The difference between fixed and variable costs

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Difference between Fixed and Variable Costs

Fixed costs which are sometimes named as sunk costs are costs that do not vary in proportion to level of activity between payment intervals. It is impractical and also due to contractual agreements that these costs cannot be adjusted on a short term period. These costs remained the same regardless on how much product are produced with the capacity range.

Variable costs, as the name implies, is in contrast to fixed cost. The costs incurred changes with payment intervals. The costs changes in total as the number or amount of production changes per unit.

Examples of Fixed Costs

UrPrint Factory rental

Factory rental are fixed cost as it is usually based on contractual agreement annually or bi-annually depending on the lease. So the rental cost will not change on monthly basis and the cost of rental would be the same regardless on how much T shirts were printed daily, weekly or monthly. The rental cost will only change unless there is an expansion of business where the current rental space is insufficient to support the production and require larger rental space.

UrPrint Operation Manager salaries

Managerial salaries are considered fixed costs as their salary are based on contractual agreement. Their salary will not change every month. And there are no "over time pay" required for managerial position. Hence their salary will not change over short term basis regardless of amount of production or work. Their salary will not be adjusted probably on per annum basis when there is a pay increment.

Factory Insurance

Insurance for factory would not change over night; it is usually based on renewal contract on a yearly basis. Hence it is considered as fixed costs to the factory. The cost of insurance will not change with increased or decreased printing of Tshirts.

Examples of Variable Costs

Material costs

Material costs such as t-shirt, silk screens and paint required by UrPrint are considered variable costs. The cost of material will change with more/less units required. Example when there are more printing required, the factory would need to purchase more t-shirt and the purchase cost of 100 t-shirt is cheaper than cost of 50 t-shirt hence it will bring down the cost of material and it will change the cost with different amount of t-shirt purchased.

Labour costs

Labour costs which are the manpower cost are variable cost. It will change with the level of activity of the production. Example when there was an increased in demand for printing of t-shirt and in order to meet the timeline given by customers, the factory may need to run over time which will warrant the need to pay the production staff over time pay which would result in changes in the labour costs.

Utility costs

Utility costs which include electricity and water are variable costs to the factory. The amount required depends on the size and amount of production.

Example when the factory has to run over time to meet the demand of customers, the amount of electricity used to support the function of the production will be increased.

Question 3b)

"All Variable costs are controllable while all fixed costs are uncontrollable".

I would partially agree with the above statement.

And agreed that "most" variable costs are controllable but "not" all fixed costs are uncontrollable.

Variable costs are controllable but not for all. And though many fixed costs are uncontrollable, there are some that are within control by the management. Variable costs are mostly controllable. Variable costs include material, labor and overhead costs that change over level of production and activity. Example material costs are controllable when the factory can source the raw material and select the best quotation from different vendors or suppliers to make sure the company pay reasonably for the material costs. The factory can bargain for less material cost with bigger quantity purchased. Labor cost can also be controllable as the operation manager can schedule the production time properly and efficiently to ensure that the production time is optimized and no over run production is required and will not result in increased labor cost.

However there are also cases when variable costs are not controllable. Take material costs as example, the cost of raw materials can be highly dependent on the availability of the raw materials. Such as when there is a drought in Thailand where many crops were destroyed, the costs of wheat go up and are not within control. Similar to variable cost, some fixed costs are controllable as well.

Fixed cost though they do not change as often as variable cost, it may be controllable. Fixed costs are mostly mandatory cost such as rental cost. A company would definitely need an office or production space however the cost is controllable. The management can control fixed cost such as rental cost by choosing a rental space that is less costly. Example, the rental space for UrPrint for current location and space is $50K per month; the management can cut cost by renting a space that is cheaper and compromise on the location of the space.

In this scenario, the management of UrPrint has the intention to buy a new and bigger factory as part of their future expansion plans instead of rental. That would affect the fixed cost of the company.

And also the marketing (fixed) cost incurred by the marketing executive to engage an advertising agency can be controlled as well. The executive can negotiate for better advertising contracts by sourcing from different agencies. Hence when there is a choice or option, it is often controllable.

In summary, many of the variable costs are controllable while some of the fixed costs are controllable as well.

Question 3 c)

Difference between Direct and Indirect Costs

Direct costs include activities or services that benefit and impact the project specifically. While indirect costs include activities or services that benefit and impact more than one project.

For direct costs, the activities and services are likely and easily traced to the project and the costs are charged to the project respectively. Example, in a manufacturing plant, the raw material costs and direct labor costs needed to produce the goods are direct costs.

For indirect costs, the activities and services are less likely and less easily traced to the project. It is not easily identified to benefit a specific project. Example, it is rather difficult to account for the activities of the director in a company on how it benefits the operations of the company.

Indirect costs do not change significantly within certain production volume hence are often considered to be fixed cost whereas direct costs usually change within certain production and are often considered as variable costs.

However I only agree on the statement that "all variable costs are direct costs while all fixed costs are indirect costs" to a certain extent.

In this scenario, the cost of producing a silk screen mould is considered direct cost however it is not variable cost as the cost is not dependent on the amount of t-shirt being printed.

Take for instance; the cost of silk screen mould is fixed at $2000 regardless of whether 600 or 1000 t-shirts are printed. Hence the silk screen mould is direct cost to the production with fixed cost that is not dependent on production volume. Hence not all direct cost is variable cost which was proven in this instance. But generally most variable costs are direct costs and most fixed costs are indirect costs. Example, when there is an error committed when making the silk screen which resulted in 40 t-shirt printed with the wrong logo, this incident is considered direct cost to the production.

