Types Of Costs
Profits are the difference between selling price and cost of production. In general, the selling price is not within the control of a firm but many costs are under its control. The firm should therefore aim at controlling and minimizing cost. The various relevant concepts of cost are:
1. Opportunity costs and Outlay costs:
Opportunity costs refer to the „costs of the next best alternative foregone‟. We have scarce resources and all these have alternative uses. Where there is an alternative, there is an opportunity to reinvest the resources. In other words, if there are no alternatives, there are no opportunity costs. It is necessary that we should always consider the cost of the next best alternative foregone before committing the funds on a given option. In other words, the benefits from the present option should be more than the benefits of the next best alternative. Opportunity cost is said to exist when the resources are scarce and there are alternative uses for these resources. If there is no alternative, Opportunity cost is zero.
For example: if a firm owns a land, there is no cost of using the land (i.e., the rent) in firm‟s account. Bust the firm has an opportunity cost of using this land, which is equal to the rent foregone by not letting the land out on (the return of second best alternative is regarded as the cost of first best alternative) rent.
Outlay costs are as actual costs which are actually incurred by the firm. these are the payments made for labour, material, plant, building, machinery traveling, transporting etc., These are all those expenses appearing in the books of account, hence based on accounting cost concept.
2. Explicit costs and Implicit costs:
Explicit costs are also called as out-of-pocket cost that involve cash payments. These are the actual or business costs that appear in the books of accounts. These costs include payment of wages and salaries, payment for raw materials, interest on borrowed capital funds, rent on hired land, Taxes paid etc.
Implicit costs are also called as imputed costs which don‟t involve payment of cash as they are not actually incurred. They would have been incurred had the owner not been in possession of the facilities. Ex: Interest on own capital, saving in terms of salary due to own supervision and rent of own building etc.
3. Historical costs and Replacement costs:
Historical cost is the original cost that has been originally spent to acquire the asset of an asset.
Historical valuation is the basis for financial accounts.
A replacement cost is the price that is to be paid currently to replace the same asset. A replacement cost is a relevant cost concept when financial statements have to be adjusted for inflation.
4. Short – run costs and Long – run costs:
Short-run is a period during which the physical capacity of the firm remains fixed. Any increase in output during this period is possible only by using the existing physical capacity more extensively. So short run cost is that which varies with output when the plant and capital equipment are constant.
Long run is defined as a period of adequate length during which a company may alter all factors of production with high degree of flexibility.
5. Out-of pocket costs and Books costs:
Out-of pocket costs also known as explicit costs are those costs that involve current cash payment such as purchase of raw material, payment of salary rents payment, interest on loan etc.
Book costs also called implicit costs do not require current cash payments. Depreciation, unpaid interest, salary of the owner is examples of back costs.
6. Fixed costs, Variable costs and Semi-variable costs:
Fixed cost is that cost which remains constant for a certain level to output. It is not affected by the changes in the volume of production but fixed cost per unit decreases, when the production is increased. Fixed cost includes salaries, Rent, Administrative expenses depreciations etc.
Variable is that which varies directly with the variation in output. An increase in total output results in an increase in total variable costs and decrease in total output results in a proportionate decrease in the total variables costs. The variable cost per unit will be constant. Ex: Raw materials, labour, direct expenses, etc.
Semi-variable costs refer to such costs that are fixed to some extent beyond which they are variable. Ex: telephone charges, Electricity charges, etc.
7. Past costs and Future costs:
Past costs also called historical costs are the actual cost incurred and recorded in the book of account these costs are useful only for valuation and not for decision making.
Future costs are costs that are expected to be incurred in the future. They are not actual costs. They are the costs forecasted or estimated with rational methods. Future cost estimate is useful for decision making because decisions are meant for the future.
8. Separable costs and Joint costs:
The costs which can be traced or identified directly with a particular unit, department, or a process of production are called separable costs or direct costs or traceable costs.
The costs which cannot be identified directly with a particular unit, department or a process of the production are called joint costs or indirect costs or common costs. These costs are apportioned among various departments. Ex: Rent, Electricity, Administration salaries, Research and Development expenses etc.
9. Avoidable costs and Unavoidable costs:
Avoidable costs are those costs, which can be reduced if the business activities of a concern are curtailed. For example, if some workers can be retrenched with a drop in production, the wages of the retrenched workers are escapable costs.
Unavoidable costs are those that are essential for the sustenance of the business activity and hence they have to be incurred.
10. Controllable costs and Uncontrollable costs:
Controllable costs are ones, which can be regulated by the executive who is in charge of it. Direct expenses like material, labour etc. are controllable costs.
Some costs are not directly identifiable with a process of product. They are apportioned to various processes or products in some proportion. These apportioned costs are called uncontrollable costs.
11. Incremental costs and Sunk costs:
Incremental cost also known as differential cost is the additional cost due to a change in the level or nature of business activity. The change may be caused by adding a new product, adding new machinery, replacing a machine by a better one etc.
Sunk costs are those which are not altered by any change – They are the costs incurred in the past. This cost is the result of past decision, and cannot be changed by future decisions. Investments in fixed assets are examples of sunk costs. Once an asset is bought, the funds are blocked forever. They can neither be changed nor controlled.
12. Total costs, Average costs and Marginal costs:
Total cost is the total expenditure incurred for the input needed for production. It may be explicit or implicit. It is the sum total of the fixed and variable costs.
Average cost is the cost per unit of output. It is obtained by dividing the total cost (TC) by the total quantity produced (Q)
Marginal cost is the additional cost incurred to produce an additional unit of output.
13. Accounting costs and Economic costs:
Accounting costs are the costs recorded for the purpose of preparing the profit & loss account and balance sheet to meet the legal, financial and tax purpose of the company. The accounting concept is a historical concept and records what has happened in the past.
Economic cost refers to the cost of economic resources used in production including opportunity cost. Economics concept considers future costs and future revenues, which help future planning, and choice, while the accountant describes what has happened, the economics aims at projecting what will happen.
14. Urgent costs and Postponable costs:
Urgent cost are those costs such as raw materials, wages and so on, necessary to sustain the productivity.
Postponable costs are those costs which can be conveniently postponed. For example, white washing the building etc.