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1.5. Other Costs Distinctions Relevant for Decision-Making

Direct costs

Direct costs are the costs that result from a single activity, production, production facility, or cost bearer, and a direct cost can exist at different levels, such as the unit, the product line, the activity, the process or the department. Direct costs are separated into fixed and variable costs.

In a production firm, the direct costs in medium-short term are:

o Direct variable costs are materials employed, power consumed directly in production, calculated waste, salaries to production workers, etc.

o Direct fixed costs are operation of relevant buildings, technical facilities, yield of the capital tied up (opportunity cost principle), control etc.

With regards to the car case, direct fixed costs are insurance and vehicle excise duty. The direct variable costs are fuel consumption, as the fuel consumption varies with the mileage, while it is also directly attributed to the covered kilometer.

Indirect costs

Indirect costs are the costs that cannot be attributed to the specific action, production, production facility or cost bearer. Indirect costs are separated into fixed and variable costs.

In a production firm the indirect costs in the medium-short term are:

o Indirect variable costs are repair and maintenance, cleaning, quality control, management of production/cleaning/service as well as parts of the administration.

o Indirect fixed costs are senior level management, directors, accountants, legal and strategic advisors, general types of insurance, operation of non attributable offices (directors offices, in-firm fitness facilities etc.), parts of the sales and administrative departments, IT-backbone etc.

Examples of indirect variable costs from the car case are: maintenance costs, as these costs vary with the mileage but cannot be attributed directly to specific covered kilometer. These costs appear abruptly and concern repairs that cannot be planned. Other examples of indirect costs are: a broken external rear-view mirror, repair of the wipers etc. An example of indirect fixed costs is depreciation of the car's value as it becomes an older model.

Reversible costs

Reversible costs are the costs that appear as a result of a production increase and disappear with a production decrease.

A high degree of reversible costs enhance the firm's capability to disengage from costs and thus change production level. Costs can also be partly reversible, which means that they increase more under a production increase than they decrease in conjunction with a production decrease, in which case it is only partially possible to disengage from the costs by lowering production.

In the car case, the vehicle excise duty and insurance are examples of reversible costs, as these disappear if the car is sold. Both the vehicle excise duty and the insurance premium is returned proportionally when cancelled.

A partly reversible cost is when a firm buys a car, and later wishes to sell it. In this case the car dealer's profit is lost. In most cases a car bought at a dealer's for 130,000 DKK and sold back after a short period of time, will only bring in 100,000 DKK. This partly reversible cost results in a loss of 30,000 DKK.

Irreversible costs

Irreversible costs are costs that are not annulled upon a decrease in production.

A high degree of irreversible cost deteriorates the firm's possibilities of disengaging from costs by changing production level.

With regards to the car case the subscription to companies such as AAA, FDM, or other driving-support companies, are a short-term horizon irreversible costs, because these memberships do not stop when the car is sold.

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