COST CONCEPTS

1. Cost: It is the amount of resources, expressed in monetary terms, given up in exchange for some goods
or services. Cost is defined as “the amount of expenditure incurred on or attributable to a given thing
or to ascertain the cost of a given thing.” The Committee on Cost Terminology of the American
Accounting Association has defined cost as “the foregoing, in monetary terms, incurred or potentially
to be incurred in the realization of the objective of management which may be manufacturing of a
product or rendering of a service.” Thus, cost is that which is given or is sacrificed to obtain something.

2. Expense: Expenses are costs which have been applied against revenue of particular accounting period
in accordance with the principle of matching cost to revenue e.g., cost of goods sold, office salaries of
the period in which they are incurred.

3. Loss: It represents diminution in ownership equity other than from withdrawal of capital for which no
compensating value has been received e.g., destruction of property by fire.

4. Responsibility Centre: Normally, companies are organized according to function or product line. The
segments or departments organized along the functional lines perform a specified function such as
marketing, finance, purchasing, production or personnel. Some large companies have started to
organize segments according to the product lines such as electrical products division, food division and
garment division. A responsibility centre is a segment of an organization for which a particular
executive is responsible. There are three types of responsibility centres- cost centres, profit centres and
investment centres.

5. Cost Centre: A cost centre is the smallest segment of activity or area or responsibility for which costs
are accumulated. A cost centre is a responsibility incurring only expenses and producing no direct
revenue from the sale of goods or services. A cost centre can be a location, i.e., an area such as
department, storeyard or sales area or an item of equipment, i.e., lathe machine, delivery vehicle or a
person, e.g., salesman, foreman. Cost centres may be classified as under:
 Personal and impersonal cost centres: Personal cost centre is one which consists of a person or a
group of persons. On the other hand, impersonal cost centre consists of a machine, a department
or plant.
 Operation and process cost centres: Operation cost centre consists of those persons and/or
machines carrying out the same kind of operation. On the other hand, a centre which has a
continuous sequence of operations is called process cost centre.
 Production and service cost centres: Product centre refers to a centre through which a product
passes and generally corresponds to a production department. Service centre is a department or
centre which incurs direct and indirect costs but does not work directly on products.

6. Profit Centre: A profit centre is that segment of activity of a business which is responsible for both
revenue and expenses and discloses the profit of a particular segment of activity.

7. Investment Centre: An investment centre is that centre which is responsible for earning adequate
return. An investment centre has revenues, expenses and an appropriate investment base. This centre
is evaluated on the basis of rate of return it can earn on its investment.

8. Cost Unit: It is the unit of quantity of product, service or time in relation to which costs may be
ascertained, e.g., tonne in case of coal. Cost units are usually the units of physical measurement e.g.,
number, weight, area, volume, etc. It must be clearly defined and selected before the process of cost
finding can be started.
9. Cost Object: This includes a product, service, cost centre activity, sub-activity, project, contract,
customer or distribution channel or any other unit in relation to which costs are ascertained.

10. Cost Driver: It is a factor that influences costs. A change in the cost driver will lead to a change in the
total cost of a related cost object. Examples of cost drivers are: number of units produced, number of
advertisements, number of products produced, etc.

11. Contribution Margin: This is the excess of sales price over variable costs.

12. Carrying Costs: Carrying costs, also known as holding costs, are basically the costs incurred on the
maintenance of inventory and include cost of the money locked up in the inventory.

13. Out-of-Stock Cost: This cost takes place when a stock shortage occurs and includes loss of sales, loss of
goodwill on account of disgruntled customers and employees’ ill will and cost of idle machines.

14. Ordering Costs: These costs are incurred each item an order for the purchase of material is placed and
are expressed as rupee cost per order and include the cost of getting an item into the firm’s inventory.

15. Development Cost: It is the cost of the process which begins with the implementation of the decision
to produce a new or improved method and ends with the commencement of formal production of the
product by that method.

16. Policy Cost: It is the cost which is in addition to normal requirement incurred in accordance with the
policy of an undertaking.

17. Idle Facilities Cost: It is the cost of abnormal idleness of fixed assets or available services.

18. Expired Cost: It is the cost which is related to the current period as an expense or loss.

19. Incremental Revenue: Incremental revenue reflects the difference in revenue between two
alternatives.

20. Added Value: It is the change in market value resulting from an alternation in the form, location or
availability of a product or service.

21. Urgent Costs: These costs are to be incurred immediately in order to avoid the hampering of
production line. These are absolutely essential and their shifting to future period will have adverse
effect on the efficiency of operation in hand.

