CLASSIFICATION OF COSTS

Costs as we all know are usually measured in monetary terms and include such items as wages, rent, rates, interest, and the amounts paid for raw materials, fuel, power, trans­port and so on.

Just as some inputs are fixed and others variable, so some costs are fixed and others variable.

Fixed costs

These are costs which do not vary as output varies. They are obviously the costs associated with the fixed factors of production, and include such items as rent, rates, insur­ance, interest on loans, and depreciation.

A major hem in fixed costs, especially in capital — inten­sive industries, is the item known as depreciation. It may seem rather illogical to classify depreciation charges as a fixed cost for many people will think that the rate of depreciation of a capital asset is directly related to the extent to which it is used (i.e. output). In fact the life of capital assets tends to be mea­sured in economic rather than technical terms. Machinery depreciates even when even not in use and, even more impor­tant, it becomes obsolete. It is normal practice, therefore, to fix an annual depreciation charge which will write off the cost of equipment over some estimated working lifetime. There are many ways of doing this, but the simplest is to make an annual charge equal to a fixed proportion of the total value. If a machine costs 20 000 pounds and has an expected life of 5 years, then 4 000 pounds per annum will be added to costs and placed in a depreciation fund to cover the expenses of renewal.

Fixed costs (sometimes described as overhead or indi­rect costs) are not influenced by changes in output. Whether a firm is working at full capacity or half capacity the items of costs mentioned above will be unaffected. Thus, when a super-tanker is lying empty in port, or a Jumbo-jet is stand­ing in the hanger, or your new car is locked away in the