1.4 Cost Classifications Used for Planning and Control

In this course, we will cover many cost classifications useful for planning and control.  We will introduce the basic concepts behind these classifications but you will use them (and get in greater depth) in other chapters.

1.  Fixed vs Variable Costs.

A fixed cost remains the same in total but changes per unit.  Fixed costs examples include your monthly rent, salaried employees, straight-line depreciation as these amounts do not change based on volume.  A variable cost remains the same per unit but changes in total.  Variable cost examples include sales commissions, hourly workers, units-of-production method depreciation as these amounts will change based on total volume but the amount charged per unit does not change.

2.  Direct vs Indirect Costs.

A direct cost is an amount that can be traced to a specific department, process or job.  Direct costs can be product costs like direct materials or direct labor or they can be period costs like an accountant’s salary would be traced to the accounting department.  Indirect costs is an amount that cannot be traced to a specific department, process or job.  These costs are typically allocated (or estimated) to the departments, processes or jobs using those items.  Indirect costs can be product costs like overhead or period costs like an IT employee’s salary to the sales department.  The sales department needs the services provided by IT and the IT employee’s time would be an indirect expense to the sales department.

Here is a video that provides a real world example of the differences between direct and indirect costs (focus on the first 2 minutes of the video):

3.  Controllable vs Non-controllable Costs.

When evaluating the performance of an executive or manager under managerial accounting, it is helpful to recognize that some costs and expenses may be out of the control of that manager or executive.  One example is the the manager’s salary.  The manager has no control over his own salary and has no power to change or stay within the budget for the salary.  Controllable costs are things the executive, manager, or department even can control or change.  If the executive, manager or department cannot change or control the cost, it is an uncontrollable cost.  An example of an uncontrollable cost would be an allocation of administrative expenses to each job or department.

4.  Differential Costs including Sunk and Opportunity Costs.

Differential Costs represent the difference between two alternatives.  We will analyze what is relevant to our decision making including any opportunity costs.  Opportunity costs are what you give up by choosing one alternative over another (think about what you are giving up by taking this course — what else could you be doing?).  Sunk costs are not relevant for decision making as the cost cannot be recovered at a later date.  Watch this video to get a better idea of these concepts.