Cost Descriptor Memo

Memo

To: HR Managers

From:

CC:

Date:

Re: Cost Descriptors

It has been brought to my attention that since we last meet several of you are unclear with the “Cost Descriptor” terms I used in our last meeting. It was not my intent to confuse anyone therefore, I am writing to go over the seven terms I used. They were fixed, variable, direct, indirect, sunk, actual costs and Opportunity Costs. In this memo, I will give you a clear definition as well as an example of each.

Fixed Cost

Fixed costs are costs that are constant from month to month. Fixed costs include items such as rent, car note and insurance. For example, Tom Reality will be leasing office space to conduct business. For the space being leased to us, we must pay a monthly lease fee of five hundred dollars a month. The cost of this space is fixed, because the rent amount stays the same month after month. Fixed cost are cost the must be paid whether or not we open five days or seven (Ward, 2006).

Variable Cost

Variable costs are expenses that change in direct proportion to the activity of a business. Along with fixed costs, variable costs make up the two components of total cost. Direct Costs; however, are costs that can be associated with a particular cost object. Not all variable costs are direct costs however; for example, variable manufacturing overhead costs are variable costs that are not a direct costs, but indirect costs. For example, a computer firm pays for raw materials. When movement is decreased, fewer raw materials are used so the expenditure for raw materials falls. When action is greater than before, additional raw materials are used and expenditure therefore rises (Piana 2003).

Direct Costs

Direct cost are identified with a specific product, department or activity. For example the cost of material and labor to manufacture a widget is identified as a direct cost of that physical product. Examples of direct cost are direct materials, direct labor and direct expenses. Direct cost that are grouped together are called prime cost (Investopedia.com, 2006).

Indirect Cost

Indirect cost can not be identified with a specific product. Taxes, depreciation of plant and machinery and factory rent are common indirect