Types Of Costs
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sunk

See vocabulary here

opportunity

See vocabulary here

direct costs

See vocabulary here

indirect costs

See vocabulary here

marginal costs

See vocabulary here

Leasing and Outsourcing:

Leasing

  • Two types of leases
  1. operating lease – like apartment or car rental, lease payments made, possible other incidental costs, property returned to lessor after period of lease expires
  2. capital lease – terms more complex. Risks of ownership transferred to lessee as lease is essentially an agreement to purchase the leased property at the end of the lease’s term. For financial reporting, the lease is an asset, from a managerial point of view it is more important to understand the cash inflows and outflows related to the lease agreement.
  • capital lease likely to include several options that do not occur with operating lease.
  • bargain purchase option
  • sale and leaseback (defense contract example)
  • cost comparisons of leased vs. purchase
    • costs compared over same time periods (term of lease)
    • present value analysis is usually used (time value of money)
    • periodic rental payments in a lease treated as annuities (usually paid at beginning of period, so annuity due)

Outsourcing

  • Essentially renting or leasing labor to perform a task
  • Can be useful in some situations
  • Control on received product only as good as the contract for the outsourcing
  • Good application of differential cost analysis
  • Difficulty comes in choosing what are relevant costs

Question the Lease/Outsource Contract

  • Problems arise in leasing or outsourcing primarily due to the lessee not sufficiently questioning the respective responsibilities of the lessor and lessee as well as consequences for non-performance (breach) of the contract.
  • Examples of such questions are:
    • Who pays maintenance costs?
    • Who pays for insurance?
    • Who is responsible if the leased asset is damaged or destroyed or stolen?
    • Is there a charge for early termination of the lease?

Trade Offs with Leasing

  • By leasing equipment you keep up with latest technology
  • You need to evaluate the lessor regarding quality and reliability
  • There is less paperwork, but more administrative effort
  • Inflationary costs passed on to lessee
  • Range and quality of tasks performed by leased personnel should be examined carefully

Hidden Costs with Leases

  • Changeover costs from in-house to leased
  • Continuous monitoring of service standards
  • Service standards must be explicitly stated in the lease, which requires careful analysis of leased service.
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