COST CONCEPTS

Money value of inputs

Cost of production Important factor in

Cost are subject to varying interpretations

Business analysis & Business decision making

Pertaining to

« Locating the weak points in production management « Minimizing the cost « Finding the optimum level of output « Determining price and dealers¶ margins « Estimating or projecting the cost of business operations

IMPORTANCE OF COST ANALYSIS

1. LOCATING THE WEAK POINTS IN PRODUCTION MANAGEMENT 2. MINIMISING THE COST 3. FINDING THE OPTIMUM LEVEL OF OUTPUT 4. ESTIMATING OR PROJECTING THE COST OF BUSINESS OPERATIONS

COST CONCEPTS

CONCEPTS USED FOR ACCOUNTING PURPOSES

CONCEPTS USED IN ECONOMIC ANALYSIS OF THE BUSINESS ACTIVITIES

COST CONCEPTS Accounting Costs

OPPORTUNITY COSTS AND ACTUAL COSTS BUSINESS COSTS AND FULL COSTS EXPLICIT AND IMPLICIT OR IMPORTED COSTS OUT OF POCKET AND BOOK COSTS

Analytical Costs

1 2

FIXED AND VARIABLE COSTS SHORT-RUN AND LONG-RUN COSTS TOTAL, AVERAGE AND MARGINAL COST INCREMENTAL COSTS AND SUNK COSTS HISTORICAL AND REPLACEMENT COSTS

1 2 3 4

3 4 5

OPPORTUNITY COST AND ACTUAL COST

EXAMPLE A BUSINESSMAN HAS HAS TWO INVESTMENT ALTERNATIVES EXPECTED ANNUAL INCOME FROM PRINTING MACHINE EXPECTED ANNUAL INCOME FROM LATHE RS. 1,00,000 (1) Printing Machine (2) Photo copier RS. 20,000 RS. 15,000

The Opportunity Cost Of His Income From Printing Machine Is The Expected Income From The Photo copier, ie., Rs. 15,000

OPPORTUNUITY COST DEFINED OPPORTUNITS COST IS THE LOSS OF EARNINGS DUE TO LOST OPPORTUNITIES SCARCE RESOURCES ARE PUT TO THE MOST PRODUCTIVE USE AND THET HAVE TO FOREGO THE INCOME EXPECTED FROM THE SECOND BEST USE OPPORTUNITY COST MAY BE DEFINED AS THE LOSS OF EXPECTED RETURNS FROM THE SECOND BEST USE OF RESOURCES FOREGONE FOR AVAILING THE GAINS FROM THEIR BEST POSSIBLE USE

ACTUAL COSTS ARE THOSE WHICH ARE ACTUALLY INCURRED BY THE FIRM LABOUR MATERIAL PLANT BUILDING MACHINERY EQUIPMENTS TRAVELLING TRANSPORT

BUSINESS COSTS AND FULL COSTS BUSINESS COSTS Includes Expenses Incurred In Carrying Out A Business
1. ALL PAYMENTS 2. CONTRACTUAL OBLIGATIONS 3. DEPRECIATION Used For Calculating 1. Business Profits & Losses 2. Filing Returns 3. Legal Purposes

FULL COSTS Includes business costs opportunity costs and normal profits

EXPLICIT AND IMPLICIT COSTS

EXPLICIT COSTS ARE THOSE WHICH FALL UNDER ACTUAL OR BUSINESS COSTS ENTERED IN THE BOOKS OF ACCOUNTS WAGES , SALARIES UTILITY EXPERSES INTEREST, RENT, PAYMENTS FOR MATERIALS, LISCENCE FEE, INSURANCE PREMIUM DEPRECIATION IMPLICIT COSTS MAY BE DEFINED AS THE OWNER¶S RESOURCES EMPLOYED IN THEIR BEST ALTERNATIVE USE WHICH DO NOT APPEAR IN THE ACCOUNTING SYSTEM IMPLICIT WAGES IMPLICIT SALARIES IMPLICIT RENT IMPLICIT INTEREST

