COST CONCEPTS

IMPORTANCE OF COSTS
An important role in managerial decision involving a selection between alternative courses of action Helps in specifying various alternatives in terms of their quantitative values The kind of costs to be used in a particular situation depends on the business decision to be made.

Incremental costs and Sunk costs

Incremental costs are defined as the change in total costs as a result of particular decisions. Incremental costs may include both fixed and variable costs. In the short period incremental costs will consist of variable costs-costs of additional labour, additional raw materials, power fuel etc which is the result of a new decision made by the firm. Incremental costs may also be regarded as the difference in total costs resulting from a contemplated change,and hence are called differential costs Sunk cost is one which is not altered by a change in the level of activity eg. depreciation

Out of pocket and Book costs

Out of pocket costs are those which involve immediate payments to outsiders.eg. Wages and salaries paid to the employees. Book costs do not require current cash expenditure.eg. Salary of the owner manager, if not paid or interest cost of the owners fund, depreciation costs. If a factor of production is owned, its cost is book cost while if it is hires its cost is an out- of pocket cost.

Historical cost and replacement cost

Historical cost of an asset states the cost originally paid for them. Replacement cost is the cost which the firm would have to pay if it wants to replace or acquire the same asset now.

Explicit cost and implicit cost or Accounting concept of cost and Economic concept of cost Explicit costs are those actually paid out by the firm, appearing in the accounting records of the firm Implicit costs are defined as the earnings of those employed resources which belong to the owner himself.eg opportunity cost of the owners services as the manager of the firm

Actual costs and Opportunity costs

Actual costs mean the actual expenditure incurred for acquiring or producing a good or service.These costs are generally recorded in the books of account,for example, wages paid, cost of materials purchased, interest paid etc. Opportunity costs are the returns from the next best alternative which the firm foregoes in order to avail the returns from the given use of the resources.

Direct or separable costs and Indirect or common costs

Cost which can be directly attributed to the production of a unit of a given product, which can be easily separated,ascertained and imputed to a unit of output are direct costs.All direct costs are variable. Costs which cannot be directly attributed to the production of a given unit of output are classified as indirect costs in the accounting process. Indirect costs may or may not be variable.

Private costs and social costs

Private costs are those costs which are actually incurred by by an individual or firm for its business activity- micro level. Social costs are the total costs to the society on account of the production of a good or society- macro level. Economic costs include both private costs and social costs.

Fixed costs and variable costs

Fixed costs are those which do not vary with the level of output in the short run.They are also known as overheads and include charges such as contractual rent, insurance fee, maintenance costs, property tax, interest on capital invested, minimum administrative expenses such as managers salary, watchmans wages etc. Variable costs changes with changes in output in the short run. Includes payments of labour employed, raw materials purchased fuel and power used etc

Short run cost curves

TC Y cost TFC TVC

output

Total cost Average cost, and Marginal Cost

Total cost includes all cash payments made to hired factors of production and all cash charges imputed for the use of the owners factors of production in acquiring or producing a good or service. Average cost is the cost per unit of output ie. TC/X Marginal cost is the additional cost incurred in producing each additional unit of output ie MCn = TCn TCn-i

Table showing TC, AC &MC

Unit of output 10
11 12 13

TC
5000 5300 5550 5700

AC
500 481.82 462.5 438.46

MC
300 250 150

14
15

5950
6350

425
423.33

250
400

Short run Average costs and output

Y MC ATC AVC

Cost

AFC

output