Cost Types

Costs can be defined as the amount of expenses that an organization or business pays to produce a product, service, or  a group of products and services, where costs can be linked to a specific product or service. It is of vital importance for a business to properly understand the nature and different components of cost, because this helps to determine the price of a product or service and affects the competitiveness and profitability of the organization. The cost must be estimated by calculating all direct and indirect costs, while also calculating the cost of the alternative opportunity, as it is important to take the cost into account when pricing and not only have pricing based on market and competitors’ prices.

Costs can be classified under:

Direct costs: these are the costs that can be traced directly to a specific good or service, and include the cost of direct materials and direct labour involved in a given product. This includes:

• Direct material costs: these are the materials that enter directly into the product, such as the costs of fabric, threads and accessories that go into the manufacturing of clothing
• Direct labour costs: these are the wages, salaries, compensations, insurance, and all other allowances paid to  workers associated with the production of a given good or service, such as the costs of sewing, ironing and packaging workers in a garment factory.

Indirect costs: these are the costs that cannot be traced or linked to a specific product or service, such as general administrative costs, public relations and marketing costs, depreciation, audit costs, transportation and communication costs, etc.

There is also another classification of costs:

1. Fixed costs: these are the costs that do not go up when production increases, but are based on time instead of quantity, such as rental costs, administrative salaries, utility bills and insurance, and are often called fixed cost or overheads.
2. Variable costs: these are  the costs that change as the quantity of production changes,  such as the costs of materials and piecework, production requirements’ costs, commissions, delivery costs, and packaging delivery costs, sometimes called  cost of merchandise sold.