Accounting Concepts

9. How do variable costs and fixed costs differ? Give an example of each.


Variable costs vary commensurately with changes in activity level of some particular items such as production or sales volumes. For instance in a motor vehicle assembly plant, the costs of materials such as the aluminum used to make the bodies of the vehicles or plastic used to make the interior is directly related to the number of vehicles manufactured (Albrecht, 2007).

Fixed costs on the other hand are not determined by the level of activity. These costs must be incurred whether there is any activity going on in the organization or not. Such costs include rent, wages for permanent staff, business licenses and insurance premium costs.


11. What is C-V-P analysis used for? In the process of using C-V-P analysis, what does it mean to “break even”?

C-V-P analysis refers to cost-volume-profit analysis which is a management tool used in the planning process to determine at what level of activity the company would be operating profitably. The break even point represents the point where the fixed costs of the organization are equal to the sales made. Beyond this point, the company is said to be operating profitably (Albrecht, 2007).


16. What is the difference between a direct cost and an indirect cost? Give an example of each in the context of teaching an accounting class at your school.


Direct costs are those costs that are directly attributable to a business segment. This segment may be a production line, division, plant or sales territory whose performance needs to be analyzed. Direct costs may include the cost of operations or labor of a business segment. In most circumstances the direct costs are usually variable costs but in some peculiar cases they can also be fixed costs. The direct costs can only be avoided if the business segment is discontinued.

Indirect costs on the other hand are those costs that are not directly accountable to a particular product. Most of the times these costs are fixed. Indirect costs may include taxes, administration, personnel and security costs (Albrecht, 2007). They are often to as overheads. These costs only serve to increase the output cost of a company and therefore it is of great benefit if these costs can be avoided or minimized.


18. How can out-of-pocket costs and opportunity costs be applied to your personal financial decisions?


Out of pocket costs are those costs which are incurred in order for a project to be undertaken by a firm. For example the cost of networking the different branches of a company are out of pocket costs. Most costs discussed above can also be classified as out of pockets. Opportunity costs are the benefits lost that are forfeited as a result of choosing an alternative course of action as opposed to another. Going for a drink instead of working for five hours at a rate of $10 per hour has an opportunity cost of $50 in addition to the out of pocket costs of buying the drinks (Albrecht, 2007).


d. Fixed costs and variable costs:

A fixed cost is a cost that does not vary with production or sales levels. Such costs include: rent, property tax, insurance, or interest expense.

Certain costs such as the cost of labor, materials or overheads vary according to the change in the volume of production units. These are referred to as variable costs and coupled with fixed costs; variable costs constitute the total cost of production.

e. Direct and Indirect Costs

A direct cost is a cost that is directly related to the manufacture of a product or provision of a service. A good example of a direct cost is the cost of the materials needed to make a product as the materials are directly used in the manufacture of the final product. Direct costs can also be classified as variable costs but the two should be taken to mean the same.

Indirect costs represent those costs of an entity’s operation that cannot be traced to a particular activity or function undertaken by the business. However this does not mean that these costs are superfluous as they are necessary for the general operation of the organization and the conduct of activities it performs.


f. Out-of-Pocket Costs and Opportunity Costs

Out-of-pocket costs are those costs which result in direct outlays of cash which are not reimbursable. These are also referred to as revenue expenditures as there is no way to recover these costs after they have been incurred.

An opportunity cost is defined as the benefit or the profit foregone as a result of choosing the next best alternative. Due to the scarcity of resources, opportunity costs will always have to be incurred.


Cost Classifications:

There are a number of different ways that we can classify costs:

Costs can be classified by behavior. This involves looking at how they vary in response to changes in the production or sales. Costs can also be classified by function. Costs incurred during the manufacturing or production process are charged to inventory and then written off as part of cost of goods sold. Other costs which are not related to the manufacture of goods are also incurred and these are mostly administrative costs which are also referred to as overheads. Such costs are not charged to the inventory and the business has to look for other means of recovering these costs.






















Albrecht S. W. (2007) Accounting: Concepts and Applications. 10th edition. South-Western College Pub.

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