Solution:

Cost Concepts:

• Cost concepts differ because of differences in viewpoint. Different combinations of cost ingredients are important for various kinds of management problems.

• Disparities occur form deletions, from additions from recombination which do not appear anywhere in the accounting records.

• Different cost concepts explained in our study are:

  (a) Actual cost and opportunity costs

  (b) Past and future costs

  (c) Short-run and long-run costs

  (d) Variable or Prime cost and fixed costs or supplementary costs

  (e) Incremental costs and sunk costs

  (f) Traceable and Non-Traceable costs

  (g) Explicit and Implicit costs

  (h) Controllable and Non-Controllable Costs

  (i) Private, External and social costs

  (j) Total. Average and Marginal Costs

(a) Actual Cost and Opportunity Cost:

• Actual costs are those that involve financial expenditure incurred for acquiring inputs for producing a commodity.

• These expenditures are recorded in the books of accounts of the firm. The expenditures are wages, payments made for the purchase of raw materials machinery, etc.

• These costs are called actual costs or outlay costs or real costs. The real cost of production has been interpreted in different forms. According to Adam Smith, Pains and sacrifices of labor are the real cost of production.

• Opportunity cost is not the actual expenditure but it is the revenue earned by employing that good or service in some other alternative uses. Opportunity cost is the cost of producing any commodity in the next best alternative cost.

• For example, the inputs which are used to manufacture a car may also be used in the production of military equipment. A farmer who is producing paddy can also produce sugar cane with the same factors.

• Therefore, the opportunity cost of one quintal of paddy is the amount of sugarcane given up. The main points of opportunity cost are:

  1. The opportunity cost of any commodity is only the next best alternative forgone.

  2. The next best alternative commodity that could be produced with the same value of the factors, which are more or less the same.

  3. It helps in determining relative prices of factor inputs at different places.

  4. It helps in determining the remuneration for services.

  5. It helps the manager to decide what he should produce in the factory.

(b) Past and Future Costs:

• Past costs are actual costs incurred in the past. These costs are mentioned in the financial accounts. Future costs are those costs that are to be incurred shortly. This is only a forecast.

• Future costs matter for managerial decisions because, the management can evaluate the desirability of that expenditure, since the past costs are costs that have already been incurred, and there is no scope for managerial decision.

• If the management finds out that the past costs are excessive, it cannot do anything to rectify them now. In the case of future costs, if the management considers them very high, it can either reduce them or postpone their use of them.

(c) sort Run and Long-Run Costs:

• Shorts run costs are those associated with variation in the utilization of fixed plans or other facilities, whereas long-run costs encompass changes in the size and kind of plant.

• Short-run cost is relevant when a firm has to decide whether or not to produce more or less with the given plant and equipment.

• If the firm decides to expand the capacity of the plant, it must examine the long-run cost. Long-run cost is useful in making investment decisions.

(d) Prime or Variable Costs:

• Prime costs are variable or direct costs. Normally, they include the money cost of the raw material used in making a commodity, the wages of the labor directly spent on it, and the extra wear and tear of the a machine that makes it.

• Suppose a carpenter has been asked to charge for a chair, he would first think of the wood and cane that he used and the number of days he spent making it.

• This is the prime cost. The prime cost of a commodity differs from the quantity produced. When more chairs are made, more money will have to be spent on carpenter‘s wages as well as on wood.

• When production is stopped, the prime costs disappear. Prime costs, therefore, are also called the Variable Costs.

(e) Supplementary or Fixed Costs:

• The carpenter will not only charge for the chair but also for the wood and his wage. In addition to the above, he will think of including a portion of rent in the cost that he is paying and also interest on the capital invested, the municipal taxes, etc.

• A big company will further have to include a portion of the salaries of the manager, the peons, the cost of advertisement and salesmanship, etc. These costs must also be covered.

  

• They are called supplementary costs on costs or head charges or fixed costs. The fixed costs do not change with the volume of production.

• Irrespective of the number of goods produced, big or small, the charges on account of rent, taxes, interest salaries, etc will be included. Even if the orders cease to flow in and the factory is closed, these costs will continue.

• They are fixed costs. Generally, the distinction between the variable and fixed costs applies only to the short period, because nothing can remain fixed in the long run.

• In the long, the strength and the salary bill of the staff may change, and the amount of capital invested may be different, hence the amount of interest would vary.

• Thus, all costs, which were regarded as fixed in the short run, may vary in the long run. Thus, in the long run, all costs are variable.