Concept of Costs

It is a commonly accepted fact that physical inputs or resources are important for enhancing production. We, however, tend to miss out on the financial aspect of this rule. Some of the most important decisions pertaining to business often relate to the cost of production, instead of physical resources themselves. Hence, it is important for producers to understand cost analysis. Let’s understand the general concept of costs for that. 

Concept of Costs 

In order to understand the general concept of costs, it is important to know the following types of costs: 

  1. Accounting costs and Economic costs 
  1. Outlay costs and Opportunity costs 
  1. Direct/Traceable costs and Indirect/Untraceable costs 
  1. Incremental costs and Sunk costs 
  1. Private costs and Social costs 
  1. Fixed costs and Variable costs 

Concept of Costs in terms of Treatment 

1. Accounting costs 

Accounting costs are those for which the entrepreneur pays direct cash for procuring resources for production. These include costs of the price paid for raw materials and machines, wages paid to workers, electricity charges, the cost incurred in hiring or purchasing a building or plot, etc. Accounting costs are treated as expenses. Chartered accountants record them in financial statements. 

2. Economic costs 

There are certain costs that accounting costs disregard. These include money which the entrepreneur forgoes but would have earned had he invested his time, efforts and investments in other ventures. For example, the entrepreneur would have earned an income had he sold his services to others instead of working on his own business 

Similarly, potential returns on the capital he employed in his business instead of giving it to others, the output generated by his resources which he could have used for others’ benefits, etc. are other examples of economic costs. 

Economic costs help the entrepreneur calculate supernormal profits, i.e. profits he would earn above the normal profits by investing in ventures other than this. 

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