Different Types Of Costs In Depth

Costs can be classified in a host of different ways. They can be classified as being expired or unexpired. An expired cost is an expense. For example, advertising expense is the cost of advertising that we did in the past. Maintenance expenses for last July are the costs we incurred for maintenance services last July. Rent expense is the cost of having used the office. These all represent costs that were incurred for a service that has expired.

Unexpired costs are assets. Assets represent stored-up services. As those services are used, the cost of the asset becomes an expense of doing business. Equipment represents future production capability. Inventory represents the cost of future sales. A building represents future shelter, and so on. Consequently, many assets can be thought of as expenses waiting to happen. Cash, accounts receivable, marketable securities and land are exceptions. As buildings and equipment are used, their book values are reduced when the firm records depreciation expense. When inventory is sold, its value is reduced by the amount charged to cost of goods sold.

Costs can also be classified by the way they behave in relation to changes in output or other factors. We can classify most costs as variable, fixed or mixed. In the short-short run, the majority of costs firms face are fixed. As time goes by firms have greater and greater opportunities to change their cost structure and control the behavior of costs. For example, most firms probably cannot do much about the size of their workforce or productive capacity for the next week or so. Over the next several months, however, these firms can increase or decrease their workforce and increase or decrease their production capacity.

A variable cost is one that varies in total with output. The perfect example of a variable cost is direct materials. If we increase production, say, 10 percent, we will use 10 percent more materials and our materials costs will increase accordingly, assuming, of course, a constant rate of usage and a constant cost per unit of materials.

Fixed costs are sometimes referred to as capacity costs because most fixed costs relate to capacity. The larger the manufacturing plant or the larger the retail store, the greater the fixed costs such as depreciation, rent, taxes and insurance.

The term "relevant range" is somewhat of a misnomer, but nevertheless it refers to that range of activity over which a firm expects fixed costs to be consistent. By definition, fixed costs remain fixed within the relevant range. However, as we increase production beyond the upper limit of this range we will run out of room and max out the capacity of our equipment. We will need to increase the size of our plant and buy more machinery. This in turn will increase the costs related to these assets which were fixed at a lower level.

Tina Smith is an accountant with SageNext Infotech. She is having expertise in project management, accounting operations. With SageNext, she consults the client accountants about the benefit of QuickBooks Hosting. SageNext is a leading QuickBooks Hosting provider, dealing in all kinds of tax and accounting application hosting.


Author:  Tina S Smith
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