Question

1. Distinguish between direct and indirect costs with 2 examples of each. 2. Why is it important the differences between the two variables discussed in 1 as a manager? 3. Distinguish between fixed, variable, and semivariable costs. 4. You have been presented with a mixed costs sheet and you need to perform some analyzes to write your report for the year. Select and explain what graph will be more accurate for this analysis.

Answer 1

               

Direct Cost	Indirect Cost
Costs associated directly with the production of specific products and can be easily identifiable.	Cost associated in the production process but cannot easily be identified.
It can be calculated and converted into per unit cost of the product.	It cannot be converted into per unit cost
Aggregate or total direct cost is called prime cost.	Aggregate of total indirect cost is known as overheads.
Example - Direct materials cost, direct labor cost and other direct expenses	Example - Indirect materials cost, indirect labor cost and other indirect expenses.

Variable Cost	Fixed Cost	Mixed or Semi – variable Cost
A cost that changes, in total dollar amount, with the change in the level of activity is called variable cost. A common example of variable cost is direct materials cost.	A cost that does not change, in total, with the change in activity is called fixed cost.	A cost that has the characteristics of both variable and fixed cost is called mixed or semi-variable cost.
Example – lubricants, sales commission and shipping costs etc.	Example – Rent	Example – Rent of a machine is fixed at a minimum of $100 and $10 every additional piece after 10 pieces.

Variable costs

Variable costs are the costs that change in total each time an additional unit is produced or sold. With a variable cost, the per unit cost stays the same, but the more units produced or sold, the higher the total cost. Direct materials is a variable cost. If it takes one yard of fabric at a cost of $5 per yard to make one chair, the total materials cost for one chair is $5. The total cost for 10 chairs is $50 (10 chairs × $5 per chair) and the total cost for 100 chairs is $500 (100 chairs × $5 per chair).

Graphically, the total fixed cost looks like a straight horizontal line while the total variable cost line slopes upward.

Total Fixed Costs Total Variable Costs 30,000 20,000 10,000 200 150 100 50 0 10 2030 40 0 10 2030 40 Units Units

The graphs for the fixed cost per unit and variable cost per unit look exactly opposite the total fixed costs and total variable costs graphs. Although total fixed costs are constant, the fixed cost per unit changes with the number of units. The variable cost per unit is constant.

Fixed Cost Per Unit Variable Cost Per Unit R 1,000 R 15 T 500 I 10 C 5 0 10 20 30 40 0 10 20 30 Units Units

When cost behavior is discussed, an assumption must be made about operating levels. At certain levels of activity, new machines might be needed, which results in more depreciation, or overtime may be required of existing employees, resulting in higher per hour direct labor costs. The definitions of fixed cost and variable cost assumes the company is operating or selling within the relevant range (the shaded area in the graphs) so additional costs will not be incurred.

Total Fixed Costs Total Variable Costs 30,000 $ 20,000 10,000 200 150 S 100 50 0 200,000 300,000 0 10 20 30 40 Units Units

Mixed costs

Some costs, called mixed costs, have characteristics of both fixed and variable costs. For example, a company pays a fee of $1,000 for the first 800 local phone calls in a month and $0.10 per local call made above 800. During March, a company made 2,000 local calls. Its phone bill will be $1,120 ($1,000 +(1,200 × $0.10)).

2,000 1,500 1,000 500 Total Cost Line .. Variable Costs _ Fixed Costs 800 1,600 2,400

To analyze cost behavior when costs are mixed, the cost must be split into its fixed and variable components. Several methods, including scatter diagrams, the high‐low method, and least‐square regression, are used to identify the variable and fixed portions of a mixed cost, which are based on the past experience of the company.