calculations of profitability.

He wrote: "Brown … related turnover to earnings as a percentage of

sales (still the standard definition of profit in American industry). He did this by multiplying
turnover by profit so defined, which gave a rate of return that reflected the intensity with which
the enterprise's resources were being used."

THE BASICS OF COSTING METHODS

FIXED COSTS.

One of the key issues in conventional costing methods (i.e., process costing and job-order
costing) is distinguishing among types of costs. A basic distinction is made between fixed and
variable costs. Fixed costs are those costs that are invariant with respect to changes in output and
would accrue even if no output were produced. Such costs might include interest payments on
the purchase of plant and equipment, rent, property taxes, and executive salaries. The notion of
fixed costs is restricted within a certain time frame, since over the long run fixed costs can vary.
For example, a manufacturer may decide to expand capacity in the face of increased demand for
its product, requiring a higher level of expenditure on plant and equipment.

VARIABLE COSTS.

Variable costs change proportionately to the level of output. For manufacturers, a key variable
cost is the cost of materials. In terms of total costs at increasing output levels, fixed costs are
constant and variable costs are increasing at a constant rate. In terms of unit costs at increasing
output levels, fixed costs are declining, and variable costs constant. Manufacturers are vitally
interested in unit costs with respect to changes in output levels, since this determines profit per
unit of output at any given price level. The characteristics of fixed and variable costs indicates
that as output increases, unit costs will decline, since there is constant variable cost and lesser
fixed cost embodied in each unit. These costing methods thus suggest that it is in manufacturers'
interest to run, within the limits of plant design, at high capacity levels.

DIRECT COSTS.

Costing methods distinguish between the direct and indirect costs of any costed object. Direct
costs are those costs readily traceable to the costed object, whereas indirect costs are less-readily
traceable. Direct costs typically include the major components of any manufactured good and the
labor directly required to produce that good. Direct costs are often subdivided into direct material
costs and direct labor costs. Direct costs are also referred to as prime costs.

INDIRECT COSTS.

Indirect costs include plant-wide costs such as those resulting from the use of energy and fixed
capital, but indirect costs may also include the costs of minor components such as solder or glue.
While all costs are conceivably traceable to a costed object, the determination of whether to do
so depends on the cost-effectiveness with which this can be done. Indirect costs of all kinds are
sometimes referred to as overhead, and in this sense prime costs can be distinguished from
overhead costs.