Categories of Cost Can Be Divided Into

Categories of Cost

Cost can be divided into following six categories:

Variable Costs

Fixed Costs

Semi-Variable or Mixed Costs

Total Production Costs

Direct Costs

Indirect Costs (Overhead)

Variable Costs: Variable costs are those costs that change with number of units produced or volume of production (Jackson, Sawyers and Jenkins, 2009). These are also called as the product costs as they vary with each unit of production. Some of the variable costs that changes with the production level include materials, labor and shipping.

Fixed Costs: Fixed cost is the costs that is not affected by the volume of production and remains the same, regardless of the number of units produced. It is also called as period costs which is the name derived by its ability of being occurring over a particular period. Examples include: Rent, business licenses etc.

Semi-Variable or Mixed Manufacturing Costs: Semi- Variable or a mixed cost has components of both fixes as well as variable costs. The fixed cost part of the cost is paid irrespective of the level of production or activity carried out in the entity (Drury, 2008) while the variable part varies. A simple example is of a telephone bill in which some charges are fixed while remaining varies depending upon the service used.

4. Total Production Costs: Total Production Costs is the total cost used for making or producing a product or service. It includes direct as well as indirect costs that are incurred during the production.

5. Direct Costs: Direct cost is the cost that can directly be related to each unit produced. In most of the cases, direct cost is also the material cost, for instance materials and labor used. Advertising expense can also be a direct costs but it is not variable.

6. Indirect Costs: Indirect costs are the costs that cannot be related to any product. These are the overhead costs for doing business; for example marketing, accounting, rent of the place etc.

Incremental Cost Analysis

Incremental analysis is a decision making tool in which all costs and revenues of one alternative are compared with all the costs and revenues of another alterative in order to choose the best available option. Costs that are different between the two alternatives are the relevant cost while the costs that are same in both alternatives are the irrelevant costs.

Only the variable and direct costs are added in the incremental analysis because these are different in case of different alternatives (Yoe, 2012). The fixed cost, like rent of the factory and other indirect cost like business and accounting are considered as irrelevant as they remain same in case of both alternatives, so not considered in the cost incremental analysis. As stated above, this analysis involves, doing comparison of those costs that are different in both alternatives.

Example: A Pharmaceutical Company

A pharmaceutical company has following costs: