Top 17 Cost concepts in Cost accounting: They are; 1) Product and period costs, 2) Common and joint costs, 3) Short-run and long-run costs, 4) Past and future costs, 5) Controllable and non-controllable costs, 6) Replacement and Historical Costs, 7) Escapable and unavoidable costs, 8) Out of pocket and Book Costs, 9) Imputed and Sunk Costs, 10) Relevant and Irrelevant Costs, 11) Opportunity and Incremental Costs, 12) Conversion cost, 13) Committed cost, 14) Shutdown and Abandonment costs, 15) Urgent and Postponable costs, 16) Marginal cost, and 17) Notional cost.
Here are important topic or questions is Discussion; What is the Cost concepts in Cost accounting?
The clear understanding of various cost concepts is essential for the study of cost accounting and cost systems.
Description of these cost concepts follows now for cost accounting.
Product and period costs:
First Cost concepts, The product cost is the aggregate of costs that are associative with a unit of product. Such Costs may or may not include an element of overheads depending upon the type of costing system in force-absorption or direct. Product costs are related to goods produce or purchase for resale and are initially identifying as part of the inventory.
These product or inventory costs become expenses in the form of cost of goods sold only when the inventory is sold. Product cost associative with the unit of output. The costs of inputs informing the product viz., the direct material, direct labor, factory overhead constitute the product costs. The period cost is a cost that tends to be unaffecting by changes in the level of activity during a given period.
The period cost associative with a period rather than manufacturing activity and these costs deduct as expenses during. The current period without have been previously classifying as product costs. Selling and distribution costs are period costs and are deducting from the revenue without their being regarded as part of the inventory cost.
Common and joint costs:
The common cost is an indirect cost that incurs for the general benefit of several departments or for the whole enterprise and which is necessary for present and future .operations. The joint costs are the cost of either a single process or a series of processes. That simultaneously produce two or more products of significant relative sales value.
Short-run and long-run costs:
The short-run costs are costs that vary with the output when fixed plant and capital equipment remain the same and become relevant. When a firm has to decide whether or not to produce more in the immediate future. The long-run-costs are those which vary with the output when all input factors including plant and equipment vary and become relevant. When the firm has to decide whether to set up a new plant or to expand the existing one.
The past costs are actual costs incur in the past and are generally containing in the financial accounts. These costs report past events and the time lag between event and its reporting makes the information out of date and irrelevant for decision-making.
These costs will just act as a guide for the future course of action. The future costs are costs expecting to incur at a later date and are the only costs that matter for managerial decisions because they are subject to management control.
Future costs are relevant for managerial decision making in cost control, profit projections, appraisal of capital expenditure, the introduction of new products, expansion programs, and pricing, etc.
Controllable and non-controllable costs:
The concept of responsibility accounting leads directly to the classification of costs as controllable or uncontrollable. The controllable cost is a cost chargeable to a budget or cost center. Which can influence the actions of the person in whom control the center vests? It is always not possible to predetermine responsibility, because the reason for deviation from expected performance may only become evident later.
For example, excessive scrap may arise from inadequate supervision or latent defect in purchased material. The controllable cost is a cost that can influence and regulate during a given period by the actions of a particular individual within an organization. The controllability of cost depends upon the level of responsibility under consideration.
Direct costs are generally controllable by shop level management. The uncontrollable cost is a cost that is beyond the control of a giving individual during a given period. The distinction between controllable and uncontrollable costs are not very sharp and may be left to individual judgment. Some expenditure which may uncontrollably on a short-term basis controllably on a long-term basis,
There are certain costs which are difficult to control due to the following reasons.
- Physical hazards arising due to flood, fire, strike, lockout, etc.
- Economic risks such as increased competition, change in fashion or model, higher prices of inputs, import restrictions, etc.
- Political risk like change in Government policy, political unrests, war, etc.
- Technological risk such as a change in design, know-how, etc.
Replacement and Historical Costs:
The Replacement costs and Historical costs are two methods for carrying assets in the balance sheet and establishing the amounts of costs that are used to determine income.
- The Replacement cost is a cost at which material identical to that is to replace could purchase at the date of valuation (as distinct, from actual cost price at the date of purchase). The replacement cost is a cost of replacing an asset at any given point of time either present or the future (excluding any element attributable to improvement).
- The Historical cost is the actual cost, determined after the event. Historical cost valuation states the costs of plant and materials, for example, at the price originally paid for them whereas replacement cost valuation states the costs at prices that would have to pay currently.
Costs reported by conventional financial accounts are based on historical valuations. But during periods of changing price level, historical costs may not be the correct basis for projecting future costs. Naturally historical costs must adjust to reflect current or future price levels.
The Escapable cost is an avoidable cost that will not incur if an activity does not undertakes or discontinue. The avoidable cost will often correspond-with variable costs. The avoidable cost can identify with an activity or sector of a business and which would avoid if that activity or sector did not exist. The escapable costs refer to costs which can reduce due to the contraction in the activities of a business enterprise. It is the net effect on costs that is important, not just the costs directly avoidable by the contraction. Examples:
- Closing an unprofitable branch house-storage costs of other branches and transportation charges would increase.
- Reducing credit sales costs estimated may be less than the benefits otherwise available.
Note: Escapable costs are different from controllable and discretionary costs.
