5.4.1 Cost information
The need for accurate cost information
- pricing: a business must know its costs to set prices that cover them and earn a profit
- profit measurement: profit = revenue − costs; wrong cost figures mean wrong profit figures
- decision-making: whether to launch, drop or keep a product, accept an order, make or buy (outsource) a component
- control and efficiency: comparing actual costs with budgets reveals waste and inefficiency
- setting budgets and targets, and preparing cash flow forecasts and business plans
Different types of costs
Definition Fixed costs are costs that do not change with the level of output in the short run — they must be paid even if nothing is produced (rent, salaries, insurance, loan interest).
Variable costs are costs that change in direct proportion to the level of output (raw materials, packaging, piece-rate wages, sales commission).
Direct costs are costs that can be clearly identified with a particular product or cost centre (the materials used to make a chair; the wages of workers on one production line).
Indirect costs (overheads) are costs that cannot be identified with any one product, because they are shared by the whole business (head-office rent, managers' salaries, advertising for the whole brand).
| Cost | Fixed or variable? | Direct or indirect? |
|---|
| Wood used to make tables in a furniture factory | Variable | Direct (for tables) |
| Salary of the factory's managing director | Fixed | Indirect |
| Rent of a factory making only one product | Fixed | Direct (for that product) |
| Electricity for the whole site | Mostly fixed (semi- variable) | Indirect |
| Piece-rate wages of machinists on one product line | Variable | Direct |
The two classifications are different questions: fixed/variable asks does it change with output?; direct/indirect asks can it be traced to a product? Most direct costs are variable and most indirect costs are fixed — but not all (a factory used for only one product has a fixed but direct rent). Some costs are semi-variable, with a fixed element and a variable element (a phone bill with a line rental plus call charges).
Worked calculation
Total cost = total fixed costs + total variable costs
Total variable cost = variable cost per unit × output
A café in Pune has fixed costs of ₹60 000 per week and a variable cost of ₹80 per cup. At 800 cups:
Total variable cost = 80 × 800 = ₹64 000; total cost = 60 000 + 64 000 = ₹124 000
🔒 Also in the full notes
- 5.4.2 Approaches to costing: full, contribution
- 5.4.3 Uses of cost information
- 5.4.4 Break-even analysis
- Exam practice: 5 practice questions
- 2 exemplar answers with full model answers and mark breakdowns
- Where students commonly lose marks
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