A PROJECT REPORT

ON
COST AND ITS TYPE
REPORT SUBMITTED TOWORD PARTIAL FULFILLMENT OF THE
REQAIRMENT OF DEGREE OF BECHELOR BUSSINESS ADMINISTRATION

(AFF TO – MAA SHAKUMBHARI UNIOVERSITY SAHARANPUR)

(B.COM 2022-2025)

Submitted To Submitted By

Dr. Mayank Sangal Saloni

B.COM II Sem

Roll No : 235262530051

SILVER BELLS INSTITUTE FOR HIGHER EDUCATION SHAMLI, UP

COST AND ITS TYPE
MEANING OF COST- Cost may be defined as the monetary value
of all sacrifices made to achieve an objective i.e. to produce goods
and services. Cost are very important in business decision making.
Cost of production provides the floor to pricing. It helps manager
to take correct decision, such as what price to quote, whether to
place particular order for inputs or not whether to abandon or add a
product to the existing product line and so on.
Ordinarily, cost refer to the money expenses incurred by a firm in
the production process. Cost also included imputed value of the
entrepreneur’s own resources and services, as well as salary of the
owner-manager.
DETERMEAINTS OF COST-
Factors determining the cost are:
(a) Size of plant: There is an inverse relationship between size of
plant and cost. As size of plant increases, cost falls and vice versa.
(b) Level of Output: There is a direct relationship between output
level and cost. More the level of output, more is the cost ( i. e.,
total cost) and vice Versa.
(c) Price of Inputs: There is a direct relationship between price of
inputs and cost. As the price of inputs rises, cost rises and vice
versa.
(d) State of technology: More modern and upgraded the technology
implies lesser cost and vice versa.
(e) Management and administrative efficiency: Efficiency and cost
are inversely related. More the efficiency in management and
administration better will be the product and less will be the cost.
Cost will increase in case of inefficiencies in management and
administration.
COST CONCEPT-
The concept of cost is central to business decision making. To
make effective business decisions, the business manager needs to
be aware of a number of cost concepts and their respective uses.
Actual cost-
Actual cost means the actual expenditure incurred on producing
goods and services. Value of raw material, wages, rent, salaries
paid and interest of borrowed capital etc. are some of the example
of actual cost. Actual cost is also known as absolute cost or out lay
cost or money cost.
Opportunity Cost-
The opportunity cost is measured in terms of the forgone benefits
from the next best alternative use of a given resource. For example
the inputs which are used to manufacture a car may also be used in
the productions of military equipment. 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 to services.
5. It helps the manager to decide what he should produce in the
factory.
Explicit cost-
An explicit cost is a cost that is directly incurred by the firm,
company or organization during the production. The explicit cost is
kept on record by the accountant of the firm. Salaries, wages, rent,
raw material are few example of the explicit cost. The explicit cost
is also known as out- pocket cost. This cost is handy in calculating
both accounting and economic profit.
Implicit cost-
The implicit cost is directly opposite to it, as it is the cost that is not
directly incurred by the firm or company. In implicit cost outflow
of cash doesn’t take place. It is not in the record and is heard to be
traced back. The interest on owner’s capital or the salary of the
owner are the prominent example of the implicit cost. The implicit
cost is also known as imputed cost. Through implicit cost , only the
economic profit is calculated. Incremental cost- Incremental costs
are the added costs of a change in the level of production or the
nature of activity. It may be adding a new product or changing
distribution channel, or adding new machinery, etc. It appears to be
similar to marginal cost, but it is not managerial cost. Marginal
cost refers to the cost on added unit of output.
Sunk Cost-
Sunk costs are costs which cannot be altered in any way. Sunk
costs are costs which have already been uncured. For example, cost
incurred in constructing a factory. When the factory building is
constructed cost have already been incurred. The building has to be
used for which originally envisaged. It can not be altered when
operation are increased or decreased . Investment of machinery is
an example of sunk cost.
Shutdown cost-
Shutdown cost are those cost which would be incurred in the event
of suspension of plant operations and which could be saved if
operation were continued. For example cost of sheltering the plant
equipment and construction of sheds for protecting the exposed
property, or fixed cost and maintenance cost etc.
Abandonment cost-
Abandonment cost are those cost which are incurred for the
complete removal of the fixed asset from use. These may occur due
to obsolesce or due to improvisation of the firm. Abandonment
costs thus involve problem of disposal of the asset.
Book cost –
Book cost are those business cost which don’t involve any cash
payment is made but a provision is made in the books of accounts
in order to include them in the profit and loss account and take tax
advantages.
Out of pocket cost-
Out of pocket cost are those costs or expenses which are current
payments to the outsiders of the firm. All the explicit costs fall into
the category of out of pocket costs.
Past cost-
Past costs are actual costs incurred in the past. These costs are
mentioned in the financial accounts. , since the past costs 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 it now.
Future cost-
