The cost of a product is not the same as its price. In fact, most people think that if they pay more for something it must be better quality.
But does it really? There are so many factors that go into determining the cost of a product or service and these can have little to do with its value to you.
What Is Cost Concept is an online course that will teach you how to recognize what goes into the cost of a product and how this impacts your buying decisions.
We’ll also show you how to find products at their actual costs, rather than based on marketing hype. You’ll learn all about fair trade, sustainability, and ethical production methods too!
- 1 What is Cost Concept?
- 2 Concept of Cost In Accounting
- 2.1 Types of Cost Concept
- 2.2 Based On The Nature of Expenses
- 2.3 Classification In Terms Of Traceability
- 2.4 Concept of Costs In Terms of Treatment
- 2.5 Classification Based on the Purpose
- 2.6 Types of Cost Concept based on Players and Variability
- 2.7 Fun Facts
- 3 Characteristics of the Cost Concept of Accounting
- 4 Pros and cons of activity-based costing system vs traditional accounting methods
- 5 Example of cost concept
- 6 FAQs
- 7 Conclusion
What is Cost Concept?
A cost concept is a model from which costs are derived. The four most common cost concepts are job order, process, transactional and global. A company’s management identifies the most relevant of these to use for their particular type of business organization.
This decision typically rests on one or more of three criteria: volume (number of transactions), stability (variation in volume) and complexity.
Concept of Cost In Accounting
Types of Cost Concept
The most essential part of business computing is the accurate evaluation and recording of all costs that are involved with production, sales, and administration.
In short, a company must determine as many as the types of cost as possible to be able to understand its financial position. The first type of cost required for this is fixed costs.
In economics, a fixed cost is the total amount of costs that does not vary according to the amount of goods or services produced. This type of cost can be easily identified with, which makes it very important when determining total costs for either production or sales.
An example would be annual insurance premiums. Since this expense does not change throughout the year, it is a fixed cost. Another example would be yearly rent on an office. This payment does not change over the course of the year, so it is a fixed cost as well.
The second type of cost required in business computing would be variable costs. In economics, a variable cost is the total amount of costs that varies according to the amount of goods or services produced.
This type of cost plays a vital role in determining total costs because it allows for small and large amounts to be easily determined.
An example would be the cost of raw materials that are produced or purchased during production, such as plastic or paper. Because these goods’ prices tend to change frequently, this is a variable cost. Another example would be the hourly wages of a cashier.
Since this payment does change depending on the number of hours worked, it is a variable cost as well.
The last type of cost used in business computing is fixed costs. In economics, a fixed cost is the total amount of costs that does not vary according to the amount of goods or services produced.
Based On The Nature of Expenses
Every entrepreneur faces a cost of living when they work. This includes not only things like fuel and rent, but also the price of electricity– which can add up over time!
Concept of Opportunity Cost
The next best thing you give up whenever a decision is made by you.
Classification In Terms Of Traceability
A direct cost is a cost that can be traced back to the specific activity in order for an organization to recoup its investment.
Indirect costs are the expenses that could not be traced back to a single cost object or source. They’re also known as “untraceable” because they affect total profitability, but since these types of spending cannot always easily identified with one item.
It becomes necessary for businesses operating in this manner take them into account when making decisions on how best spend their money wisely so no unnecessary mistakes get made due consideration given towards eliminating indirect items from any equation when considering things like budgeting models which can skew results based off inaccuracies found during calculations if certain assumptions aren’t correct (which often happens).
Concept of Costs In Terms of Treatment
First, the cost of treatment is arguably the most important concept in terms of its direct impact on patients. This view interprets costs as the amount of money spent by health care providers to deliver services to individuals during a period of time.
This can be usually related to both public and private hospitals. Some may relate it only to public hospitals since the bulk of patients who use this are covered by the national health insurance. The second interpretation includes all expenses related to treatment.
This means it does not only include direct costs but also indirect costs which include, among others, patient travel expenses, overtime compensation for hospital staff and equipment depreciation.
Cost in terms of treatment is therefore an additional figure that can be added to the initial cost of treatment to arrive at an estimate of what is spent by the health care sector in terms of total costs.
The third interpretation includes both direct and indirect expenses incurred during treatment. It also adds other important factors like loss of productivity, morbidity (illness which may lead to death), mortality (death) and even opportunity costs (pros and cons of an action, which in this case is not doing something).
Loss of productivity is cost associated with sick leave. It is the value of foregone production while on sick leave. This involves both short-term and long-term loss of productivity.
Classification Based on the Purpose
The incremental cost of a decision is the increase in future costs as a result after you make this choice.
The sunk cost is the total value of all expenses that have already been incurred. The term can be used in marketing, because it refers to expenditures on research and advertising for a product or service regardless if they were profitable at first glance (when accounting profit margins).
Types of Cost Concept based on Players and Variability
Private cost is the economic burden a person incurs when he or she produces something.
Personal consumption implies personal gains from buying things, while business-related costs are those sustained by an individual as they produce more of their own stuff with private interests at stake such as profit margins and how much time/money must be invested into producing some good idea before it can generate any kind return on investment…
The Institute of Cost Accountants has constituted the Cost Accounting Standards Board (CASB) to procure suggestions and uniformity in costing.
