Types of costs

There are several costs that a firm should consider under relevant circumstances. It is quite essential for a firm to understand the difference between various cost concepts for the purpose of production/business decision making. The following are the various cost concepts/types of costs.

Actual Cost Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or service. The actual costs or expenditures are recorded in the books of accounts of a business unit. Actual costs are also called as " Outlay Costs" or " Absolute Costs" or " Acquisition Costs". Examples: Cost of raw materials, Wage Bill etc.

Opportunity Cost Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second best use of the firms resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input. Opportunity cost is also called as " Alternative Cost".

If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account. But the firm has an opportunity cost of using the land, which is equal to the rent forgone by not letting the land out on rent.

Sunk Cost Sunk costs are those do not alter by varying the nature or level of business activity. Sunk costs are generally not taken into consideration in decision - making as they do not vary with the changes in the future. Sunk costs are a part of the outlay/actual costs. Sunk costs are also called as " Non-Avoidable costs" or " Inescapable costs".

Examples: All the past costs are considered as sunk costs. The best example is amortization of past expenses, like depreciation.

Incremental Cost Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity in the activity, they are also called as " Avoidable Costs" or " Escapable Costs". More ever incremental costs resulting from a contemplated change is the Future, they are also called as " Differential Costs"

Example: Change in distribution channels adding or deleting a product in the product line.

Explicit Cost Explicit costs are those expenses/expenditures that are actually paid by the firm. These costs are recorded in the books of accounts. Explicit costs are important for calculating the profit and loss accounts and guide in economic decision-making. Explicit costs are also called as " Paid out costs"

Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc.

Implicit Cost Implicit costs are a part of opportunity cost. They are the theoretical costs ie., they are not recognised by the accounting system and are not recorded in the books of accounts but are very important in certain decisions. They are also called as the earnings of those employed resources which belong to the owner himself. Implicit costs are also called as " Imputed costs".

Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity capital etc.

Book Cost Book costs are those business costs which don't involve any cash payments but a provision is made in the books of accounts in order to include them in the profit and loss account and take tax advantages, like provision for depreciation and for unpaid amount of the interest on the owners capital.

Out Of Pocket Costs Out of pocket costs are those costs are expenses which are current payments to the outsiders of the firm. All the explicit costs fall into the category of out of pocket costs.

Examples: Rent Payed, wages, salaries, interest etc.

Accounting Costs Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm.

Examples: All Sunk costs are accounting costs

Economic Costs. Economic costs are related to future. They play a vital role in business decisions as the costs considered in decision - making are usually future costs. They have the nature similar to that of incremental, imputed explicit and opportunity costs.

Direct Cost Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs are related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as " Traceable Costs".

Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs.

Indirect Costs Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary ie., they may or may not be variable in nature. However, the nature of indirect costs depend upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.

Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour etc.

Controllable Costs Controllable costs are those which can be controlled or regulated through observation by an executive and therefore they can be used for assessing the efficiency of the executive. Most of the costs are controllable.

Example: Inventory costs can be controlled at the shop level etc.

Non Controllable Costs The costs which cannot be subjected to administrative control and supervision are called non controllable costs.

Example: Costs due obsolesce and depreciation, capital costs etc.

Historical Costs and Replacement Costs. Historical cost or original costs of an asset refers to the original price paid by the management to purchase it in the past. Whereas replacement costs refers to the cost that a firm incurs to replace or acquire the same asset now. The distinction between the historical cost and the replacement cost result from the changes of prices over time. In conventional financial accounts, the value of an asset is shown at their historical costs but in decision-making the firm needs to adjust them to reflect price level changes.

Example: If a firm acquires a machine for $20, 000 in the year 1990 and the same machine costs $40, 000 now. The amount $20, 000 is the historical cost and the amount $40, 000 is the replacement cost.

Shutdown Costs The costs which a firm incurs when it temporarily stops its operations are called shutdown costs. These costs can be saved when the firm again start its operations. Shutdown costs include fixed costs, maintenance cost, layoff expenses etc.

Abandonment Costs Abandonment costs are those costs which are incurred for the complete removal of the fixed asset from use. These may occur due to obsolesce or due to improvisation of the firm. Abandonment costs thus involve problem of disposal of the asset.

Urget Costs and Postponable Costs Urgent costs are those costs which have to be incurred compulsorily by the management in order to continue its operations. If urgent costs are not incurred in time the operational efficiency of the firm falls.

Example: Cost of material, labour, fuel etc

Postponable costs are those which if not incurred in time do not effect the operational efficiency of the firm. Examples are maintenance costs.

Business Cost and Full Cost Business costs include all the expenses incurred by the firm to carry out business activities. Costs Include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment.

Full costs include business costs, opportunity costs, and normal profits. Opportunity costs is the expected return/earnings from the next best use of the firms resources like capital, land and building, owners efforts and time. Normal profits is necessary minimum earning in addition to the opportunity costs, which a firm must receive to remain in its present occupation.