Types of Costs
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Types of Costs

Types of Cost Outlay Costs and Opportunity Costs Outlay or actual costs are the costs which a firm incurs while producing or acquiring a product or service. These costs are recorded in the books of account. These are also known as acquisition costs or out of pocket costs. On the other hand, opportunity cost or alternative cost are the benefit from the second best use of the firm's resources which are foregone in order to avail of the return from the best use of resources. For example, a business firm can buy other a lathe machine or a paper pressing machine with its limited resources. He can earn annually Rs. 50000 and Rs. 40000 respectively from the two machines.

Types of Costs

Outlay Costs and Opportunity Costs

Outlay or actual costs are the costs which a firm incurs while producing or acquiring a product or service. These costs are recorded in the books of account. These are also known as acquisition costs or out of pocket costs. On the other hand, opportunity cost or alternative cost are the benefit from the second best use of the firm's resources which are foregone in order to avail of the return from the best use of resources. For example, a business firm can buy other a lathe machine or a paper pressing machine with its limited resources. He can earn annually Rs. 50000 and Rs. 40000 respectively from the two machines. The firm buys the lathe machine. Then the outlay cost of lathe machine is Rs 50000 per annum and the opportunity cost is Rs. 40000 per annum. The difference between outlay cost and opportunity cost is known as economic rent or profit. Opportunity cost is not recorded in the books of account.

Shut Down and Sunk Costs

A business firm may have to suspend its operations for a period due to some temporary problems, e.g., shortage of raw materials, non-availability of required labor or power, etc. During this period though no work is done yet certain fixed costs such as rent, insurance, depreciation, etc., of plant may have to be incurred. Such costs of the idle plant are known as shut down costs.

Sunk costs are historical or past costs which cannot be changed by any future decision. Investments in plant and machinery, buildings, etc., are examples of sunk costs. These costs are irrelevant for decision-making because they cannot be altered by later decisions.

Product Costs and Period Costs

Costs which become part of the cost of the product are known product costs. They are included in the value of inventory. Such costs are treated as assets until goods they are assigned to are sold. These costs may be fixed as well as variable, e.g., cost of raw material and direct wages, depreciation of plant and machinery, etc.

Costs which are associated with period not products are called period costs. They are treated as an expense of the period in which they are incurred. They may also be fixed as well as variable, administrative expenses, salesmen's salaries, depreciation of office building, etc., are examples of period costs.

Historical and Replacement Costs

Historical or original costs mean the price at which an asset was originally acquired. On the other hand, replacement cost means the cost which the firm would have to incur to replace or acquire the same asset now. Difference between original cost and replacement arises due to increase in price level or inflation.

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