The board issued 24 standards for a better understanding of different components related with cost, as well as procedures that will be used by companies worldwide when performing general ledger reports or preparing monthly invoices from now on out – all thanks to John Stuart Mill’s original idea known today simply enough: opportunitycost!
Characteristics of the Cost Concept of Accounting
One of the primary concepts of accounting is that of “cost.” The idea behind cost centers around the value or worth that an item has to a company.
This value can then be used in financial records and reports to help measure how well a company is doing over time. But what are the characteristics of the cost concept?
The first characteristic of the cost concept is that it’s a process, not an event. An example of this would be depreciation.
Even though the recording and reporting of depreciation takes place in a single moment in time, it reflects a process that has been going on for quite some time already. In other words, although something may have stopped happening long ago, its effects can still be seen.
The second characteristic is that it represents a sacrifice to the business, even if the company doesn’t have a clear understanding of what exactly is being sacrificed.
For example, if a factory uses fuel in order to create their products, then they are sacrificing that fuel for other purposes that may or may not add up to as much as the fuel actually costs. In some cases, a business may even sacrifice good will by choosing not to make their customers happy.
The third characteristic of the cost concept is that it’s a universal condition for all businesses. No matter how big or small a company is, they have to deal with costs in some way shape or form.
Small businesses have to consider things like their employees’ salaries, while larger companies have to deal with much bigger expenses. Some back-of-the-napkin math can help a CEO or manager to calculate costs and cost centers.
The final characteristic of the cost concept is that it’s an essential part of financial accounting. Every company has to deal with costs in order for financial records and reports to have any legitimacy. To ignore it would be to ignore a vital part of the equation that makes up the basis for finance.
Cost Concept and the Relevance Convention
If you are reading this article, there is a good chance that you have heard of the “Relevance Convention” before. It is one of the common practices in technical writing, but not all writers are aware of what it entails or why it’s important to adhere to.
This convention uses parentheses around words that need clarifying because they might be confusing to the reader. The convention is used in the way described below:
For example, a sentence may read “(cost concept).” In this case, it means that cost concept should be made clear due to possible confusion with other similar sounding words, such as “concept.” Without parentheses, you can’t be sure which word the writer meant. It becomes a guessing game for the reader.
Another example: “(cost, not price)” means that you should look at cost and not price. Without parentheses, it could sound like the writer meant to choose between only two options (cost or price), which isn’t the case. It is good practice to clarify such things in writing so there is no confusion.
The convention is also written as “cost (concept)” or “cost, not price.” Both are correct; it all depends on how you want to write it.
This is a basic convention that should be used in every academic setting, particularly those where technical writing is needed. At the very least, there should be a footnote with a definition or clarification.
Pros and cons of activity-based costing system vs traditional accounting methods
Businesses that decide to use ABC system should be aware of several important advantages:
Product or service costing by activity is effective as it shows managers where they can manipulate costs in their favor. By identifying high-cost activities, company’s employees know which areas they should focus on and which ones to improve in order to reduce costs.
ABC system enables managers to know the exact cost of everything they make or sell. It can be very useful when companies need to understand how much each product costs to produce, especially when the products are similar in nature and one has low price while another one is very expensive.
ABC system is beneficial for those companies that want to prepare cost estimates. It provides a method of connecting products or services with their costs and it enables the prediction of future price changes as well as profit margins.
With this system, managers can predict likely revenue based on the production volume and by knowing how much these products will cost them to produce.
Management can also use ABC system to analyze product or service costs. It enables them to discover which products are not profitable enough and stop selling them without losing much money in the process.
This way, employees know for sure that they should focus their efforts on high-profit margins instead of working hard on something that will bring very little revenue.
In general, ABC system is more beneficial for businesses that have a wide range of products or services to sell. It can also be useful for companies selling similar products with minor price differences.
However, the disadvantage of this accounting method is its high costs of implementation and use.
ABC requires a lot of time to implement while it might not be worth it at all. On the other hand, for companies that need to know the costs of each product or service they sell will benefit greatly from this system.
The disadvantages of ABC accounting can be summarized as follows:
Companies that use traditional accounting methods are not likely to see any benefits of switching to ABC system. Also, traditional system is often reliable. Finally, in most cases the change from traditional accounting to ABC requires a lot of time and can be very costly in terms of implementation.
Example of cost concept
The approximate retail value (or variable costs) per unit include the following:
Variable manufacturing costs such as direct materials, direct labor and variable manufacturing overhead. Variable selling and administrative costs such as commissions and general office expenses. Variable transportation costs.
These are direct variable costs that vary with changes in activity.
Fixed manufacturing costs are not included in variable manufacturing costs, although they are included in the total manufacturing costs.
They include semi-variable manufacturing overhead such as indirect materials and indirect labor, which have fixed characteristics over a relevant range of production volume.
Fixed selling and administrative costs are also excluded from variable selling and administrative costs because they are incurred regardless of the activity level. Fixed transportation costs are excluded because they generally do not vary with volume or sales revenue changes.
For example, assume that variable production costs (direct materials, direct labor and variable manufacturing overhead) per unit are $1.00, variable selling and administrative expenses (commissions, general office expenses) per unit are $0.90 and variable transportation costs (freight in, freight out) per unit are $0.10.