Which cost category varies directly with production or service levels?

Variable costs are the correct answer because they change in direct proportion to the level of production or service provided. This means that as production increases, variable costs rise, and as production decreases, variable costs drop. Examples of variable costs include materials used in production, direct labor costs, and other expenses that fluctuate with the quantity of goods or services created.

In contrast, fixed costs remain constant regardless of production levels, which means they do not vary with the quantity of goods produced or services rendered. Sunk costs are past costs that cannot be recovered and thus do not vary with current production levels. Capital costs generally refer to the costs involved in acquiring fixed assets for long-term use and also do not fluctuate directly with production levels. Understanding the nature of variable costs is crucial for effective budgeting and financial analysis in any organization.