The Meaning of Cost
Cost is a measure of the sacrifice or forgoing of a scarce resource to achieve a specific objective. An organization sacrifices scarce resources, i.e. the purchase cost, in order to obtain other resources. A cost is usually measured in terms of money paid to acquire goods or services. One can observe that the term cost is rarely used without an adjective in front of it. The term ‘Cost’ has multiple meanings and different types of costs are used in different situations. Therefore a preceding term must be added to clarify the assumptions that underlie a cost measurement. Examples include variable cost, average cost, total cost, fixed cost, opportunity cost and sunk cost. A few types of costs are as given below: * Total Costs and Average Costs: Total cost includes the cost of all resources acquired or used by an organization during a specified time period. In certain decisions, calculating the unit cost is imperative. A unit cost, also called the average cost, is computed by dividing the total cost of the product by the related number of units. Units may be expressed in different ways. Unit costs are regularly used in financial reports. However, in organizations with different products and services, unit cost usually is not a meaningful number for making decisions about the uses of capacity. For example, the company may be profitable overall (i.e. unit selling price exceeds unit cost) it still may be carrying some very unprofitable products (e.g. cost of resources used exceeds sales revenues).
* Manufacturing Costs: Manufacturing costs are the costs associated with the production of goods. They include three cost categories: direct material, direct labor and manufacturing overhead.
* Non-Manufacturing Costs: These costs can be defined as all the costs that are not associated with the production of goods. These costs typically include selling as well as general and administrative costs.
* Direct Cost: A direct cost is a cost that can be easily and conveniently traced to a particular cost object under consideration. The term cost tracing is used to describe the assignment of direct costs to the particular cost object.
* Indirect Cost: This is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. A particular cost may be direct or indirect depending on the cost object. While the salary of plant manager is a direct cost of the plant, it is an indirect cost of manufacturing cars.
* Variable Costs: Variable costs are the costs that vary, in total, in direct proportion to changes in the level of activity. Variable costs increase or decrease in response to the increase or decrease in the level of business activity.
* Fixed Costs: Fixed costs are costs that do not change with changes in the level of business activity. As the activity level increases and decreases, the fixed costs remain constant in total amount unless influenced by external factors, such as price change.
* Product Costs: Product costs are those costs that are involved in acquiring or making a product. In case of manufactured goods, these costs consist of direct material, direct labor, and manufacturing overhead.
* Opportunity Cost: Opportunity cost is the potential benefit that is forgone when one alternative is selected over another. Opportunity cost is not usually entered in the accounting records, but it is a cost that must be considered in every decision a manager makes since every alternative has some opportunity cost attached to it.
* Sunk Cost: A sunk cost is a cost that has already been incurred and that cannot be changed by current or future action. Since sunk costs cannot be changed by any decisions, they should be ignored when making a decision.
JOB COSTING AND PROCESS COSTING METHODS
There are two basic types of costing systems that the companies can adopt- Job costing and...