Cost Definition Key Characteristics Examples Formula
- Raw materials
Variable costs are costs that
change in direct proportion to
- Direct labor (wages for workers
the level of activity or
Proportional: They rise or fall involved in production)
production. As the production Total Variable Cost = Variable Cost per Unit ×
Variable Costs depending on the volume of
increases, total variable costs Quantity Produced
goods or services produced. - Utility costs (e.g., electricity used in
increase, and as production
manufacturing)
decreases, total variable costs
decrease.
- Commissions based on sales
- Rent or lease payments
Fixed costs are costs that Unresponsive to changes in
remain constant regardless of activity: Whether the business
- Salaries of permanent staff Total Fixed Cost =
the level of activity or produces more or less, fixed costs
Fixed cost Constant cost amount, regardless of production volume
production. These costs do not stay the same within a certain
- Depreciation of equipment or buildings
change with the volume of period or production capacity.
goods or services produced.
- Insurance premiums
Step costs are costs that - Hiring additional staff after reaching a
remain constant within a Fixed within ranges: The cost certain production level
certain range of activity but stays the same over a certain
increase in steps once a range of activity, but when the - Buying more equipment once a Behavior: The cost is not proportional to the activity but
Step Costs
specific level of activity is activity level crosses a threshold, production level exceeds a capacity limit jumps as activity reaches new levels.
surpassed. These costs are not the cost increases in a stepwise
continuous or linear but manner. - Additional facilities or space rental
increase in increments or steps required as output grows
as activity levels rise.
Mixed costs, also known as - Utilities (e.g., a basic fixed charge for
semi-variable costs, are costs electricity plus additional charges based
Combination of variable and
that contain both a variable on usage) Variable cost
fixed costs: The cost includes a
component and a fixed m = (High cost - Low cost ) ➗ (High activity - Low activity)
fixed part (which remains
Mixed cost component. These costs - Phone bills (fixed monthly fee +
constant) and a variable part
change with the level of variable charges depending on usage) Fixed cost
(which fluctuates with the level of
activity, but also include a fixed c = y - mx
activity).
portion that remains constant - Equipment rental (fixed rental fee +
regardless of the activity level. variable charges based on hours of use)
Impact on decision-making: - Future Costs: Costs that will be
Relevant costs are costs that Only costs that will change as a incurred in the future, which can be
have a direct financial impact result of a decision are considered influenced by the decision.
on the decision-making relevant.
process of an organization. - Differential Costs: The difference in
These costs are considered Future-oriented: Past costs cost between two alternatives. It helps
Relevant cost when making decisions (sunk costs) are not relevant, only in comparing the costs of different
because they can either future costs are. decisions.
increase or decrease costs and
revenues, ultimately affecting Affects profitability: Relevant - Cashflow: The actual movement of
the profit or loss of the costs can either increase or cash in and out of the business,
company. decrease profitability depending important for decisions like investment
on the decision made. or pricing.
, Benefit forgone: When a - If a company chooses to invest in a
decision is made, the opportunity new project, the opportunity cost might
Opportunity cost is the best
cost reflects the potential profit or be the potential returns from an
benefit forgone by choosing a
benefit that could have been alternative investment they decided
particular course of action over
gained from choosing the against.
the next best alternative. It
Opportunity cost alternative.
represents the lost opportunity
- For a student deciding between
of not choosing the most
Greatest benefit or least cost: working part-time or studying, the
profitable or cost-effective
The best alternative is usually the opportunity cost would be the earnings
option.
one that either provides the they give up by choosing to study over
greatest profit or the least cost. working.
Cost comparison: Differential A company deciding whether to
cost is used to compare the costs manufacture a product in-house or
of different alternatives to make outsource it would calculate the
informed decisions. differential cost by comparing:
Differential cost is the
Focus on relevant costs: Only - Direct materials and labor costs for in-
difference in cost between two
costs that differ between house production
or more alternatives. It
alternatives are considered in
Differential cost represents the additional or
differential cost. Sunk costs, - Outsourcing costs, including any
reduced cost that results from
which are already incurred, are additional fees or charges for external
choosing one option over
not considered. suppliers
another.
Impact on decision-making: It The difference between these two sets
helps in evaluating the financial of costs would be the differential cost. If
implications of choosing one outsourcing is cheaper, the company
option over another. may choose that option, and vice versa.
Irrelevant to decisions: Since
sunk costs cannot be recovered
or altered, they should not affect
future decisions. - Marketing Costs for a product that
Sunk cost refers to costs that
have already been spent, regardless of
have already been incurred
Past expenses: Sunk costs are whether the product is continued or
and cannot be recovered,
typically expenses already paid discontinued.
regardless of the future course
Sunk cost for in the past.
of action. These costs are
- Salaries paid to employees, as these
irrelevant to decision-making
No impact on future outcomes: are costs already incurred and won’t be
because they do not change
The decision made going forward recovered if the business changes its
based on the decision at hand.
will not change the amount of direction.
sunk costs, so they should not
influence the decision-making
process.
1. Direct labour
- Direct labour refers to labour costs that can be directly traced and attributed to the production of a specific product or service. These are
the wages or salaries paid to employees who are directly involved in the manufacturing process.
