Cost Descriptors Memo

Cost Descriptors Memo

As Human Resource Manager for our organization, it is imperative that you understand the current discussions surrounding the company’s budget issues. There are several terms used to describe cost. Hopefully this memo will provide you a better understanding of the terms used when discussing our budget. The terms of importance include, but are not limited to: fixed, variable, direct, indirect, sunk, marginal and total cost.

Fixed Cost

Fixed cost is a cost that does not vary depending on production or sales levels, such as rent, property tax, insurance, or interest expense (Investorwords, 2008). Fixed costs remain constant regardless of the company’s activities. An example of one of our organization’s fixed cost is the building lease. If we lease our office building for $4500 per month, this will stay the same regardless of the financial performance of the company. Other examples of fixed costs include insurance and property taxes. Fixed costs are much different than variable costs. Variable costs are those cost that can vary over time.

Variable Cost

A variable cost is a cost of labor, material or overhead that changes according to the change in the volume (InvestorWords, 2008). Variable costs often include labor expenses and raw material costs, because labor and raw material usually must be increased to increase output. When production is zero, the variable cost is equal to zero. Some examples of variable costs would be cost of goods sold, shipping charges, cost of direct materials or supplies and wages of part-time or temporary staff. While the total variable cost changes with increased production, the total fixed costs stay the same.

Direct Cost

A direct cost can be directly traced to producing specific goods or services (InvestorWords, 2008). Direct costs do not have to be allocated to a product, department, or other cost object. For example, if a company produces computer chips, the cost of the material and the employees’ salary are direct cost because both of these expenses are directly related to the production of the product. Indirect cost is the exact opposite of direct cost.

Indirect Cost

Indirect costs represent the expenses of doing a business that are not readily identified with a particular product or department but are necessary for the operation of the company. Looking at it in simple terms, indirect costs are those costs that are not classified as direct costs. An example of indirect cost would be the salary of the managers in our company because they provide a service to the entire company and not just a single department or function.