Cost ConceptsCost Concepts

Cost conceptsCost concepts

• Cost Concepts which are relevant to Cost Concepts which are relevant to business operations and decisions business operations and decisions can be based on 2 categoriescan be based on 2 categories

1.1. Concepts used for accounting Concepts used for accounting purposespurposes

2.2. Analytical cost conceptsAnalytical cost concepts

Opportunity costOpportunity cost

• The opportunity cost may be defined The opportunity cost may be defined as the expected returns form the as the expected returns form the second best use of the resources second best use of the resources which foregone due to the scarcity of which foregone due to the scarcity of resources. The opportunity cost is resources. The opportunity cost is also called alternative cost. Had the also called alternative cost. Had the resource available been unlimited, resource available been unlimited, there would be no opportunity cost.there would be no opportunity cost.

Actual CostsActual Costs

• Actual costs are those which are Actual costs are those which are actually incurred by the firm in actually incurred by the firm in payment for labor, material, plant, payment for labor, material, plant, building, etc.building, etc.

Business costs and Full Business costs and Full Costs Costs

• Business costs include all the Business costs include all the payments and contractual payments and contractual obligations made by the firm obligations made by the firm together with the book of costs of together with the book of costs of depreciation on plant and equipmentdepreciation on plant and equipment

• Full Costs includes business costs, Full Costs includes business costs, opportunity cost and normal profit. opportunity cost and normal profit.

Explicit and Implicit CostsExplicit and Implicit Costs

• Explicit costs are those which fall Explicit costs are those which fall under actual costs entered in the under actual costs entered in the books of accountsbooks of accounts

• In contrast, there are costs that do not In contrast, there are costs that do not take the form of cash outlays nor do take the form of cash outlays nor do they appear in the accounting system. they appear in the accounting system. Such costs are called Implicit or Such costs are called Implicit or Imputed Costs.Imputed Costs.

Out of Pocket and Book Out of Pocket and Book CostsCosts• The items of which involve cash payments, The items of which involve cash payments,

both recurring and non-recurring, are both recurring and non-recurring, are known as out-of-pocket costsknown as out-of-pocket costs

• There are certain actual business costs There are certain actual business costs which do not involve cash payments, but a which do not involve cash payments, but a provision is made in the books of accounts provision is made in the books of accounts and they are taken into account while and they are taken into account while making the profit and loss accounts. Such making the profit and loss accounts. Such expenses are known as book costs. expenses are known as book costs.

Fixed Costs and variable Fixed Costs and variable costscosts• Fixed costs are those which are fixed Fixed costs are those which are fixed

in volume for a certain given output. in volume for a certain given output. Fixed cost does not vary with Fixed cost does not vary with variation in output between zero and variation in output between zero and a certain given level of output. a certain given level of output.

• Variable costs are those that vary Variable costs are those that vary with the variation In total outputwith the variation In total output

Total, average and Marginal Total, average and Marginal costscosts

• Total cost is the total expenditure incurred in Total cost is the total expenditure incurred in the production of goods and servicesthe production of goods and services

• Average cost is not actual cost. It is obtained Average cost is not actual cost. It is obtained by dividing the total cost by the total outputby dividing the total cost by the total output

• Marginal cost is the addition to the total cost Marginal cost is the addition to the total cost on account of producing one additional unit on account of producing one additional unit of product.of product.

Short Run and long run Short Run and long run costscosts• Short run costs are costs that vary with Short run costs are costs that vary with

variation in output. Short run costs are the variation in output. Short run costs are the same as variable costssame as variable costs

• Long run costs are costs that are incurred Long run costs are costs that are incurred on fixed assets like plant, machinery, etcon fixed assets like plant, machinery, etc

• It is to be noted that running costs and It is to be noted that running costs and depreciation of capital assets are included depreciation of capital assets are included under short run costsunder short run costs

Incremental and Sunk CostsIncremental and Sunk Costs

• Incremental costs are closely related to Incremental costs are closely related to marginal costs but while marginal refers to the marginal costs but while marginal refers to the cost of the marginal unit of output, cost of the marginal unit of output, incremental costs refers to the total additional incremental costs refers to the total additional cost associated with the expand in outputcost associated with the expand in output

• Sunk Costs are those which cannot be altered, Sunk Costs are those which cannot be altered, increased or decreased by varying the rate of increased or decreased by varying the rate of outputoutput

Historical and replacement Historical and replacement costcost

• Historical cost refers to the cost of an Historical cost refers to the cost of an asset acquired in the past. asset acquired in the past.

• Replacement cost refers to the Replacement cost refers to the outlay which has to be made for outlay which has to be made for replacing an old asset.replacing an old asset.

Private and Social CostsPrivate and Social Costs

• Private costs are those which are actually Private costs are those which are actually incurred or provided for by an individual or a incurred or provided for by an individual or a firm on the purchase of goods and services firm on the purchase of goods and services from the market. For a firm, all actual costs from the market. For a firm, all actual costs both explicit and Implicit are private costs.both explicit and Implicit are private costs.

• Social Costs refers to the total cost borne by Social Costs refers to the total cost borne by the society due to production of a commoditythe society due to production of a commodity