Cost Descriptors Memo for MBA 503

Essay by dakiniveronaUniversity, Master'sA-, June 2008

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In our last Senior Management Team meeting I was asked to provide a clear definition of various terms used which were introduced in our budget discussion. The "cost descriptor" terms I will define are fixed, variable, semi-variable, direct, indirect, sunk, actual costs and opportunity costs.

Fixed CostsA fixed cost does not vary. These are ongoing costs which remain relatively constant from month to month. Examples of fixed costs are rent, salaries, insurance.

For example, our lease costs us $10,500 per month. This cost will be fixed for the duration of the lease.

Variable CostsVariable costs are costs that are directly related to changes in production and are defined as the costs of goods sold, variable costs include raw materials, labor, and sales commissions. As volume of output increases so does the amount of materials needed as well as the costs of shipping and the additional cost of payroll for hourly staff.

For example, when the number of students increases from 6,000 a year to 7,000 a year, the costs of the production and shipment of the textbooks will increase. If the number of students decreases, the costs of production and shipment will also decrease. The costs will vary depending on the number of students.

Semi-VariableSemi-variable costs, or mixed costs, are costs that are partially fixed and partially variable.

For example, utility bills, copier lease and telephone bills, these can start of off with a flat fee and incur a per-minute or another variable charge (going over the maximum number of copies for the copier) once a certain level is reached.

The table below helps illustrate the differences in fixed, variable and semi-variable costs.

OPERATIONAL COSTSFIXEDVARIABLESEMI-VARIABLELeaseTextbook production costsUtilitiesInsurance (building)Shipping chargesPhoneNon exempt SalariesHourly employee's payrollCopier leaseSupplies (paper)Direct CostsDirect costs are those that are directly attributable to the manufacturing of a product. For...