Theory of CostPresented by:Seetal Daas

BBA(Hons)-IIIUniversity of Sindh Laar Campus @ Badin

Cost & Cost Concepts

• What is Cost?• Decision Making• Ordinarily, Cost refers to the money expenses• In Economics; cost is used in broader sense.• There are various concepts of cost.• It is essential to know the fundamental differences & uses.

Cost Concepts• Accounting Costs:Money costs are the total money expenses incurred by a firm in producing a commodity.E.g. wages, salaries of labor, cost of raw materials, expenditure on machines and equipment, depreciation charge on machine, insurance charges, and all types of taxes etc.• Economic Costs:Economic costs include accounting costs plus implicit costs and explicit costs.• Production Costs:The total costs of production of a firm are divided into total variable costs and total fixed costs.E.g. Rent and interest payments, depreciation charges, wages and salaries of the permanent staff, etc.

Continued…• Variable Costs: The expenses of production which change with the change in output.(E.g. Raw materials, power; fuel, etc. )• Fixed Costs: The expenses of production which does not change with the change in output.(E.g. Rent and interest payments, depreciation charges, wages and salaries of the permanent staff, etc )• Actual Costs:The costs refer to the costs which a firm incurs for acquiring inputs or producing a good and service.E.g. Cost of raw materials, wages, rent, interest, etc.

Continued…• Opportunity Costs: The cost of sacrifice of the best alternative in the production of a good or service.E.g. the cost of using land for wheat growing in the value of alternative crop grown on it.• Direct Costs:The costs that have direct relationship with a unit of operation or plant.E.g. The salary of a branch manager, when the branch is a costing unit, is a direct cost.• Indirect Costs:Those costs whose source cannot be easily and definitely traced to a plant, a product, a process or a department.E.g. Electricity, Stationery, office expenses, depreciation on building, decoration expenses etc

Continued…• Private Costs:The costs incurred by a firm in producing a commodity or service.E.g. production of commodities like steel, rubber and chemicals etc.• Social Costs:Adding together the private costs of production and economic damage upon others such as environmental pollution, etc., we arrive at social costs. E.g. Education, Sanitation services, park facilities etc.• Incremental Costs:These costs are the additions to costs resulting from a change in the nature and level of business activity.E.g. change in product line or output level, adding or replacing a machine, changes in distribution channels, employ more employees etc.

Continued…• Sunk Costs:the costs that are not affected or altered by a change in the level or nature of business activity. E.g. All past costs and actual costs etc.• Explicit Costs:Those payments that must be made to the factors hired from outside the control of the firm. E.g. Rent, wages, interest, salaries, payment for raw materials, fuel, power, insurance premium, etc.• Implicit Costs:The costs refer to the payments made to the self-owned resources used in production.E.g. A businessperson utilizes his services in his/her own business leaving his job as a manager in a company.

Continued…• Past Costs:The costs which have been actually incurred in the past.• Future Costs:The costs refer to the costs that are reasonably expected to be incurred in some future periods. • Business Costs:The costs which include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment. • Full Costs:The costs consist of opportunity costs and normal profit.

Continued…• Shutdown Costs:The costs that are incurred in the case of a closure of plant operations.E.g. employment and training of workers when the operation is restarted, all types of fixed costs etc.• Abandonment Costs:The costs which are incurred because of retiring altogether a plant from use. E.g. costs related to discontinuance any service in country.Urgent Costs:Those costs that are necessary for the continuation of the firm’s activities. E.g.cost of raw materials, labour, fuel, etc.

Continued…• Postponable Costs:The costs which can be postponed for some time, i.e., whose postponement does not affect the operational efficiency of the firm.E.g. maintenance costs which can be postponed for the time-being.• Marginal Costs:Marginal cost is the cost of producing an additional unit of output.E.g. If producing additional vehicles requires building a new factory, the marginal cost of the extra vehicles includes the cost of the new factory

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