And the accident includes covering the mistake on the 40 t-shirts with white paint which incurred variable cost of $20 white paint and additional labour cost of $60 with usual overhead application. The cost incurred is dependent on the amount of mistake or number of t-shirt with mistake so it is variable cost.

Another incident in this scenario resulted in direct costs with variable costs when the sleeves of 20 other t-shirts are burnt and additional variable cost of $1 per t-shirt is incurred to cover up the burnt and resell to their employees. It is a direct cost to the company and the cost of fixing and reselling of the burnt t-shirt changes, it is variable cost.

Hence generally most variable costs are direct costs but not for all instances which were explained earlier in the case for the direct cost of silk screen which is considered as fixed cost.

Question 4

Lian Beng Group Ltd is an investing holding company, it provides engineering and leasing of construction machinery, building construction, civil engineering and construction support services. The group also manufactures and sells ready-mixed concrete. The company also involves in energy related industry, property development and construction workers training.

The board of directors consists of chairman, two independent directors and two executive directors.

Chairman and Managing Director of the group is responsible for the management business development and group's overall strategic direction.

Independent Director who does not hold any shares in the company or any of its subsidiaries. He serves as Chairman of the Remuneration Committee and is also a member of the Nominating and Audit Committees.

Another Independent Director who does not hold any shares in the company or any of its subsidiaries. He serves as Chairman of the Nominating and Audit Committees and is a member of the Board's Remuneration Committee.

The Executive Director of the group is the head of the Group's contracts department; overseeing several key aspects of the Group's construction operations, which consist all tender submissions, the management and review of project costs and budget, key materials procurement, and the award of contracts to sub-contractors. She also assists in progress reviews and implementation of workflow initiatives that seek to improve and fine-tune the Group's work processes in accordance to new market trends and changes.

Another executive director of the group, she is in charge of the Group's finance and human resource functions. In her present capacity, she is responsible for the organization and management of the Group's accounting, finance and corporate actions, as well as for all matters relating to human resource management within the Group. Together with her fellow executive directors and key executives, she is also involved in progress reviews and implementation of workflow initiatives for the purpose of improving and fine-tuning the Group's work processes in accordance to new market trends and changes.

There are another eight key executive officers who have important roles and responsibility in the group.

The Plant and Machinery director is responsible for overseeing the group's engineering division; he has to monitor the progress of materials utilisation by the group's construction division. In addition, he is also responsible for overseeing the operations and management of the group's ready-mix concrete business.

The second executive, Project director is responsible for the group's foreign labour planning and deployment functions, he also has to manage the group's foreign workers training division. In addition, he is part of a management team that manages the construction division's building projects.

Third executive, Purchasing Director of the group manages the group's purchasing division and oversees the group's inter-companies material and machinery logistics deployment. She also administers the Group's foreign workers' payroll function. Since joining the Group in 1988, she has gained vast experience in procurement activities in the construction

industry in her position as Purchasing Director. Her well-honed skills and extensive knowledge has enabled her to discharge her responsibilities efficiently and effectively.

Fourth executive, Financial Controller of the group is responsible for the financial accounting, financial management and internal control functions of the group. Before he joins the group, he had over 16 years experience in financial and management accounting, costs and budgetary control and financial management in the trading, construction and manufacturing business.

Fifth executive, Director of Deenn Engineering Pte Ltd ("Deenn"), he forms part of the management team that manages the Group's construction division's building projects, with special focus on its design-and-build functions.

Sixth executive, Construction Director of the Group, he forms part of the management team that manages the Group's construction division's building projects, with special focus on its quality management and productivity enhancement. He has more than 20 years of project management experience in the construction industry and has been the key driver in quality and sustainable green initiatives for all the private condominium projects undertaken by the company. His vast experience and strong emphasis on delivering quality products have enabled him to instruct the setting up of the construction division's Quality Assurance & Quality Control (QA/QC) committee. He also takes charge of the division's ISO integrated management system and its green initiatives.

Seventh executive, Senior Construction Manager Construction division in the group, he forms part of the management team that manages the construction division's building projects. He also oversees the division's workplace safety and health portfolio. With more than 20 years of construction and project management experience, he is actively involved in the management of various building contracts undertaken by the group. He also has been tasked to manage the Group's construction projects and its safety and health functions.

Last executive, Director of Sinmix Pte Ltd (Sinmix), he is in charge of the daily management of Sinmix's business operations. His 25 years of experience in the ready-mix industry has enabled him to lead the division efficiently in managing its assets allocation and cost control measures, as well as ensure a smooth supply chain within the division's network of customers and suppliers.

To effective corporate governance, three committees are formed, namely Nominating Committee (NC), Remuneration Committee (RC) and Audit Committee (AC). They also appoint an external audit company which determines the company's stated business activity is the same with the results reported in the financial statement. The audit company also checks on the company's bookkeeping methods to determine they are in accordance with generally accepted accounting practices.

The Audit Committee consists of 1 non-executive director and 2 of the independent directors. The committee has authority to investigate all matters within its terms of reference, full access and cooperation by management.

means there should be different ppl doing different scope. as in the purchaser should not be the one who do the accounting aso. i think lecture notes have one... u check it out.