Future costs are those costs which are to be incurred in the near
future. This is only a forecast. Future costs matter for managerial
decisions because, the management can evaluate the desirability of
that expenditure. In the case of future costs, if the management
considers them very high , it can either reduce them or postpone
the use of them.
Direct cost-
Direct costs are related to a specific process or product. They are
also called traceable costs as we can directly trace them to a
particular activity, product or process. They can vary with changes
in the activity or product. Examples of direct costs include
manufacturing costs relating to production, customer acquisition
costs pertaining to sales, etc.
Indirect costs-
Indirect costs, or untraceable costs, are those which do not directly
relate to a specific activity or component of the business. For
example, an increase in charges of electricity or taxes payable on
income. Although we cannot trace indirect costs, they are
important because they affect overall profitability.
Fixed Cost-
Fixed cost are the amount spent by the firm on fixed inputs in the
short run. Fixed cost are thus, those costs which remain constant,
irrespective of the level of output. These costs remain unchanged
even if the output of the firmis nil. Fixed costs therefore, are
known as Supplementary costs or Overhead costs.
Variable Costs-
Variable costs are those cost that change directly as the volume of
output changes. As the production increases variable cost also
increases, and as the product decreases variable costs also
decreases, and when the production stops variable cost is zero.
Semi Variable Cost-
This type of cost lies in between fixed and variable cost. It is
neither perfectly variable nor perfectly fixed in relation to changes
in output. This type of costs include a portion of fixed cost and a
portion of variable cost, this is known as semi variable cost. For
example- electricity bill generally include both a fixed charge
(meter rent) and a variable charge(charge based on units
consumed) and the total payment made is semi variable cost.
Stair Step Cost-
Certain expenses increase in a stair step manner, i.e. remaining
constant over a range of output but rising suddenly to a new higher
level as output passes beyond. The given level. For example- up to
a point the attendants salary may remain fixed as output increases
but beyond that point further increase in output may require an
additional attendant leading to a sudden jump in supervision
expenses.
Total cost-
Total cost is the total expenditure incurred in the production of
goods and services.
TC= TFC+TVC
Average cost-
Average cost is not actual cost, It is obtained by dividing the total
cost by the total output.
AC= Total Cost/Units Produced
Marginal cost-
The cost incurred on producing one additional unit of commodity
is known as marginal cost. Thus it shown a change in total cost
when one more or less unit is produced.
MC= TCn – TC(n-1 )
Cost function-
The cost output relationship plays an important role in determining
the optimum level of production.
TC=F(Q)
Where,
TC= Total cost
Q= Quantity produced
F= Function
The cost function can be classified as:
Short run cost-
Short run is a period where the time is too short to expand the size
of industry and the increased demand has to be met within the
existing size of industry because there are certain factors which
cannot be changed in short run. So short run costs are those which
vary with output when fixed plant a capital equipments remain
unchanged.
Long run costs-
In the long run the size of an industry can be expanded to meet the
increased demand for products such as in long run all the factors of
production can be increased according to need. Hence long run
costs are those which vary with output when all input factors
including plants equipment vary.
Cost output relationship in short run
In the short-run a change in output is possible only by making
changes in the variable inputs like raw materials, labour etc. Inputs
like land and buildings, plant and machinery etc. are fixed in the
short-run. It means that short-run is a period not sufficient enough
to expand the quantity of fixed inputs.
Thus Total Cost (TC) in the short-run is composed of two elements
– Total Fixed Cost (TFC) and Total Variable Cost (TVC).
TFC remains the same throughout the period and is not influenced
by the level of activity. The firm will continue to incur these costs
even if the firm is temporarily shut down. Even though TFC
remains the same fixed cost per unit varies with changes in the
level of output.
On the other hand TVC increases with increase in the level of
activity, and decreases with decrease in the level of activity. If the
firm is shut down, there are no variable costs. Even though TVC is
variable, variable cost per unit is constant.
So in the short-run an increase in TC implies an increase in
TVC only. Thus:
 TC = TFC + TVC
TFC = TC – TVC
TVC = TC – TFC
TC = TFC
when the output is zero. The graph below shows Short-run cost
output relationship. In the graph X-axis measures output and Y-
axis measures cost. TFC is a straight line parallel to X-axis,
because TFC does not change with increase in output.
TVC curve is upward rising from the origin because TVC is zero
when there is no production and increases as production increases.
The shape of TVC curve depends upon the productivity of the
variable factors.
The TVC curve above assumes the Law of Variable Proportions,
which operates in the short-run. TC curve is also upward rising not
from the origin but fromthe TFC line. This is because even if there
