All You Need to Know about Economic Cost Clikc Now

Are you struggling to understand the theory of cost?

In business and accounting, the cost is a monetary value that a company has spent to produce a product or a service. To a seller, the cost is the amount of money spent to produce a good. To a buyer, the cost of a product is known as the price. The cost has different meanings in various fields.

Let’s discuss in details the intricacies of cost.

What is Cost?

In production, research, retail, and accounting, cost is the value of money that has been used to produce a good or deliver a service.

In business, cost is generally a monetary valuation of efforts, materials, time and utilities consumed. It also includes the cost of risks incurred. In other words, cost is a relationship between the value of production outputs and the level of output. Total cost means the total expense that was incurred to reach a specific output level.

The cost does not include the mark-up for the profit of a company. If a producer was to sell his products at the production price, he would not lose his money on the sales. He would not even make a profit. In the perspective of a buyer, the cost of a product is known as the price. This is the amount that a seller charges for a product. It includes both the production cost and the mark-up that is totalled by the seller to make a profit.

How Cost Relates to Accounting and Economics?

Running a business demands that you keep a track on the financial factors that affect net profits.

In accounting, the term cost explains the monetary value of expenditures for raw materials, equipment, supplies, services, labour, products, etc. Cost is the amount which is recorded as an expense in book-keeping records.

Accounting costs are the costs that have a specific monetary value one needs to pay to gain the associated benefit. Accounting costs are also known as explicit costs. Economic costs include accounting costs. It also includes opportunity costs.

What are the Types of Economic Costs?

It is necessary for a firm to comprehend the difference between various concepts of cost to take important decisions in business. Various types of economic costs are as follows:

Actual cost: Actual cost is the cost that a firm incurs to produce or acquire a good or service. The actual cost or expenditure is recorded in account books of a business enterprise. Actual costs are also known as “Outlay costs” or “Absolute costs” or “Acquisition Costs.”

Example: Cost of raw materials, Wage bill, etc.

Opportunity cost: Opportunity cost refers to the cost of alternatives or opportunities. The term originally explains the comparison between the policy that was chosen by a firm and the policy that was rejected by them. Opportunity cost is also known as the “Alternative cost.”

Fixed cost: It is the value of fixed inputs used in production. These costs do not vary with the change in the volume of the production.

Example: Rent, salaries, utilities, insurance, etc.

Variable cost: It is the cost of variable inputs used in the production. These expenses vary with the changes in the production volume.

Example: Production supplies, raw materials, billable staff wages, etc.

Semi-Variable cost: This refers to the cost that is partly fixed and partly variable. These costs do not affect the production level but may vary with the changes in production facilities.

Example: Administrative cost, maintenance cost, depreciation cost, etc.

Sunk cost: Sunk costs refer to the costs that do not alter with the variation in nature or the level of business activity. These costs are usually not taken into consideration while making decisions as these do not vary with the changes in the future. These are a part of the outlay or the actual costs. Sunk costs are also known as “Non-Avoidable costs” or “Inescapable costs.”

Incremental cost: Incremental costs are additional costs as a result of a change in the nature of business activities. These costs can be avoided by not introducing any variation in the activity. Therefore, these are known as “Avoidable costs” or “Escapable costs.”

Example: Adding or deleting a product from the product line of a company.

Explicit cost: Explicit cost is the expenses that are paid by the firm. These costs are recorded in account books. Explicit costs are crucial for calculating the profit and loss of a business company. These also act as a guide in decision-making. Explicit costs are also known as “Paid out costs.”

Example: Interest payment on borrowed money, utility expenses, etc.

Implicit cost: These are a part of the opportunity cost. These theoretical costs are not recognised by the accounting system of a firm. These costs are not recorded in the account books but are considered to be significant in certain business decisions. These are also known as “Imputed costs.”

Example: Interest on the equity capital.

Book cost: These are business costs that do not involve any cash payments. A provision of these costs is made in accounting books to include them in the profit and loss account. This is done to avail tax advantages.

Example: Provision for depreciation, and the unpaid amount of interest on the owner’s capital.

Out of Pocket costs: Out of pocket expense is the direct payment of money that may or may not be reimbursed from a third-party source.

Example: During the operating of a vehicle, gasoline, parking, fees, and tolls are considered out-of-pocket expenses for a trip.

Accounting cost: Accounting costs is the monetary outlay for producing a certain good or a product. It includes variable and fixed costs of a company.

Example: All sunk costs are accounting costs.

Direct cost: Direct costs are those costs which have a direct relationship with a unit of operation like manufacturing of a product, organising a process or an activity, etc. In simple words, direct costs are directly and definitely identifiable. The nature of these costs is related to a particular product or process. These costs are also called “Traceable costs.”

Example: In the operation of railway services, the cost of wagons, coaches, and engines are direct costs.

Indirect Costs: Indirect costs are the costs which can be easily and definitely identifiable. Like direct costs, indirect costs do not vary. Indirect costs are also known as “Non-traceable costs.”

Example: The expense of factory building, the track of a railway system, etc.

Shutdown costs: The costs that a firm incurs when it temporarily stop its operations are called shutdown costs. Shutdown costs can be saved when the firm starts its operations.

Example: Maintenance cost, layoff expenses, etc.

A firm should consider these costs before taking significant decisions in business.

How to Estimate Cost?

The key function of a successful business is to prepare accurate cost estimates. The estimates can be for the internal functioning of a business unit or for a customer. The cost estimate is the approximation of the value of a program, project or operation.

These methods can be used to estimate the cost to complete a project. To improve the reliability of the estimate, you can choose any of the methods given below:

Itemised costs: The most general way to estimate cost is to make a list of the items you need, and then add up their costs. Include all applicable costs like equipment, materials, supplies, labour, fees, financing, licensing, transportation and acquisition costs for land. If estimated correctly, the result of cost obtained is accurate. This method is a bit time-consuming, costly and lengthy.

Per-unit costing: This is a quicker and less expensive method for estimating cost. The cost per unit is usually obtained when a company produces a large number of identical products. The cost per unit is derived from the variable costs and fixed costs incurred in the process of production. This valuation is then compared to standard or budgeted cost to see if the organisation is producing goods in a cost-effective way.

Parametric costing: This technique uses regression or other statistical methods to develop Cost Estimating Relationships (CER). A CER is the equation used to estimate a given cost element by using an established relationship with one or more independent variables.

Analogy costing: This technique is used to estimate the cost based on the historical data obtained from an analogous system or subsystem. In this technique, a currently fielded system which is the same in design and operation to the proposed system is used as the basis for analogy. The value of the proposed system is then estimated by adjusting the historical cost of the current system to get an idea of the differences.

These are some of the significant methods used by successful business companies to estimate cost.

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