- Raw materials
Variable costs are costs that
change in direct proportion to
- Direct labor (wages for workers
the level of activity or
Proportional: They rise or fall involved in production)
production. As the production Total Variable Cost = Variable Cost per Unit ×
Variable Costs depending on the volume of
increases, total variable costs Quantity Produced
goods or services produced. - Utility costs (e.g., electricity used in
increase, and as production
manufacturing)
decreases, total variable costs
decrease.
- Commissions based on sales
- Rent or lease payments
Fixed costs are costs that Unresponsive to changes in
remain constant regardless of activity: Whether the business
- Salaries of permanent staff Total Fixed Cost =
the level of activity or produces more or less, fixed costs
Fixed cost Constant cost amount, regardless of production volume
production. These costs do not stay the same within a certain
- Depreciation of equipment or buildings
change with the volume of period or production capacity.
goods or services produced.
- Insurance premiums
Step costs are costs that - Hiring additional staff after reaching a
remain constant within a Fixed within ranges: The cost certain production level
certain range of activity but stays the same over a certain
increase in steps once a range of activity, but when the - Buying more equipment once a Behavior: The cost is not proportional to the activity but
Step Costs
specific level of activity is activity level crosses a threshold, production level exceeds a capacity limit jumps as activity reaches new levels.
surpassed. These costs are not the cost increases in a stepwise
continuous or linear but manner. - Additional facilities or space rental
increase in increments or steps required as output grows
as activity levels rise.
Mixed costs, also known as - Utilities (e.g., a basic fixed charge for
semi-variable costs, are costs electricity plus additional charges based
Combination of variable and
that contain both a variable on usage) Variable cost
fixed costs: The cost includes a
component and a fixed m = (High cost - Low cost ) ➗ (High activity - Low activity)
fixed part (which remains
Mixed cost component. These costs - Phone bills (fixed monthly fee +
constant) and a variable part
change with the level of variable charges depending on usage) Fixed cost
(which fluctuates with the level of
activity, but also include a fixed c = y - mx
activity).
portion that remains constant - Equipment rental (fixed rental fee +
regardless of the activity level. variable charges based on hours of use)
Impact on decision-making: - Future Costs: Costs that will be
Relevant costs are costs that Only costs that will change as a incurred in the future, which can be
have a direct financial impact result of a decision are considered influenced by the decision.
on the decision-making relevant.
process of an organization. - Differential Costs: The difference in
These costs are considered Future-oriented: Past costs cost between two alternatives. It helps
Relevant cost when making decisions (sunk costs) are not relevant, only in comparing the costs of different
because they can either future costs are. decisions.
increase or decrease costs and
revenues, ultimately affecting Affects profitability: Relevant - Cashflow: The actual movement of
the profit or loss of the costs can either increase or cash in and out of the business,
company. decrease profitability depending important for decisions like investment
on the decision made. or pricing.
, Benefit forgone: When a - If a company chooses to invest in a
decision is made, the opportunity new project, the opportunity cost might
Opportunity cost is the best
cost reflects the potential profit or be the potential returns from an
benefit forgone by choosing a
benefit that could have been alternative investment they decided
particular course of action over
gained from choosing the against.
the next best alternative. It
Opportunity cost alternative.
represents the lost opportunity
- For a student deciding between
of not choosing the most
Greatest benefit or least cost: working part-time or studying, the
profitable or cost-effective
The best alternative is usually the opportunity cost would be the earnings
option.
one that either provides the they give up by choosing to study over
greatest profit or the least cost. working.
Cost comparison: Differential A company deciding whether to
cost is used to compare the costs manufacture a product in-house or
of different alternatives to make outsource it would calculate the
informed decisions. differential cost by comparing:
Differential cost is the
Focus on relevant costs: Only - Direct materials and labor costs for in-
difference in cost between two
costs that differ between house production
or more alternatives. It
alternatives are considered in
Differential cost represents the additional or
differential cost. Sunk costs, - Outsourcing costs, including any
reduced cost that results from
which are already incurred, are additional fees or charges for external
choosing one option over
not considered. suppliers
another.
Impact on decision-making: It The difference between these two sets
helps in evaluating the financial of costs would be the differential cost. If
implications of choosing one outsourcing is cheaper, the company
option over another. may choose that option, and vice versa.
Irrelevant to decisions: Since
sunk costs cannot be recovered
or altered, they should not affect
future decisions. - Marketing Costs for a product that
Sunk cost refers to costs that
have already been spent, regardless of
have already been incurred
Past expenses: Sunk costs are whether the product is continued or
and cannot be recovered,
typically expenses already paid discontinued.
regardless of the future course
Sunk cost for in the past.
of action. These costs are
- Salaries paid to employees, as these
irrelevant to decision-making
No impact on future outcomes: are costs already incurred and won’t be
because they do not change
The decision made going forward recovered if the business changes its
based on the decision at hand.
will not change the amount of direction.
sunk costs, so they should not
influence the decision-making
process.
1. Direct labour
- Direct labour refers to labour costs that can be directly traced and attributed to the production of a specific product or service. These are
the wages or salaries paid to employees who are directly involved in the manufacturing process.
