Cost concepts
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This document defines and explains various cost concepts that are important for business decision making. It discusses the differences between future and past costs, incremental and sunk costs, out-of-pocket and book costs, historical and replacement costs, explicit and implicit costs, actual and opportunity costs, direct and indirect costs, shut down and abandonment costs, and private and social costs. The key message is that different types of costs are relevant for different business problems, so it is important to use the right cost analysis approach.
Cost concepts
- 2. COST CONCEPTSSELECTION BETWEEN ALTERNATIVESDEPENDS ON BUSINESS DECISIONSIMPORTANAT TO USE RIGHT ANALYSIS OF COSTTHE COST ESTIMATES BY CONVENTIONAL FINANCIAL ACCOUNTING ARE NOT APPROPRITE FOR ALL MANAGERIAL USES.DIFFERENT BUSINESS PROBLEMS CALL FOR DIFFERENT KINDS OF COSTS.
- 3. TYPES OF COSTSFUTURE AND PAST COSTSINCREMENTAL AND SUNK COSTSOUT-OF-POCKET AND BOOK COSTS (ac)HISTORICAL AND REPLACEMENT COSTSEXPLICIT AND IMPLICIT COSTS(ac)ACTUAL AND OPPURTUNITY COSTS (ac)DIRECT AND INDIRECT COSTSSHUT DOWN AND ABANDONMENT COSTSPRIVATE AND SOCIAL COSTS
- 4. FUTURE AND PAST COSTSFUTURE COSTS ARE THE ESTIMATES OF TIME ADJUSTED PAST OR PRESENT COSTS AND ARE REASONABLY EXPEECTED TO BE INCURRED IN SOME FURTURE PERIOD OR PERIODS.
- 5. FUTURE AND PAST COSTSPAST COSTS ARE ACTUAL COSTS INCURRED IN THE PAST AND THEY ARE ALWAYS CONTAINED IN THE INCOME STATEMENTS.RECORD KEEPING ACTIVITY.
- 6. INCREMENTAL AND SUNK COSTSINCREMENTAL COSTS ARE DEFINED AS THE CHANGE IN OVERALL COSTS THAT RESULT FROM PARTICULAR DECISIONS BEING MADE
- 7. INCREMENTAL AND SUNK COSTSSUNK COST IS THE ONE NOT AFFECTED OR ALTERED BY A CHANGE IN THE LEVEL OR NATURE OF BUSINESS ACTIVITY.
- 8. OUT-OF-POCKET AND BOOK COSTSOUT-OF-POCKET COSTS INVOLVE IMMEDIATE PAYMENTS TO OUTSIDERS.WAGES AND SALARIES
- 9. OUT-OF-POCKET AND BOOK COSTSIF OUT-OF-POCKET COSTS NOT PAID IT BECOMES BOOK COST. THIS CAN BE CONVERTED INTO OUT-OF-POCKET COST BY SELLING ASSETS AND LEASING THEM BACK FROM THE BUYER.
- 10. HISTORICAL AND REPLACEMENT COSTSHISTORICAL COST STATES THE COST OF PLANT, EQUIPMENT AND MATERIALS AT THE PRICE ORIGINALLY PAID FOR THEM.
- 11. HISTORICAL AND REPLACEMENT COSTSREPLACEMENT COST MEANS THE PRICE THAT WOULD HAVE TO BE PAID CURRENTLY FOR ACQUIRING THE SAME PLANT.
- 12. EXPLICIT AND IMPLICIT COSTSEXPLICIT COSTS ARE THOSE EXPENSES THAT ARE ACTUALLY PAID BY THE FIRM (PAID-OUT-COSTS). THEY ARE GENERALLY RECORDED IN BOOKS OF ACCOUNT.
- 13. EXPLICIT AND IMPLICIT COSTSIMPLICIT COSTS ARE THEOROTICAL EXPENSES IN THE SENSE THAT THEY GO UNRECOGNISED BY THE ACCOUNTING SYSTEM. MAY BE DEFINED AS THE EARNINGS OF THOSE EMPLOYED RESOURCES THAT BELONG TO THE OWNER HIMSELF
- 14. ACTUAL AND OPPURTUNITY COSTSTHE ACTUAL EXPENDITURE INCURRED FORACQUIRING OR PRODUCING A GOOD OR SERVICE. THESE COSTS ARE GENERALLY RECORED IN THE BOOK OF ACCOUNTS.
- 15. ACTUAL AND OPPURTUNITY COSTSTHE OPPURTUNITY OR ALTERNATIVE COST ARE THE RETURNS FROM SECOND BESTUSE OF THE FIRM’S RESOURCES WHICH THE FRIM FORGOES IN ORDER TO AVAIL ITSELFOF THE RETURNS FROM THE BEST USE OF THE RESOURCES.
- 16. DIRECT AND INDIRECT COSTSCOST THAT CAN BE DIRECTLY ATTRIBUTEDTO THE PRODUCTION OF A UNIT OF A GIVEN PRODUCT. THIS CAN BE EASILY SEPARATED, ASCERTAINED AND IMPUTED TO A UNIT OF OUTPUT.
- 17. DIRECT AND INDIRECT COSTSCOSTS THAT CANNOT BE SEPARATEDAND CLEARLY ATTRIBUTED TO INDIVIDUALUNITS OF PRODUCTIONLIKE ELECTRICITY CHARGES
- 18. SHUT DOWN AND ABANDONMENT COSTSSHUT-DOWN COSTS ARE REQUIRED TO BE INCURRED WHEN THE PRODUCTIONOPERATIONS ARE SUSPENDED AND WILL NOTBE NECESSARY, IF THE PRODUCTIONOPERATIONS CONTINUE.IF THE PRODUCTION IS SUSPENEDED,THE PLANT, MACHINERY OR EQUIPMENTWILL HAVE TO BE PROTECTED BY PUTTING UP SHEDS, USING TARPAULIN, PLASTIC SHEETS ETC.
- 19. SHUT DOWN AND ABANDONMENT COSTSWHEN ANY PLANT IS TO BE PERMANENTLY CLOSED DOWN,SOME COSTS ARE TO BE INCURREDFOR DISPOSING OFF THE FIXED ASSETS
- 20. PRIVATE AND SOCIAL COSTSTHE MICRO LEVEL ECONOMIC COSTS. IF THE DECISION OF A FIRM TO EXPAND ITS OUTPUT LEADS TO INCREASE IN ITS COST, IT IS PRIVATE COSTARE THOSE WHICH ARE ACTUALLY INCURRED OR PROVIDED FOR BY AN INDIVIDUAL OR FIRM FOR ITS BUSINESS ACTIVITY.
- 21. PRIVATE AND SOCIAL COSTSTHE MACRO LEVEL ECONOMIC COSTS. IF IT LEADS TO CERTAIN COSTS TO THE SOCIETY, MAY BE IN THE NATURE OF GREATER POLLUTION, CONGESTION ETCSOCIAL COST IS THE TOTAL COST TO THE SOCIETY ONACCOUNT OF PRODUCTION OF A GOOD.
- 22. THANK- U