Generally, the term cost of production refers to the ‘money expenses’ incurred in the production of a commodity. But money expenses are not the only expenses incurred on the production of a commodity. There are number of services and inputs such as entrepreneurship, land, capital etc., which are offered by an entrepreneur without changing any price or receiving any payment for them. While computing the total cost of production, allowance should be made for such expenses. It is therefore essential to have clean understanding for the different types of cost:
Some example of the Types of Cost:
Actual (or, Acquisition or, Outlay) Costs: Actual costs are the costs which the firm incurs while producing or acquiring a good or a service e.g. the cost on raw material, labor, rent, interest, etc. The books of account generally record this information. The actual costs are also called the out la y costs or acquisition costs or absolute costs.
Opportunity (or, Alternative) cost: are the returns from the second-best use of the firms resources which the firm forgoes in order to avail of the return from the best use of the resources.
Outlay Costs: As discussed above, outlay costs mean the actual expenditure incurred for producing or acquiring a good or service. These actual expenditures are recorded in the books of account of the business unit, e.g., wage bill. These costs are also known as actual costs or absolute costs.
Sunk Costs : are the costs that are not altered by a change in quantity and cannot be recovered; e.g., depreciation. Sunk costs are a part of the outlay costs. However, most business decisions require cost estimates that are essentially incremental and not sunk in nature.
Explicit (or, Paid-out) Costs: Explicit costs are those expenses, which are actually paid by the firm (paid-out costs). These costs appear in the accounting records of the firm.
Implicit (or, Imputed) Costs : are theoretical costs in the sense that they go unrecognized by the accounting system. These costs may be defined as the earnings of those employed resources which belong to -the owner himself.
Opportunity Costs: is concerned with the cost of forgone opportunities. In other words, it is the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses attention on the net revenue that could be generated in the next best use of a scarce input. Since this net revenue must be given up, or sacrificed, to make the scarce input available for the best use, it is called opportunity cost of the input. For Example, if the firm owns land there is no cost of using the land (i.e., the rent) in the firm's account. But the firm has an opportunity cost of using this land, which is equivalent to the rent forgone by not letting the land out on rent.
Imputed Costs : are a sub-division of opportunity costs. These never show up in the accounting records but are definitely important for certain types of decisions. Besides the return forgone on the use of , self-owned resources, the imputed costs also include rent (never paid or received) on idle land, depreciation on fully depreciated property still in use, interest on equity capital, etc.
Incremental (or, Avoidable or, Escapable or, Differential) Costs: The incremental costs are the additions to costs resulting from a change in the nature and level of business activity, e.g., change in product line or output level, adding or replacing a machine, changing distribution channels, etc. Since these costs can be avoided by not bringing about any change in the activity, the incremental costs are also called avoidable costs or escapable costs. Moreover, since incremental costs may also be regarded as the difference in total costs resulting from a contemplated change, they are also called differential costs.
Sunk (or, Non-avoidable or, Non-escapable) On the other hand, sunk costs are those that do not...
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