New Age History and Economics


Tuesday, January 10, 2012

Types of Costs;

Dear Brethren,

Primary Definitions;

1. Fixed cost (FC) is cost that does not vary depending on production or sales levels, such as rent, property tax, insurance, or interest expense.

2. Variable cost (VC) is a cost of labor, material or overhead that changes according to the change in the volume of production units. Combined with fixed costs, variable costs make up the total cost of production. While the total variable cost changes with increased production, the total fixed costs stays the same.

3. Total cost (TC) refers to the money value of the total resources/inputs required for the production of goods and services by the firm.  In other words, it refers to the total outlays of money expenditure, both explicit and implicit, on the resources used to produce a given level output.  Total cost includes both fixed and variable costs and is given by TC = VC + FC

4. Average Cost (AC), refers to the cost per unit of output assuming that production of each unit incurs the same cost.  It is statistical in nature and is not an actual cost.  It is obtained by dividing Total Cost(TC) by Total Output(Q).  AC= TC/Q

5. Marginal costs(MC), refers to the additional costs that are incurred when there is an addition to the existing output level of goods and services. In other words, it is the addition to the Total Cost(TC) on account of producing additional unit. That is cost of the additional inputs needed to produce that additional output. More formally, the marginal cost is the derivative of total production costs with respect to the level of output.

Secondary Definitions;

1. Business Cost means and includes all the expenses incurred by the firm to carry out business activities. Costs Include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment.

2. Full costs means and includes business costs, opportunity costs, and normal profits.  Opportunity costs is the expected return/earnings from the next best use of the firms resources like capital, land and building, owners efforts and time.  Normal profits is necessary minimum earning in addition to the opportunity costs, which a firm must receive to remain in its present occupation.

3. Direct cost means a cost that can be directly traced to producing specific goods or services. In other words, direct costs are those which are directly and definitely identifiable.  The nature of the direct costs are related with a particular product/process, they vary with variations in them.  Therefore all direct costs are variable in nature. It is also called as "Traceable Costs"
 Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs.

4. Opportunity Cost means cost of forgone opportunities / alternatives.  In other words, it is the return from the second best use of the firms resources which the firms forgoes in order to avail of the return from the best use of the resources.  It can also be said as the comparison between the policy that was chosen and the policy that was rejected.  The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input.  Opportunity cost is also called as "Alternative Cost".

If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account.  But the firm has an opportunity cost of using the land, which is equal to the rent forgone by not letting the land out on rent.

5. Sunk Costs are those do not alter by varying the nature or level of business activity.  Sunk costs are generally not taken into consideration in decision - making as they do not vary with the changes in the future.  Sunk costs are a part of the outlay/actual costs.  Sunk costs are also called as "Non-Avoidable costs" or "Inescapable costs".

Examples: All incurred costs are sunk costs.

6. Incremental Cost are addition to costs resulting from a change in the nature of level of business activity.  As the costs can be avoided by not bringing any variation in the activity in the activity, they are also called as "Avoidable Costs" or "Escapable Costs". More ever incremental costs resulting from a contemplated change is the Future, they are also called as "Differential Costs"
 Example: Change in distribution channels adding or deleting a product in the product line.

7. Explicit Cost are those expenses/expenditures that are actually paid by the firm.  These costs are recorded in the books of accounts.  Explicit costs are important for calculating the profit and loss accounts and guide in economic decision-making.  Explicit costs are also called as "Paid out costs"
Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc.

8. Implicit Costs are part of opportunity cost. They are the theoretical costs ie., they are not recognised by the accounting system and are not recorded in the books of accounts but are very important in certain decisions.  They are also called as the earnings of those employed resources which belong to the owner himself.  Implicit costs are also called as "Imputed costs".
 Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity capital etc.

9. Book Costs are those business costs which don't involve any cash payments but a provision is made in the books of accounts in order to include them in the profit and loss account and take tax advantages, like provision for depreciation and for unpaid amount of the interest on the owners capital.

10. Out Of Pocket Costs are those costs are expenses which are current payments to the outsiders of the firm.  All the explicit costs fall into the category of out of pocket costs.
Examples: auditors fee their expenses etc

11. Accounting Costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm.
Examples: All Sunk costs are accounting costs

12. Economic Costs are related to future.  They play a vital role in business decisions as the costs considered in decision - making are usually future costs.  They have the nature similar to that of incremental, imputed explicit and opportunity costs.

13. Indirect Costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department.  Like the direct costs indirect costs, do not vary ie., they may or may not be variable in nature.  However, the nature of indirect costs depend upon the costing under consideration.  Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.
Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour etc.

14. Controllable Costs are those which can be controlled or regulated through observation by an executive and therefore they can be used for assessing the efficiency of the executive.  Most of the costs are controllable.
Example: Inventory costs can be controlled at the shop level etc.

15. Non Controllable Costs are those which cannot be subjected to administrative control and supervision are called non controllable costs.
Example: Costs due obsolesce and depreciation, capital costs etc.

16. Historical Costs refers to the original price paid by the management to purchase it in the past.

17. Replacement Costs refers to the cost that a firm will incur to replace or acquire the same asset now.  The distinction between the historical cost and the replacement cost result from the changes of prices over time.  In conventional financial accounts, the value of an asset is shown at their historical costs but in decision-making the firm needs to adjust them to reflect price level changes.
Example: If a firm acquires a machine for $20,000 in the year 1990 and the same machine costs $40,000 now.  The amount $20,000 is the historical cost and the amount $40,000 is the replacement cost.

18. Shutdown Costs are those which a firm incurs when it temporarily stops its operations are called shutdown costs.  These costs can be saved when the firm again start its operations.  Shutdown costs include fixed costs, maintenance cost, layoff expenses etc.

19. Abandonment Costs are those costs which are incurred for the complete removal of the fixed asset from use.  These may occur due to obsolesce or due to improvisation of the firm.  Abandonment costs thus involve problem of disposal of the asset.

20. Urgent Costs are those costs which have to be incurred compulsorily by the management in order to continue its operations. If urgent costs are not incurred in time the operational efficiency of the firm falls.
Example: Cost of material, labour, fuel etc

21. Postponable Costs are those which if not incurred in time do not effect the operational efficiency of the firm.  Examples are maintenance costs.

22. Short Run Cost: These costs are which vary with the variation in the output with size of the firm as same.  Short run costs are same as variable costs.  Broadly, short run costs are associated with variable inputs in the utilization of fixed plant or other requirements.

23. Long Run Cost: These costs are which incurred on the fixed assets like land and building, plant and machinery etc., Long run costs are same as fixed costs.  Usually, long run costs are associated with variations in size and kind of plant.


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