, bad debt expense which is number twenty-one, and interest expense which is number twenty-eight. Next, the variable costs from the 2005 Journal Entry of EEC are selling expense which is number three and direct labor factory which is number fourteen. Finally, the final cost from the 2005 Journal Entry of EEC are mixed costs which are administrative expense which is number four, supplies factory which is number five, indirect labor which is number seven, maintenance factory which is number ten, and utilities factory which is number twelve. There are other items on the 2005 Journal of EEC, but none fall into the categories of fixed, variable, or mixed costs for the company (Journal Entries, 2005).

Fixed Costs Increase or Decrease

As previously stated, fixed costs are the expenses for the company that will stay continuous despite any alterations in the activity level of the business. The rate of these expenses will not be changed by the activities within the business. The total amount of fixed costs related to the business will remain continuous even as the level of activities increase and decrease, but if changes in prices were to occur on the products we manufacture this would cause the fixed costs of the business to be influenced. A very good example of fixed costs the company may have to pay is rent on the facility we use to manufacture our products. However, confusion can be created if fixed costs are conveyed on a per unit basis. This is because with changes in activity levels on a per unit basis the average fixed costs related to the business will inversely increase and decrease. Even though costs will be varied on a per unit basis, realization is that any costs associated with a cost driver, such as a machine, will not vary. For instance, if operating a machine for a given period of 8 hours costs the company $1000, the cost per unit would be would not be dependent on the amount of items generated by the machine since the fixed cost would still be $1000 to operate the machine for the 8 hour period (Accounting for Management, 2009).

Variable Costs Increase or Decrease

As previously stated, the variable costs relevant to the business will rise and fall as alterations become apparent in the productivity of products we produce. Thus, as the levels of activity within the business increase or decrease the variable cost amount to produce our products will increase or decrease. When applying the variable costs on a per unit basis, this will be different in regards to the per unit variable cost associated with our products. The variable costs will stay continuous on a per unit basis as activity levels within the business increase or decrease. In other words, if EEC’s amount of sales were to decrease the total variable costs would decrease, but the variable costs per unit would stay unchanged (Garrison, Noreen, & Brewer, 2010). For instance, if the company were to manufacture one product unit that the total cost of material was $10.00 to produce it, then the total variable cost of producing 100 unit would be $100, but in regards to the unit variable cost it would remain the same which is $10.00 (Accounting for Management, 2009).

Advantages and Disadvantage of Fixed Costs

The advantages of having most expenses fixed include a consistent structure in regard to accounting for all expenses. The financial reports will be standardized regarding the monthly expenses of the business. It will be easier to decide how many products we need to sale for a given month to generate a profit. But, a disadvantage in having most costs fixed is that if a surprising increase comes into play in the demand for any of the products we manufacture a shift in the equalized stability of manufacturing our products could occur. We would then be incapable of generating the demanded product in an accurate amount of time for our customers. Conversely, if a situation occurred where there was a decline in selling our products, then we would be left with products manufactured and not sold. Then we would need to add to the amount of products being sold to make up for the sale decrease in order to earn a profit for the time period (Accounting for Management, 2009).

Advantages and Disadvantages of Variable Costs

The advantages of having most costs variable is that with variable costing the income period for the company will not be influenced by inventory changes. When the company is using variable costing the prices of selling our products and the profits we generate will shift in the direction. Also, the data contained in costs related to variable expenses are easier to estimate in regards to the profitability of products. However, there are disadvantages to having most costs variable. One main disadvantage is that if the company tries to exercise variable costing in its external financial statements we will run the risk of not conforming to the Generally Accepted Accounting Principles (GAAP) related to our financial reporting. This is because laws related to filing taxes require the practice of some type of absorption costing, like manufacturing costs, to fill out income tax related forms of the company. But, variable costing can be employed by management for internal reporting. Also, another disadvantage is that when sales are higher than production a greater profit in relation to this may deceive management into making inappropriate decisions regarding production levels associated with sales (Accounting for Management, 2009).

Conclusion

It is evident that the impact of profitability related to the company will impacted by all costs discussed throughout this paper. Respective to fixed cost, it should be understood that the more produced at a fixed rate by the company the fewer each product per unit will cost and the volume of sales for the company will be better. As it relates to covering the total costs incurred with the operations of the business the total fixed and per unit cost will be useful in regards to pricing our products and understanding the demands of income we require. In determining what degree of sales are allocated to fixed, variable, or mixed costs, the volume of sales related to proportion of these costs will be directly influenced by the net income the company generates. In order to ensure appropriate submission related to the accounting process of the company, the mixed costs of the company will require accurate segregation than that of the fixed and variable costs of the company (Accounting for Management, 2009). Once these costs are understood and broken down, management will be allowed to make better decisions regarding the operations of the business in order to ensure the company is earning returns within all departments of the business.

References

Accounting Coach. (2010) What are mixed costs? Retrieved from http://blog.accountingcoach.com/mixed-costs-fixed-costs-variable-costs/

Accounting for Management. (2009). Cost classifications for predicting cost behavior: Variable and fixed costs. Retrieved from http://www.accountingformanagement.com/variable_cost_and_fixed_cost.htm

Garrison, R., Noreen, E., & Brewer, P. (2010). Managerial accounting, (13th ed.). New York, NY: McGraw-Hill Irwin.

Journal Entries. (2005). Eddison Electronic Company. Retrieved from https://campus.ctuonline.edu/pages/MainFrame.aspx?ContentFrame=/Home/Pages/Default.aspx


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