Cost concepts2.ppt

7/30/2019 Cost concepts2.ppt

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Cost concepts


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Definition

The Amount of expenditure,

notional or actual, attributable to athing or product.


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Cost of Production

Business Decisions are generallytaken on the basis of the moneyvalue of the inputs and outputs.

Input multiplied by the respectiveprices is the cost of production. It isotherwise called as money value of

the inputs.


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Cost Function

Cost is the function of output c=f(X)

C=f(X, T, ,K)

WHEREC=TOTAL COST

X=outputT=technologyK=price of factors = FIXED FACTORS(S)


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Determinants Of Cost

(1) Rate of output (i.e., utilization of fixed plant)

(2) Size of plant

(3) Prices of input factors (materials and labor)

(4) Technology

(5) Stability of output

(6) Efficiency (of management as well as labor)


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Elements of cost

MATERIAL

LABOUR

OTHER EXPENSES


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Accounting and Economic Cost

The cost concepts are categorizedon the basis of purpose and nature.

Cost Concepts used in accountingpurposes

Cost concepts used in economicanalysis of business activities


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Accounting Cost Concepts

Opportunity Cost and Actual Cost

Business Cost and Full Cost

Explicit Cost and Implicit cost.

Out of pocket and Book cost.


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Economic Cost Concepts

Fixed and Variable Cost

Total , Average and Marginal Costs

Short Run and Long Run costs

Incremental Costs and Sunk Cost.

Historical and Replacement Cost.


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Actual Cost

The actual expenditure incurred forproducing a commodity. These costare recorded in the books ofaccounts. It is otherwise called asoutlay cost or absolute cost.

Eg: Wages paid

Cost of materials purchased

Interest paid.


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Opportunity Cost

The cost of the best alternativeforegone.

It is revenue earned or incomewhich could have been earned byemploying a commodity in someother alternative use.


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Eg:

One hectare of land, lets assume

one can grow either paddy, wheat orsugarcane. If one decides to growpaddy as against either sugarcane orwheat. the benefit foregone by not

producing sugarcane is theopportunity cost of growing paddy.


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Business cost

All expense which are incurred tocarry out a business is business cost.

It includes all payments andcontractual obligations made by thefirm together with the book cost ofdepreciation on plant and equipment.

These cost concepts are used forcalculating business profits and lossesfor filling returns of income tax .


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Full Cost

The concept of full cost includesbusiness cost, opportunity cost andnormal profit.


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Explicit Cost

Explicit cost are those which fallunder the actual or business costwhich are entered in the books ofaccounts.

Eg: Payment of wages and salaries

Materials

License fee

Insurance Premium

Depreciation.


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Implicit Cost

Implicit cost are those which do nottake the form of the cash outlays, orthey do not appear in the accountingsystem.

Eg: Opportunity cost.


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Out of Pocket cost

The items Which involves cashpayments or cash transfers bothrecurring and non recurring.

Eg: Explicit cost


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Book cost

Certain actual business cost which donot involve cash payments, but theprovisions are made in the books ofaccounts are book cost.

Eg: Interest unpaid

Depreciation allowances.


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Economic Cost


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Fixed cost

In a short period there are factorsthat are fixed and some variable.

The fixed factors are Machinery andplant , Factory building.

The cost incurred for the fixed factorsare called as fixed cost.

Fixed cost do change in the long run.


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Fixed Cost Curve


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Variable Cost

Variable cost vary with every changein Output.

Variable Cost increase as the volumeof the Production Increases.

Variable Cost include cost of rawmaterials , wages of labor, Fuel ,

Electricity.etc.


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Variable Cost Curve

VC

Output

Cost


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Total Cost

Total Expenditure incurred on theproduction of goods and service.

It includes both Fixed and Variablecost.


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Total Cost

TC = TFC + TVC

TVC

Output

Cost

TC

TFC


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Average Cost

Average Fixed Costs (AFC)

The total fixed costs divided by output.

Average Variable Costs (AVC)

The total variable costs divided by output.

Average Total Costs (ATC)

The total costs divided by output.

The summation of average fixed costs and

average variable costs, i.e., ATC=AFC+AVC.


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Average Fixed costAVC = TFC / No. of units (Fixed cost per Unit)


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AC and MC

$

Y

ATC

MC

AVC

AFC


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Marginal Costs

Marginal Cost is the addition to thetotal cost , when the production ofgood is increased by one unit.

The cost involved in producing oneunit is Marginal cost.

It is otherwise called as Incremental

Cost or Differential Cost.


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The change in total costs divided bythe change in output.

TC/Y

The change in total variable costsdivided by the change in output.

TVC/Y


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Marginal Cost & AC

Output

Cost MC

AC


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Incremental, Marginal and SunkCosts

Incremental Cost

Incremental cost is the change in costtied to a managerial decision.

Fixed cost and variable cost changes

Marginal cost

Additional cost of producing one

additional unit of output Only the variable cost changes


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Shut down & AbandonmentCosts

Shutdown cost Expenses of temporaryclosure

Abandonment cost Expenses ofpermanent closure

Is an expenditure that cannot be

recovered Sunk costs are irrelevant to presentdecisions.

Sunk Cost


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Avoidable and Unavoidablecost

Cost that can be avoided byeliminating a product ordepartment is avoidable and thatwhich cannot be, is unavoidable.

Ex. Rent of factory is unavoidableif a product is discontinued


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Historical, Current andReplacement Cost

Historical Versus Current Costs

Historical cost is the actual cash outlay.

Current cost is the present cost ofpreviously acquired items.

Replacement Cost

Cost of replacing productive capacity

using current technology.


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Short-run and Long-run Costs

How Is the Operating PeriodDefined? At least one input is fixed in the short run.

All inputs are variable in the long run.

Fixed and Variable Costs

Fixed cost is a short-run concept.

All costs are variable in the long run.


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Cost Concepts

Total Fixed Costs (TFC)

The summation of all fixed and sunk costs toproduction.

Total Variable Costs (TVC) The summation of all variable costs to

production.

Total Costs (TC)

The summation of total fixed and total variablecosts.

TC=TFC+TVC


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Marginal Cost

Output

Cost MC


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Typical Average &


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Typical Average &Marginal Cost Curves

AFC is alwaysdeclining at adecreasing rate.

ATC and AVC declineat first, reach aminimum, thenincrease at higherlevels of output.

The differencebetween ATC andAVC is equal to AFC.

MC is generallyincreasing.

MC crosses ATC andAVC at their minimum

point. If MC is below the

average value:

Average value will bedecreasing.

If MC is above theaverage value:

Average value will beincreasing.


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Long-Run cost curves

Nothing is fixed everything isvariable.

The long run average cost curve

is called as the envelope curve

L R A C t


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Long-Run Average CostCurve

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