Cost Classification

Topics: Costs, Microeconomics, Economics Pages: 5 (1567 words) Published: September 13, 2013
Cost Classifications for Decision-Making. Every decision involves choosing from among at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in making the selection. This concept is explored in greater detail in the chapter on relevant costs. However, decision-making contexts crop up from time to time in the text before that chapter, so it is a good idea to familiarize students with relevant cost concepts. 1. Differential Costs. A differential cost is a cost that differs between alternatives. The cost may exist in only one of the alternatives or the total amount of the cost may differ between the alternatives. In the latter case, the differential cost would be the difference between the cost under one alternative and the cost under the other. Differential costs are also called incremental costs. Differential costs and opportunity costs should be the focus of decision-making. They are the only relevant costs and all others should be ignored. 2. Opportunity Costs. An opportunity cost is the potential benefit that is given up by selecting one alternative over another. The concept of an opportunity cost is rather difficult for students to understand because it is not an actual expenditure and it is rarely (if ever) shown on the accounting books of an organization. It is, however, a cost that must be considered in decisions. 3. Sunk Cost. A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed and therefore cannot be differential costs, they should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people they often have difficulty putting this idea into practice. *

* Every decision involves a choice between at least two alternatives. * Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored.

The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending this program, you could save TL 10,000 per year. Your opportunity cost?

Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions.
Example: You bought an automobile that cost TL10,000 two years ago. The TL10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the TL10,000 cost. 1. By Decision making Costs: These costs are used for managerial decision making. * Marginal Costs: Marginal cost is the change in the aggregate costs due to change in the volume of output by one unit. * Differential Costs: This cost is the difference in total cost that will arise from the selection of one alternative to the other. * Opportunity Costs: It is the value of benefit sacrificed in favor of an alternative course of action. * Relevant Cost: The relevant cost is a cost which is relevant in various decisions of management. * Replacement Cost: This cost is the cost at which existing items of material or fixed assets can be replaced. Thus this is the cost of replacing existing assets at present or at a future date. * Shutdown Cost:These costs are the costs which are incurred if the operations are shut down and they will disappear if the operations are continued. * Capacity Cost: These costs are normally fixed costs. The cost incurred by a company for providing production, administration and selling and distribution capabilities in order to perform various functions. * Other CostS

5) On the basis of Controllability and Decision Making: Based on the managerial decision making and controllability the classifications are as follows: (a) Controllable Cost, (b) Uncontrollable Cost, (c) Sunk Cost, (d) Opportunity...
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