The concept of cost is a key concept in Economics. It refers to the amount of payment made to acquire any goods and services. In a simpler way, the concept of cost is a financial valuation of resources, materials, undergone risks, time and utilities consumed to purchase goods and services. From an economist's point of view, the cost of manufacturing any goods and services is often said to be the concept of opportunity cost.
With heightened competition in today's world, companies urge to make maximum profits. The company's decision to maximize earnings relies on the behaviour of its costs and revenues. Besides the concept of opportunity cost, there are several other concepts of cost namely fixed costs, explicit costs, social costs, implicit costs, social costs, and replacement costs.
Hence there are several different types of concepts of cost, which have been discussed in the following.
The idea behind the concept of opportunity cost is that the cost of one item is the lost opportunity to do something else. For example, by being married to a person, one could lose the opportunity to marry some other person or by investing more capital on video games, one might lose the opportunity in watching movies.
The concept of cost can be effortlessly comprehended by classifying the costs. The process of grouping costs is based on similarities or common characteristics. A well-defined classification of costs is certainly essential to mention the costs of cost centres. The different types of cost concept are:
Outlay costs and Opportunity costs
Accounting costs and Economic costs
Direct/Traceable costs and Indirect/Untraceable costs
Incremental costs and Sunk costs
Private costs and Social costs
Fixed costs and Variable costs
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The authentic payments undergone by an entrepreneur in employing input is known as outlay cost. It includes costs on payments of fuel, rent, electricity, etc.
Concept of Opportunity Cost
It is the value of the next best thing you give up whenever a decision is made by you.
A direct cost is a cost that is related to the production method of a good or service. It is the opposite of an indirect cost.
These costs are related to a certain product or a process. They are also known as traceable costs as it could be traced to a specific activity. It is the opposite of an indirect cost.
Indirect costs are the expenses that could not be traced back to a single cost object or cost source. They are also known as untraceable costs. However, they are extremely important as they affect the total profitability.
Accounting costs are direct costs. They are also known as hard costs. The entrepreneur pays the cash directly for obtaining resources for production. It includes the cost of prices that are paid for the machines and raw materials, electricity bills, etc. These costs are treated as expenses.
The economic cost is the combination of gains and losses of the products. This cost is mainly used by economists to compare one with another.
Incremental costs are the changes in future costs and that will occur as a result after a decision is made.
2. Sunk Costs
Sunk costs are the costs that cannot be recovered after sustaining. It includes the amount spent on conducting research and advertising.
Based on Payers
Private cost implies the cost that is sustained when an individual produces or consumes something. The business person spends his/ her own private or business interests. The social cost is the cost to an entire society that results from a news event or a change in the policies.
In Terms of Variability
As the term predicts, fixed costs don't change in the volume of output. These costs are constant even with an increment or decrement in the volume of services/ goods produced or sold. Variable costs, in simple words, are a cost that varies according to the outcome of the output. Higher production costs higher expenses and lower production costs lower expenses. If the production is more, the business will pay more and vice versa.
The Institute of Cost Accountants has constituted the Cost Accounting Standards Board (CASB) to procure suggestions and uniformity in Costing. The board has issued 24 standards to arise a better knowledge of distinct components of cost and better procedures to be used. The idea of opportunity cost in the concept of the cost was first begun by John Stuart Mill, a major concept in Economics.
1. Explain the difference between Relevant Costs and Irrelevant Costs?
Ans: In the concept of cost, the relevant cost concept is greatly useful to get rid of irrelevant information from a particular decision-making process. It is sustained as a result of the decision. It is also known as differential cost. These costs tend to vary based on the decision.
Irrelevant costs are unavoidable. Irrelevant costs do not affect the future cash flow while the relevant costs affect the future cash flow. The irrelevant cost is a cost that will not change as the result of a management decision. This is the primary difference between relevant and irrelevant types of cost concept.
2. What is the Importance of Cost in Business?
Ans. Costs play a critical role in business and decision-making. It assists the managers to make the right decision if he has to place a specific order for inputs or not. In normal circumstances, costs refer to money. However, in Economics, they have a broader meaning. Here, costs comprise the imputed price of the entrepreneur's own resources, services as well as the salary of the owner-manager.
In order to make a reasonable business decision, it is necessary to know the primary variations and uses of the major concepts of cost. This is the importance of types of cost concept in the business world.