Classification of Costs

 There are several types of costs that a firm may
consider relevant under various circumstances. Such costs include: Actual costs are the costs which the firm incurs while producing or acquiring a good or a service like the cost on raw materials, labor, rent, interests etc. The actual costs are also called the outlay costs or acquisition cost or absolute cost. On the other hand, opportunity costs or alternative costs are the return from the next best alternative use of the firm¶s resources which the firm forgoes in order to avail of the return from the best use of resources. 1

1. Actual Costs and Opportunity Costs:

2 . So the opportunity cost is 50.000. Economic profit or rent = Machine B ± Machine A 70.000 returns Where the firm prefers machine B as it gives more return.000 = 20.000 returns Machine B: produces 70.Example for Opportunity Cost: Machine A: produces 50.000 ± 50. The difference between the actual cost and the opportunity cost is called economic profit or economic rent.000. So.

rent. etc. the explicit cost is important but for the economic decision making.2. both explicit and implicit costs are important. These costs are also known as absolute costs. Explicit (Paid-out) Costs and Implicit (Imputed) Costs: Explicit costs are those costs which are actually paid by the firm. Sunk Cost and Outlay Cost: Sunk cost is otherwise known as DEPRICIATION. 3 . For profit and loss account. which is also called paid-out costs. outlay costs means the actual expenditure incurred for producing or acquiring goods or services. rent etc. sunk costs are the part of outlay costs. which are not altered by a change in quantity and can not be recovered. Example: Wages. Hence. implicit costs or Imputed costs are theoretical costs in the sense that they go unrecognized by the accounting system. wages. On the other hand. 3. On the other hand. Example: Interest payment from borrowed funds. which are due to the entrepreneur for employing his own resources in the firm.

On the other hand. Out-of-Pocket Costs and Book Costs: Out-of-pocket costs are those expenses which are current cash payment to the outsiders. fall in category of out-of-pocket costs. wages. interest. book costs are those business costs which do not involve any cash payment but for them a provision is made in the book of account to include the in profit and loss account and take tax advantages like the provision for depreciation and unpaid amount of the interest on the owners capital employed in the firm. All the explicit costs like payment of rent.4. 4 . transport charges etc. salaries.

5. They are in nature of incremental costs ± both the imputed and the explicit costs as well as the opportunity costs. Social Costs on the other hand. These cost point out how much expenditure has already been incurred on a particular process or on production as such. economic costs related to future. are the total costs to the society on account of production of a good. Since these costs are related to the past. 6. ‡ Economic Costs = Private Cost + Social Costs 5 . On the other hand. Private Costs and Social Costs: Private costs are those costs which are actually incurred or provided for by an individual or a firm for its business activity. are also called sunk costs. Accounting Costs and Economic Costs: Accounting costs are also called actual or outlay costs.

are called direct costs. can be used to assigning executive efficiency. or a department. Controllable Costs and Non-Controllable Costs: Controllable costs are those which are capable of being controlled or regulated by executive vigilance and. therefore. a process. Direct Costs and Indirect Costs: Costs: The direct. those due to obsolescence or depreciation. a process or a department. of 6 course.7. . or traceable or assignable costs are the one that have direct relationship with a unit of operation like a product. The costs. 8. On the other hand. which are directly and definitely identifiable. or non-traceable or common or non-assignable costs are those whose course can not be easily and definitely traced to a plant. Non-controllable costs are those costs which can not be subjected to administrative control and supervision. the indirect. a product. Most of the costs are controllable except.

000. Example: A machine was worth 10.9. Original (Historical) Costs and Replacement Costs: Historical costs of an asset states that it is the cost of plant.000 between two costs has resulted because of the price change in the machine during this period.000 now in 2007. The difference of rupees 4.000 in 1996 and the same machine is worth 14.000 and the replacement cost is 14. The replacement costs states that it is the cost that firm would have to incur if the firm wants to replace or acquire the same asset now. equipment and materials at the price paid originally for them. 7 . So the original cost is 10.

Abandonment costs. These costs could be saved if the operations are allowed to continue. the plant installed during war time may be so improvised that it may not be required during peace time. Besides fixed costs.10. Abandonment costs are the cost of retiring all together a fixed asset from use. shut down costs include the cost of sheltering plant and equipment. 8 . thus involves the problem of disposal of assets. employment and training of workers when the plant is restarted and above all loss of market. For example. Shut Down Costs and Abandonment Costs: Shut down costs are those costs which the firm incurs if it temporarily stops its operations. lay-of-expenses.

Full Cost is the summation of opportunity costs of the firm and the normal profits made by the firm. labor. post-ponable costs are those costs whose postponement does not affect (at least foe some time) the operation of the firm. and for legal and tax purposes. Full Costs = Opportunity Costs + Normal Profits.11. 9 . On the other hand. These costs include all the payment and contractual obligations made by the firm together with the cost of depreciation of a plant and equipment. Business Costs and Full Costs: Business costs are relevant for the firm¶s profit and loss account. On the other hand. fuel etc. 12. machines etc. the maintenance of building. Urgent Costs and Post-ponable Costs: Urgent costs are those that must be incurred so that the operation of the firm continues.  So. like the cost of raw materials. For example.

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