Cost Concepts

COST CONCEPTS:

Cost Determinants

The cost of production of goods and services depends on various input factors used by the organization and it differs from firm to firm. The major cost determinants are:

1.Level of output: The cost of production varies according to the quantum of output. If the size of production is large then the cost of production will also be more.

2.Price of input factors: A rise in the cost of input factors will increase the total cost of production.

3.Productivities of factors of production: When the productivity of the input factors is high then the cost of production will fall.

4.Size of plant: The cost of production will be low in large plants due to mass production with mechanization.

5.Output stability: The overall cost of production is low when the output is stable over a period of time.

6.Lot size: Larger the size of production per batch then the cost of production will come down because the organizations enjoy economies of scale.

7.Laws of returns: The cost of production will increase if the law of diminishing returns applies in the firm.

8.Levels of capacity utilization: Higher the capacity utilization, lower the cost of production.

9.Time period: In the long run cost of production will be stable.

10.Technology: When the organization follows advanced technology in their process then the cost of production will be low.

COST CONCEPTS:

1. Money Cost and Real Cost

When cost is expressed in terms of money, it is called as money cost. It relates to money outlays by a firm on various factor inputs to produce a commodity. In a monetary economy, all kinds of cost estimations and calculations are made in terms of money only.

.Hence, the knowledge of money cost is of great importance in economics. Exact measurement of money cost is possible.

When cost is expressed in terms of physical or mental efforts put in by a person in the making of a product, it is called as real cost. It refers to the physical, mental or psychological efforts, the exertions, sacrifices, the pains, the discomforts, displeasures and inconveniences which various members of the society have to undergo to produce a commodity. It is a subjective and relative concept and hence exact measurement is not possible.

2. Implicit or Imputed Costs and Explicit Costs

Explicit costs are those costs which are in the nature of contractual payments and are paid by an entrepreneur to the factors of production [excluding himself] in the form of rent, wages, interest and profits, utility expenses, and payments for raw materials etc. They can be estimated and calculated exactly and recorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as such do not appear in the books of accounts. They are the earnings of owner employed resources.

3. Actual costs and Opportunity Costs

Actual costs are also called as outlay costs, absolute costs and acquisition costs. They are those costs that involve financial expenditures at some time and hence are recorded in the books of accounts. They are the actual expenses incurred for producing or acquiring a commodity or service by a firm. For example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated and accounted without any difficulty.

Opportunity cost of a good or service is measured in terms of revenue which could have been earned by employing that good or service in some other alternative uses.

4. Direct costs and indirect costs

Direct costs are those costs which can be specifically attributed to a particular product, a department, or a process of production. For example, expenses on raw materials, fuel, wages to workers, salary to a divisional manager etc are direct costs. On the other hand, indirect costs are those costs, which are not traceable to any one unit of operation. They cannot be attributed to a product, a department or a process.

For example, expenses incurred on electricity bill, water bill, telephone bill, administrative expenses etc.

5. Past and future costs.

Past costs are those costs which are spent in the previous periods. On the other hand, future costs are those which are to be spent. in the future. Past helps in taking decisions for future.

6. Marginal and Incremental costs

Marginal cost refers to the cost incurred on the production of another or one more unit.

It implies additional cost incurred to produce an additional unit of output It has nothing to do

with fixed cost and is always associated with variable cost. Incremental cost on the other hand refers to the costs involved in the production of a batch or group of output. They are the added costs due to a change in the level or nature of business activity.

For example, cost involved in the setting up of a new sales depot in another city or cost involved in the production of another 100 extra units.

7. Fixed costs and variable costs.

Fixed costs are those costs which do not vary with either expansion or contraction in output. They remain constant irrespective of the level of output. They are positive even if there is no production. They are also called as supplementary or over head costs.

On the other hand, variable costs are those costs which directly and proportionately increase or decrease with the level of output produced. They are also called as prime costs or direct costs.

8. Accounting costs and economic costs.

Accounting costs are those costs which are already incurred on the production of a particular commodity. It includes only the acquisition costs. They are the actual costs involved in the making of a commodity. On the other hand, economic costs are those costs that are to be incurred by an entrepreneur on various alternative programs.

It involves the application of opportunity costs in decision making.