Describing Costs Within the Firm

Running head: Describing Costs Within The Firm

Describing Costs Within The Firm

Introduction

Within the operation of any company, there are several types of costs that must be considered to achieve proper book keeping and accounting practices. Some of these different types of costs are direct costs, indirect costs, fixed costs, variable costs and sunk costs. To the lay person these various costs may be confusing, but once explained are helpful in knowing how the company must allocate and account for all the costs listed.

Fixed Costs

Fixed costs are the costs that all companies must pay regardless of sales or production levels. Building payments, depreciation and taxes are just a few of the fixed costs that are common to all companies. It is easy to see why the term fixed cost is used. The costs are unmovable and must be paid each month or year without exception

Variable Costs

Opposite of fixed costs are variable costs. Variable costs fluctuate with the rate of business being performed. For example, if production drops from 100 units down to 20 units, then material cost drops to the 20 unit level. Another good example of variable cost is electricity bills. All companies must pay a general electricity bill which includes line maintenance and general usage fees. However, if production increases to a point where more power is used then the cost of electricity increases. If usage decreases then so does the electric bill. Thus the cost is variable in the amount that must be paid but fixed in that some amount will have to be paid for having the service.

Direct Costs

Direct costs are costs that can be identified specifically with a particular sponsored project, an instructional activity, or any other institutional activity. Since direct costs and fixed costs seem to be the same thing, let’s look at them a little closer to see why they are not. Fixed costs are incurred by all programs within a company. The cost is shared by all. Direct costs are only seen by a specific program in the company. Only one part of the company will see these costs.

A company that uses the direct cost structure is ATK Space Systems and Sensors. Since the end customer, for most of the parts produced at ATK, is the US Government, it is very important that costs be tracked in a very precise manner. ATK has created a cost code or number for each program that is in production. If a person is working on a part, then the person must charge his or her time to the F22 program. This applies to all programs that have a cost code associated with them. If a government auditor was to find the time keeping records have been falsified, then the company stands to be sued by the government and have all business taken away or suspended for a very long time.

It is very important in applying direct costs that the same standard be used within the entire company. In other words, a direct cost for one program must also be a direct cost for all other programs. For any company that is program based, must have an accounting structure that allows for direct cost to be reported.

Indirect Costs

Indirect costs for the company