Cost Concepts & Determinants of Cost

Submitted to:Cecil Anthony Sir

Presented by: Swetlina Shubhra Salil

COST THE TERM ‘COST’ MEANS THE AMOUNT OF EXPENSES INCURRED ON

OR ATTRIBUTABLE TO SPECIFIED THING OR ACTIVITY. THE TERM COST IS USED IN FORM OF MONEY. AS PER INSTITUTE OF COST AND WORK ACCOUNTS (ICWA) INDIA,

COST IS ‘MEASUREMENT IN MONETARY TERMS OF THE AMOUNT OF RESOURCES USED FOR THE PURPOSE OF PRODUCTION OF GOODS OR RENDERING SERVICES.’

COST PLAYS A VITAL ROLE IN DECIDING THE FINAL PRICE OF A PRODUCT.

IN REFERENCE TO PRODUCTION/MANUFACTURING OF GOODS AND SERVICES COST REFERS TO SUM TOTAL OF THE VALUE OF RESOURCES USED LIKE RAW MATERIAL AND LABOUR AND EXPENSES INCURRED IN PRODUCING OR MANUFACTURING OF GIVEN QUANTITY.

Determinants of Cost

Implicit Cost & Explicit Cost Economic Cost Incremental Cost & Sunk Cost Avoidable Cost & Unavoidable Cost Historical Cost & Replacement Cost Direct & Indirect Cost Actual Cost & Opportunity Cost Production Cost (Total, Fixed, Variable, Marginal)

Implicit Cost & Explicit Cost The term Implicit cost refers to whatever is not accountable in the

company accounts i.e. not directly related to production. The payments made to the self-owned resources used in production. Primary Examples being use of own resources or own salaries. Whatever is accounted in the company accounts is Explicit Cost i.e.

directly related to production. Explicit Cost is also known as Accounting Cost. Those payments that must be made to the factors hired from outside

the control of the firm. Primary Example of Explicit Cost are price of raw materials, wages to

labors etc.

Economic Cost Adding both the Implicit & Explicit Cost gives us the Economic

Cost. Implicit cost are imputed value of the entrepreneur's own

resources and services. The salary of the owner-manager who is content with having

normal profit but does not receive any salary, estimated rent of the building if it belongs to the entrepreneur, interest on capital invested by the entrepreneur himself at the market rate of interest.

The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen.

Avoidable Cost & Unavoidable Cost Avoidable costs are expenses that can be avoided if a

decision is made to alter the course of a project or business.

For example, a manufacturer with many product lines can drop one of the lines, thereby eliminating associated expenses such as labour and materials.

Unavoidable costs are the costs which do not vary with changes in the level of production, but they are unavoidable.

The best example of unavoidable cost is Fixed Costs.

Incremental Cost & Sunk Cost The cost incurred while expansion of a business by a user when

any new product is built is known as Incremental Cost. It is also termed as Expansion Cost. For example change in output level of production, change in

product line etc. A cost that has already been incurred and thus cannot be

recovered is known as Sunk Cost. For example a company that has spent $5 million building a factory

that is not yet complete, has to consider the $5 million sunk, since it cannot get the money back.

Historical Cost & Replacement Cost It shows the rate in change of the cost happening over a period of

time. The actual cost of an asset incurred at the time the asset was

acquired is known as historical cost. Example: Machinery depreciating (-ve) & Land appreciating (+ve). The cost incurred during replacement of any old assets is known as

replacement cost. Replacement cost means the price that would have to be paid

currently for acquiring the same product when compared to it’s historical cost.

Historical Cost are also said to be past cost & replacement cost as present cost.

Direct Cost & Indirect Cost Direct costs are the costs that have direct relationship with a

unit of operation/production. Such as wages, raw materials, machinery repairs etc. are

known as Direct Cost. Indirect costs are those costs whose source cannot be easily

and definitely traced to a plant, a product, a process or a department.

Example of Indirect Cost are Electricity Bills, Stationery Bills and other office expenses, depreciation on building, decoration expenses, etc.

Actual Cost & Opportunity Cost Actual costs refer to the costs which a firm incurs for acquiring inputs

or producing a good and service such as the cost of raw materials, wages, rent, interest, etc.

The total money expenses recorded in the books of accounts are the actual costs.

Opportunity cost is the cost of sacrifice of the best alternative foregone in the production of a good or service.

As resources are scarce, they cannot be used to produce all things simultaneously, so the company/firm decides to invest in producing the output which has more demand.

For example a company producing a variety of vehicle & also investing in R&D but postponing it for some time so as to produce more units of vehicle since the market demand has gone making it a profitable deal for them.

Production Cost In this we get the Total Cost for an output produced. Total Cost= Fixed Cost + Variable Cost. Fixed Cost is that cost which does not change (that is either goes

up or goes down) irrespective of whether the firm is operating or not.

Fixed Cost can be Land, Building, Machinery. Variable Cost on the Other hand is directly proportional to the

production operations. Variable Cost are Labour, Transport, Raw Materials. Profit is calculated over the difference between Total Revenue

compared to that of Total Cost. Average Cost is the cost that is obtained after dividing Total Cost

with the number of units produced. Average Variable Cost can be calculated as Variable Cost\Output. Marginal Cost being the change in total cost of producing extra

one unit.

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