Types of Costs

-Jigar Vakharia Prarthana Amin Abhijit Shetty Ashmita Kaur Bakshi Pgpm (c) Batch 2011- 2013

TYPES OF COSTS
MEANING OF COST

COST represents a sacrifice of value, a foregoing or a release of something of value. It is the price of economic resources used as a result of producing or doing the thing costed. It is the amount of expenditure incurred on a given thing. Cost has been defined as the amount measured in money or cash expended or other property transferred, capital stock issued, services performed or a liability incurred in consideration of goods or services received or to receive. The Chartered Institute Of Management Accountants, London defines cost as the amount of expenditure (actual or notional) incurred on or attributable to a specified thing or activity. For a consumer cost means price. For management cost means expenditure incurred for producing a particular product or rendering a particular services. The process of ascertaining the cost is known as costing. It consists of principles and rules governing the procedure of finding out the cost of goods/services. It aims at ascertaining the total cost and also cost per unit. For example, in transport companies the total cost for the period is ascertained and used to find out the cost per passenger/mile that is the cost of carrying one passenger for one mile. It provides for analysis of expenditure in such a way that the management gets complete idea about even the smallest item of cost. A cost must always be studied in relation to its purpose and conditions. Different cost may be ascertained for different purposes and under different conditions. Work-in-progress is valued at factory cost, while stock of finished goods is valued at cost of production. Even if the purpose of the study of cost is the same, different condition may lead to variation in cost. The cost per unit of a product is sure to vary with an increase in the volume of output since the amount of fixed expenses to be borne by each unit of output decreases.

1. 2. 3. 4. 5.

CHARACTERISTICS OF COSTS: The term cost is not complete unless it is fully qualified as to its nature and limitations. It does not represent the same contents under every situation. It is a flexible concept. It may be ascertained by different persons in different ways. It may vary with time, volume, firm, method or purpose.

CLASSIFICATION OF COSTS

A) On the basis of behavior different types of cost are: a) Fixed Cost: The Chartered Institute Of Management Accountants, London, defines fixed cost as the cost which is incurred for a period, and which, within certain output and turnover limits, tends to be unaffected by fluctuation in the levels of activity (output or turnover). It is that portion of total cost which remains constant irrespective of output upto capacity limit. It is called as a period cost as it is concerned with period. It depends upon the passage of time. It is also referred to as Non Variable Cost or Capacity cost or Period Cost. It tends to be unaffected by variations in output. These costs provide conditions for production rather than cost of production. They are created by contractual obligations and managerial decisions. Main characteristics of Fixed Cost are as Follows: 1) Large in value 2) Indivisible, cannot be broken in small penny pocket. 3) Irreversible, fixed cost decisions require greater thought. 4) Influence variable costs and working capital. 5) Higher Break-Even point if fixed cost is larger. 6) Image value, large fixed cost has high image value. 7) Indirect cost. Example of Fixed Cost: It is clear from the below table that fixed cost remains constant irrespective of output but fixed cost per unit goes on decreasing due to increase in output.
Output(units) 0 1 100 100 Fixed cost per unit Total fixed cost(rs) Rs. 2000 2000 2000 2000 2000 20 2000 2

b) Variable Cost: Variable cost varies according to the output. In other words, it is a cost which changes according to the changes in output. It tends to vary in direct proportion to output. If the output is decreased, variable cost also will decrease. It is concerned with output or product. Therefore, it is called as a product cost. If the output is doubled, variable cost will also be doubled. Main characteristics of Variable cost are as follows: 1) Total cost changes in direct proportion to change in total output. 2) Variable cost per unit remains constant. 3) It is quite divisible. 4) Per unit variable cost is smaller in value. 5) It is identifiable with the individual cost units 6) Functional managers can exercise control over variable cost. EXAMPLE OF VARIABLE COST: It is clear from the table given below that variable cost per unit remains fixed but total variable cost changes according to output.

Total variable cost Output(units) Rs. Variable cost per unit Rs. 0 0 0 1 50 50 10 500 50 100 5000 50 1000 50000 50

c) Semi Variable Cost: Semi variable cost referred to as semi-fixed or partly variable cost. It remains constant up to a certain level and registers change afterwards. These costs vary in some degree with volume but not in direct or same proportion. Such costs are fixed only in relation to specified constant conditions. For example, repairs and maintenance of machinery,

telephone charges, maintenance of building, supervision, professional tax etc. EXAMPLE OF SEMI VARIABLE COST: Semi variable cost Rs1,00,000 are constant upto 75% capacity (7500 units) but increase by 10% over 75% but upto 85% and then increase by 20% over 85% but upto 100% capacity:
Capacity (%) 50 60 70 80 90 100 output(units) Total Semi-Variable cost Rs. Semi-Variable cost per unitRs. 5000 100000 20 6000 100000 16.67 7000 100000 14.29 8000 100000 13.75 9000 100000 14.67 10000 100000 13.2