is no production the TCis equal to TFC.
It should be noted that the vertical distance between the TVCcurve
and TC curve is constant throughout because the distance
represents the amount of fixed cost which remains constant. Hence
TC curve has the same pattern of behavior as TVC curve.
Short-run Average Cost and Marginal Cost
The concept of cost becomes more meaningful when they are
expressed in terms of per unit cost. Cost per unit can be computed
with reference to fixed cost, variable cost, total cost and marginal
cost.
The following Table and diagram illustrates cost output
relationship in the short-run, with reference to different concepts of
cost.
 Average Fixed Cost (AFC): Average fixed cost is obtained by
dividing the TFC by the number of units produced. Thus:
AFC = TFC/Q where, ‘Q’ refers quantity of
production.
Since TFC is constant for any level of activity, fixed cost per unit
goes on diminishing as output goes on increasing. The AFCcurve
is downward sloping towards the right throughout its length, with a
steep fall at the beginning.
Average Variable Cost (AVC):
Average Variable Cost is obtained by dividing the TVC by the
number of units produced. Therefore: Due to the operation of the
Law of Variable Proportions AVCcurve slopes downwards till it
reaches a certain level of output and then begins to rise upwards.
Average Total Cost (ATC):
Average Total Cost or simply Average Cost is obtained by dividing
the TC by the number of units produced. Thus:
AVC = TVC / Q ATC = TC / Q
The ATC curve is very much influenced by the AFC and
AVCcurves. In the beginning both AFC curve and AVC curve
decline and therefore ATC curve also declines. The AFC curve
continues the trend throughout, though at a diminishing rate. AVC
curve continues the trend till it reaches a certain level and
thereafter it starts rising slowly. Since this rise initially is at a rate
lower than the rate of decline in the AFC curve, the ATC curve
continues to decline for some more time and reaches the lowest
point, which obviously is further than the lowest point of the AVC
curve. Thereafter the ATC curve starts rising because the rate of
rise in the AVC curve is greater than the rate of decline in the AFC
curve.
Marginal Cost (MC):
Marginal Cost is the increase in TC as a result of an increase in
output by one unit. In other words it is the cost of producing an
additional unit of output.
MC is based on the Law of Variable Proportions. A downward
trend in MC curve shows decreasing marginal cost (i.e. increasing
marginal productivity) of the variable input. Similarly an upward
trend in MC curve shows increasing marginal cost (i.e. decreasing
marginal productivity). MC curve intersects both AVC and
ATCcurves at their lowest points.
The relationship between AVC, AFC, ATC and MC can be
summed up as follows.
1. If both AFC and AVC fall ATC will also fall because ATC =
AFC + AVC
2. When AFC falls and AVC rises
(a) ATC will fall where the drop in AFC is more than the rise in
AVC
(b) ATC remains constant if the drop in AFC = the rise in AVC,
and
(c) ATC will rise where the drop in AFC is less than the rise in
AVC.
3. ATC will fall when MC is less than ATC and ATC will rise
when MC is more than ATC. The lowest ATC is equal to MC.
Cost output relationship in the long run-
In order to study the cost output relationship in the long run it is
necessary to know the meaning of long run. As known in the long
run the size of an industry can be expanded to meet the increased
demand for products as such in the long run all the factors of
production can be varied according to the need. Hence long run
costs are those which vary with output when all the input factors
including plant and equipment vary. T
As per the above figure suppose that at a given time the firms
operate under plant SAC2 and produces output OQ. If the
firmdecides to produce output OR and continues with the current
plant SAC2 its average cost will be uR. But if the firm decides to
increase the size of the plant to plant SAC3 its average cost of
producing ORoutput would then be TR. Since cost TR is less than
the cost on old plant uR, therefore new plant SAC3 is preferable
and should be adopted. Thus the long run cost of producing OR
output will be TRwhich can be obtained by increasing the plant
size.
Features of LAC curve
To draw long run average cost curve(LAC) we start with a number
of short run average cost(SAC) curves, each such curve
representing a particular size of plant including the optimum plant.
One can nowdraw a LAC curve which is tangential to all SAC
curves. In this connection following features are highlighted:
1- The LAC curve envelopes the SAC curves and is therefore
called as envelope curve.
2- Each point of the LAC is a point of tangency with the
corresponding SAC curve.
3- The points of tangency on the falling part of SAC curve for
points lying to the left of minimum point of LAC.
4- The points of tangency occur on the rising part of the
SACcurves for the points lying to the right of minimum point of
LAC.
5- The optimum scale of plant is a term applied to the most
efficient of all scales of plants available. This scale of plant is the
one whose SAC curve forms the minimum point of LACcurve. It is
SAC3 in our case which is tangent to LAC curve at its minimum
point at R.
6- Both LAC ad SAC curves are U shaped but the difference
between the two U shapes is that the U shape of the LAC curve is
flatter or lesser pronounced from bottom. The main reason for this
is that in the long run such economies are possible which cannot be
had in the short run, likewise some of the diseconomies which are
faced in short run may not be faced in the long run.