4.2.1 Identify and Classify Costs
Classifying costs using examples
Costs may not seem as exciting as earning revenue, but costs have a huge impact on profit. It’s essential for business people to understand where their costs come from, how costs change with production and how to control costs.
Identifying and classifying costs is much more likely as a short answer question, but it forms the building blocks of break-even analysis, and can be an key part of paper 2 questions where you are asked to make a choice between two product options.
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It’s really important to learn the definitions and examples for each type of cost, so you can easily classify costs between fixed and variable, when calculating break-even point or calculating profits .
Variable costs are costs that change as production output increases. So in a cookie factory the more cookies that are produced the higher the costs of ingredients.
Fixed costs are costs that don’t change as output increases. So in my cookie factory no matter how many cookies I produce I will still have to pay rent, and insurance and salaries to the office or management team.
Total costs are calculated by adding all costs, fixed and variable.
Average costs are calculated for each unit of production. So we divide total costs by total output. Average costs are often used for figuring out the selling price of a product. We also can see average cost decrease with economies of scale.