OUT-OF-POCKET AND BOOK COST

OUT-OF-POCKET COSTS ARE ITEMS OF EXPENDITURE WHICH INVOLVE CASH PAYMENTS OR CASH TRANSFERS BOTH RECURRING AND NON RECURRING ALL EXPLICIT COSTS FALL IN THIS CATAGORY BOOK COSTS ACTUAL BUSINESS COSTS WHICH DO NOT INVOLVE CASH PAYMENTS BUT A PROVISION IS MADE IN THE BOOKS OF ACCOUNTS BUT ADDED TO PROFIT & LOSS ACCOUNT

DEPRECIATION ALLOWANCE UNPAID INTEREST ON OWNERS CAPITAL

FIXED AND VARIABLE COSTS

FIXED COSTS ARE THOSE WHICH ARE FIXED IN VOLUME FOR A CERTAIN GIVEN OUTPUT ±DO NOT VARY WITH THE LEVEL OF OUTPUT 1. Cost of managerial & administrative staff 2. Depreciation of machinery, building and other fixed assets 3. Maintenance of land

VARIABLE COSTS ARE THOSE WHICH VARY WITH THE VARIATION IN THE TOTAL OUTPUT

1. Cost of raw materials 2. Running cost of fixed capital, such as fuel, ordinary repairs, routine maintenance expenditure, direct labour charges

TOTAL, AVERAGE AND MARGINAL COST TOTAL COST REPRESENTS THE VALUE OF TOTAL RESOURCE REQUIREMENTS FOR PRODUCTION OF GOODS AND SERVICES AVERAGE COST IS OBTAINED BY DIVIDING THE TOTAL COST (TC) BY THE TOTAL OUTPUT MARGINAL COST (MC) IS THE ADDITION TO THE TOTAL COST ON ACCOUNT OF PRODUCING AN ADDITIONAL UNIT

SHORT-RUN AND LONG-RUN COSTS

SHORT-RUN COSTS ARE COSTS WHICH VARY WITH THE VARIATION IN OUTPUT, THE SIZE OF THE FIRM REMAINING THE SAME. THEY ARE THE SAME AS THE VARIABLE COSTS

LONG-RUN COSTS ARE THE COSTS WHICH ARE INCURRED ON THE FIXED ASSETS LIKE, PLANT, BUILDING, MACHINERY ETC.

INCREMENTAL COSTS AND SUNK COSTS INCREMENTAL COSTS REFERS TO THE TOTAL ADDITIONAL COST ASSOCIATED WITH THE MARGINAL BATCH OF OUTPUT They arise owing to Change in product lines Addition or introduction of new product Replacement of old and worn out plant and machinery New techniques SUNK COSTS ARE THOSE WHICH CANNOT BE ALTERED , INCREASED OR DECREASED For example, Once it is decided to make incremental investment expenditure, and the funds are allocated and spent , all preceding costs are considered to be sunk since they cannot be revised or recovered.

HISTORICAL AND REPLACEMENT COSTS

HISTORICAL COST REFERS TO THE COST OF AN ASSET ACQUIRED IN THE PAST

REPLACEMENT COST REFERS TO THE OUTLAY WHICH HAS TO BE MADE FOR REPLACING AN OLD ASSET.

PRIVATE AND SOCIAL COSTS

PRIVATE COSTS ARE THOSE WHICH ARE ACTUALLY INCURRED OR PROVIDED FOR BY AN INDIVIDUAL OR FIRM ON THE PURCHASE OF GOODS AND SERVICES FROM THE MARKET

SOCIAL COSTS IMPLIES THE TOTAL COST TO THE SOCIETY ON ACCOUNT OF PRODUCTION OF A COMMODITY FOR WHICH THE FIRMM IS NOT COMPELLED TO PAY Atmosphere, Rivers, Lakes, Roadways, Drainage system, etc.