cost-information

The need for accurate cost information

• Cost information refers to data about all the costs involved in producing and selling a product

Why is accurate cost information needed?

• To set prices correctly

  • If a business underestimates its costs, it may set prices too low and make a loss

  • Overestimating costs may lead to prices that are too high, reducing demand

• To calculate profit

  • Accurate costs help calculate gross profit and net profit, important for judging performance

• For decision-making

  • Managers use cost data to decide whether to

    • Launch a new product

    • Continue or stop production

    • Change suppliers or production methods

• To carry out break-even analysis

  • This helps decide how many units need to be sold to cover all costs.

  • Accurate costs make break-even analysis more reliable

• To control spending

  • Comparing actual costs with budgets helps identify areas of overspending and take action

Types of costs

• In preparing goods and services for sale, businesses incur a range of costs

• These costs can be broken into different categories

Fixed costs

• Fixed costs do not change according to output

• These have to be paid whether the output is zero or 5,000 

  • Examples include rent, management salaries, insurance and bank loan repayments

• Fixed costs in this instance are $4,000

Variable costs

• Variable costs rise proportionally with output

• These increase as output rises and decrease as output falls

  • Examples include raw material costs and wages of workers directly involved in production and packaging

• At some point, a business may benefit from a purchasing economies, so the rise will no longer be proportional

Total costs

• Total costs is the combination of all fixed and variable costs involved in producing a certain level of output

• Total costs cannot be zero, as all organisations have some level of fixed costs

An alternative way to classify costs

Direct costs

• These are costs that can be directly traced to a specific product, service, or department

• They relate specifically and exclusively to the production of a particular item

• Direct costs can be fixed or variable

  • For example, a one-off licence fee for a software product is a direct fixed cost if it applies only to that product

• Examples of direct costs include:

  • The cost of raw materials used to make a table

  • Wages paid to factory workers assembling a specific product

  • Packaging for a single product line

Indirect costs

• Indirect costs are costs that cannot be traced directly to a specific product, job, or service

  • They support overall operations and are shared across departments or products

  • These costs are necessary for production or business operations, but they are not directly linked to any one unit of output

• Indirect costs can also be fixed or variable

  • For example, the monthly rent paid for a shared office space is an indirect fixed cost, as it supports multiple departments but does not vary with output

• Examples of indirect costs include:

  • Rent and utility bills for a factory or office

  • Salaries of supervisors or administrative staff

  • Office supplies and insurance

  • Depreciation of machinery used across several product lines

Comparison: direct vs indirect costs

Using cost information to make decisions

• Cost data helps businesses make key decisions

Total costs (TC)

• Total costs information can be used to assess how much money is needed to produce at a certain level and is vital for budgeting and cash flow forecasting