Question

Costs can be categorized in various ways, including the following:

• Fixed versus variable costs
• Relevant versus irrelevant costs
• Direct versus indirect

Discuss the following in your main Discussion Board post:

• Why is it important for a company to know the categorization of each cost?  
• Provide an example of each of the cost categorizations above.
• Why is it important to compare actual cost and budgeted cost?

Answer 1

Cost categorization is an important aspect in both cost and financial accounting, in budgeting and in the evaluation of the worth of the business. The categories identified provide information for managers to use in strategic planning, and help them to improve operations and make the company more profitable. Categorization also applies when accountants calculate gross and net profit margins. The categorization of costs enables a small business owner to group expenses together to understand how much he is spending on related items.

The most basic cost category is that of fixed costs, which are costs that do not vary regardless of the quantity of goods produced, the value of sales achieved or the number of staff employed. Eg: Rent

Variable cost which depends on the quantity of goods produced, the value of sales achieved or the number of staff employed. Eg:Commission based on Sales

Relevant costs are costs that will be affected by a managerial decision. Eg: Business Promotion Expenses

Irrelevant costs are costs that won't be affected by a managerial decision. Eg Fixed overhead

Direct costs are also known as the cost of sales, because they include everything that is required to produce or procure the items the company sells. Eg: Wages to Labours

Indirect costs include costs that are not directly related to production. Eg: Taxes

Importance to compare actual cost and budgeted costs:

A comparison should be made between actual costs at actual activity to budgeted costs at actual activity. At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control instrument to assist management in measuring its performance against the plan so as to improve future performance. Budgeted revenue and costs are compared to actual revenue and costs to determine variances. A determination has to be made whether the variances are controllable or uncontrollable. If controllable, the parties responsible must be identified. Action must be taken to correct any problems.