Out of pocket and Book Costs:
The out of pocket cost is a cost that will necessitate a corresponding outflow of cash. The costs involving cash outlay or payment to other parties are termed as out of pocket costs. Book costs are those which do not require current cash payments.
Depreciation is a notional cost in which no cash transaction involves. The distinction between out of pocket costs and book costs primarily shows how costs affect the cash position.
Out of pocket costs are relevant in some decision-making problems. Such as the fluctuation of prices during the recession, make or buy decisions, etc. Book-costs can convert into out of pocket costs by selling the assets and having the item on hire. Rent would then replace depreciation and interest.
Imputed and Sunk Costs:
The imputed cost is a cost which does not involve actual cash outlay. Which uses only for decision making and performance evaluation. Imputed cost is a hypothetical cost from financial accounting. Interest on capital is a common type of imputed cost. No actual payment of interest is made but the basic concept is that had the funds been investing elsewhere they would have to earn interest. Thus, imputed costs are a type of opportunity costs.
The Sunk costs are those costs that have been investing in a project and which will not recover if the project terminates. The sunk cost is one for which the expenditure has to take place in the past. This cost does not affect a particular decision under consideration. Sunk costs are always results of decisions taken in the past.
This, the cost cannot change by any decision in the future. Investment in plant and machinery as soon as it installs its cost is sunk cost and is not relevant for decisions. Amortization of past expenses e.g. depreciation is sunk cost. Sunk, costs will remain the same irrespective of the alternative selected.
Thus, it need not consider by the management in evaluating the alternatives as it is common to all of them. It is important to observe that an unavoidable cost may not be a sunk cost. The Managing Director’s salary is generally unavoidable and also out of pocket but not sunk cost.
Relevant and Irrelevant Costs:
The relevant cost is a cost appropriate in aiding to make specific management decisions. Business decisions involve planning for future and consideration of several alternative courses of action. In this process, the costs which are affecting by the decisions are future costs. Such costs are called relevant costs because they are pertinent to the decisions in hand. The cost is saying to be relevant if it helps the manager in taking. The right decision in furtherance of the company’s objectives.
Opportunity and Incremental Costs:
The opportunity cost is the value of a benefit sacrifice in favor of an alternative course of action. It is the maximum amount that could obtain at any given point of time. If a resource was selling or put to the most valuable alternative use that would be practicable.
- The opportunity cost of a good or service measure in terms of revenue. Which could have been earning by employing that good or service in some other alternative uses. Opportunity cost can define as the revenue forgone by not making the best alternative use. Opportunity cost is the prospective change in cost following the adoption of an alternative machine process, raw materials, etc. It is the cost of opportunity lost by the diversion of an input factor from use to another.
- The Incremental cost is the extra cost of taking one course of action rather than another. It also calls as different cost. The incremental cost is the additional cost due to a change in the level of nature of the business activity.
The change may take several forms e.g., changing the channel of distribution, adding a new machine, replacing a machine by a better machine, execution of export orders, etc. Incremental costs will be different in case of different alternatives. Hence, incremental costs are relevant to the management in the analysis of decision making.
The conversion cost is the cost incur for converting the raw material into the finished product. It refers to as the production cost excluding the cost of direct materials:
The committed cost is a cost that primarily associates with maintaining the organization’s legal and physical existence over which management has little discretion. The committed cost is a fixed cost which results from froth decision of the prior period.
The amount of committed cost as fixed by decisions. Which are made in the past and not subject to managerial control in the short-run? Since committed cost does not fluctuate with volume and remains unchanged until action takes to increase or reduce available capacity.
Committed cost does not present any problem in cost behavior analysis. Examples of committed cost are depreciation, insurance premium, rent, etc. This is important Cost concepts in accounting.
Shutdown and Abandonment costs:
The shutdown costs are the cost incur about the temporary closing of a department/division/enterprise. Such costs include those of closing as well as those of re-opening. The shutdown costs asses as those costs which would incur in the event of suspension of the plant operation. And, which would save if the operations are continuing. Examples of such costs are costs of sheltering the plant and equipment and construction of sheds for storing exposed property.
Further, additional expenses may have to incur when operations are restoring e.g.. Re-employment of workers may involve the cost of recruitment and training. The Abandonment cost is the cost incur in closing down. A department or a division or in withdrawing a product or ceasing to operate in a particular sales territory etc. The abandonment costs are the cost of retiring altogether a plant from service; Abandonment arises when there is a complete cessation of activities and creates a problem as to the disposal of assets.
Urgent and Postponable costs:
The urgent costs are those which must incur to continue operations of the firm. For example, the cost of material and labor must incur if production is to take place. The Postponable cost is that cost which can shift to the future with little or no effect on the efficiency of current operations. These costs can postpone at least for some time, e.g., maintenance relating to building and machinery.
The marginal cost is the variable cost of one unit of a product or a service i.e., a cost which would avoid. If the unit did not produce or provide. In this context, a unit in usually either a single article or a standard measure such as liter or kilogram. But may in certain circumstances be an operation, process or part of an organization.
They are the amount at any given volume of output by which aggregate costs are changing. If the volume of output increases or decreases by one unit. It uses full Cost concepts in accounting.
The marginal costing technique is the process of ascertaining marginal costs and of the effects of changes in the volume of the type of output on profit by differentiating between fixed and variable costs.
Final Cost concepts, The Constitutional or notional cost is hypothetical take into account in a particular situation to re-present. The benefits enjoying by an entity in respect of which no actual expense incurs.