B) On the basis of time different types of cost are: a) Historical Cost: These costs are ascertained after they are incurred. Such cost is available only when the production of a particular thing has already been done. They are objective in nature and can be verified with reference to actual operations. EXAMPLE OF HISTORICAL COST: For example, say the main headquarters of a company, which includes the land and building, was bought for 1 crore in 1925, and its expected market value today is 20 crore. The asset is still recorded on the balance sheet at $100,000. Not all assets are held at historical cost. For example, marketable securities are held at market value on the balance sheet. b) PRE-DETERMINED COST: These costs are ascertained after they are incurred on the basis of a specification of all factors affecting cost. It may be either estimated cost or standard cost.

1) Standard Cost: This is a particular concept and technique. This method involves: Setting up predetermined standards for each element of cost and each product; Comparison with actual and standard; Pin pointing the causes of such variances and taking remedial action. Obviously standard cost, through pre-determined, are arrived with much greater care than estimated costs. 2) Estimated Cost: Cost is estimated before goods are produced; these are naturally less accurate than standards. C) On the basis of Management, different types of cost are: 1) MARGINAL COST: The marginal cost of an additional unit of output is the cost of the additional inputs needed to produce that output. More formally, the marginal cost is the derivative of total production costs with respect to the level of output. EXAMPLE ON MARGIANL COSTING: For example, suppose it costs $1000 to produce 100 units and $1020 to produce 101 units. The average cost per unit is $10, but the marginal cost of the 101st unit is $20. 2) OPPPORTUNITY COST: Opportunity cost is the cost of selecting one course of action and the losing of other opportunities to carry out that course of action. It is the amount that can be received if the asset is utilized in the next back alternative. It is define as the benefit lost by rejecting the best competing alternative to the one chosen. The benefit lost is usually the net earnings or profit that might have been earned from the rejected alternative. EXAMPLE ON OPPORTUNITY COST: Capital invested in plant and machinery. It cannot be now invested in shares and debentures. The loss of interest and dividend that would be earned in

the opportunity cost. Another example is when owner of a business forgoes the opportunity to employ himself elsewhere. Opportunity costs are not recorded in the books. It is important in decision making and comparing alternatives. 3) SUNK COST: A sunk cost is one that has already been incurred and cannot be avoided by decisions taken in the future. As it refers to past costs, it is called unavoidable cost. The National Association of Accountants (USA) defines a sunk cost as an expenditure for equipment or productive resources which has no economic relevance to the present decision making process. This cost is not useful for decision making as all past costs are irrelevant. CIMA defines it as the past cost not taken in the account in decision making. It has also been defined as the difference between the purchases prices of an asset and its salvage value. EXAMPLE OF A SUNK COST: Say if i buy a share on the stock market for 100 dollars and it falls to 50, the 50 is a sunk cost so if I choose to hold onto that stock because I lost 50 on it that's irrational. The remaining 50 should be put into whatever stock will gain value the quickest. So say the market turns around and it takes 2 years to regain to the 100 in the same stock, instead of selling and buying another share at 50 and gaining to 100 in 1 year. Hope that's not confusing, but basically sunk costs are an irrational consideration people generally take into account when deciding what business course to take. 4) CONTROLLABLE COST: The Chartered Institute Of Management Accountants defines controllable cost as cost which can be influenced by its budget holder. A controllable cost can be controlled by a person at a given organizational level. Controllable costs are not totally controllable. Some costs are partly controllable by one person and partly by another. FOR EXAMPLE: maintenance cost can be control by both the production manager and maintenance manager. The term controllable cost is often used to mean variable cost. All direct costs are controllable and all long term costs are also controllable.

5) Non - Controllable cost: Non controllable cost is the cost which is not subject to control at any level of managerial supervision. It is the cost which cannot be influenced by the action of a specified member of an organization. All fixed cost are noncontrollable, all indirect cost are non-controllable. FOR EXAMPLE: a manager's salary is not within the control of the manager himself. C) On the basis of elements different types of cost are: 1) Material Cost: Material cost is the cost of material of any nature used for the purpose of production of a product or a service. Material cost includes cost of procurement, freight inwards, taxes and duties, insurance etc. directly attributable to the acquisition. Trade discount, rebates, duty drawback, refund on account of modvat, cenvat, sales tax and other similar items are deducted in determining the cost of material. 2) Labour Cost: Labour cost means the payment made to the employees, permanent or temporary, for their services. Labour cost includes salaries and wages paid to permanent employees, temporary employees and also to employees to the contractor. Here, salaries and wages include all fringe benefits like provident fund contribution, gratuity, ESI, overtime, incentives, bonus, ex-gratia, leave encashment, wages for holidays and idle time etc.