22. Postponable Costs: Such costs can be postponed or shifted to the future period generally without any
effect on the efficiency of current operations.
23. Pre-production Costs: These are costs incurred during the period when a new factory is in the process
of being established, a new project is undertaken or a new production line or product is taken up but
there is no established or formal production to which such costs may be charged.

24. Research Cost: These are the costs incurred in the discovery of new ideas or processes by experiment
or otherwise.

25. Training Cost: The cost of training workers, apprentices and staff.
 COST CLASSIFICATION

1. By Nature or Elements
 Materials: Material cost refers to the expense incurred in obtaining raw materials or
components used in the production of goods or services.
 Labour: Labour cost represents the total expenditure associated with employing workers to
produce goods or provide services.
 Expenses: Costs, other than material and labour, incurred in the process of generating
revenue.

2. By Functions
 Manufacturing and Production Cost: This is the total of costs involved in manufacture,
construction and fabrication of units of production.
 Commercial Cost: It includes administrative cost and selling & distribution cost.

3. By Degree of Traceability to the Product

 Direct Cost: Direct costs are those costs which are incurred for and may be conveniently
identified with a particular cost centre or cost unit.
 Indirect Cost: Indirect costs are those which are incurred for the benefit of a number of cost
centres or cost units and cannot be conveniently identified with a particular cost centre or
cost unit.

4. By Changes in Activity or Volume

 Fixed Cost: Fixed costs are those which remain fixed in total amount with increase or
decrease in the volume of output.
 Variable Cost: Variable costs are those which vary in total in direct proportion to the volume
of output.
 Semi-variable Cost: Semi-variable costs are those which are partly fixed and partly variable.

5. By Controllability
 Controllable Cost: Controllable costs are those which can be influenced by the action of a
specified member of an undertaking, that is to say, costs which are at least partly within the
control of management.
 Uncontrollable Cost: Uncontrollable costs are those which cannot be influenced by the
action of a specified member of an undertaking, that is to say, costs which are not within
the control of management.

6. By Normality
 Normal Cost: It is the cost which is normally incurred at a given level of output.
 Abnormal Cost: It is the cost which is not normally incurred at a given level of output in the
conditions in which that level of output is normally attained.

7. By Relationship with Accounting Period

 Capital: The cost which is incurred in purchasing an asset either to earn income or
increasing the earning capacity of the business is called capital cost. Such cost is incurred at
one point of time but the benefits accruing from it are spread over a number of accounting
years.
 Revenue: If any expenditure is done in order to maintain the earning capacity of the
concern, it is revenue expenditure.
8. By Time
 Historical Cost: The costs which are ascertained after being incurred are called historical
costs.
 Predetermined Cost: Such costs are estimated costs, i.e., computed in advance of
production taking into consideration the previous periods’ costs and the factors affecting
such costs.

9. According to Planning and Control

 Budgeted Cost: Budgeted costs represent an estimate of expenditure for different phases of
business operations such as manufacturing, administration, sales, research and
development, etc.
 Standard Cost: It is the predetermined cost based on a technical estimate for materials,
labour and overhead for a selected period of time and for a prescribed set of working
conditions.

10. By Association with the Product

 Product Cost: Product costs are associated with the purchase and sale of goods.
 Period Cost: These are the costs which are not assigned to products but are incurred on the
basis of time such as rent, salaries, etc.

11. For managerial Decisions

 Marginal Cost: Marginal cost is the total of variable costs. Fixed costs are ignored.
 Out of Pocket Cost: This is that portion of cost which involves payment to outsiders.
 Differential Cost: Differential cost is the difference in total cost between alternatives
calculated to assist decision making.
 Conversion Cost: It is the sum of direct wages, direct expenses and manufacturing overhead
costs of converting raw material from one stage of production to the next.
 Sunk Cost: It is an irrecoverable cost which is caused by complete abandonment of a plant.
 Imputed Cost: These costs are notional in nature and do not involve any cash outlay.
Example- notional rent charged on business premises owned by the proprietor.
 Opportunity Cost: It is the cost of selecting one course of action and the losing of other
opportunities to carry out that course of action.
 Replacement Cost: It is the cost at which there could be purchase of an asset or material
identical to that which is being replaced or revalued.
 Avoidable and Unavoidable Cost: Avoidable costs are those which can be eliminated if a
particular product or department with which they are directly related is discontinued.
Unavoidable cost is that cost which will not be eliminated with the discontinuation of a
product or department, such as factory rent.
 Explicit Cost: These costs involve immediate payment of cash to outsiders.
 Implicit Cost: These costs do not involve immediate payment of cash, for example,
depreciation.
 Engineered Cost: These are costs that result specifically from a clear cause and effect
relationship between inputs and outputs.