analysis of costs-12

8/4/2019 Analysis of Costs-12

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Analysis of Costs

Importance

Better cost management leads to

maximization of profits. A firm that wants tomaximize its profits should also focus onminimizing costs. Avery good example ishow Maruti Udyog Limited has posted anet profit of Rs 55 crore in the financial

year2001-02 compared to a loss of Rs147crore in the previous financial year.


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Types of costs

Opportunity Costs

Implicit and explicit costs

Economic costsMarginal incremental and sunk costs

Direct and indirect costs

Fixed and variable costs


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Opportunity costs

It can be defined as the cost of anydecision measured in terms of the bestalternative which has been sacrificed. Ex aperson who has Rs 100 as his disposal can

spend it on either of three optionshavinga dinner, going for a music concert, or for amovie. The person prefers going for adinner rather than to movie and the movieover the music concert. Hence his

opportunity cost is sacrificing the movie ,the next best alternative once he goes for adinner.


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Implicit and explicit costs

Implicit costs are the value of foregoneopportunities that does not involve aphysical cash payment.

Though implicit costs are not included inbooks of accounts , they do play animportant role in a decision makingprocess.

Explicit costs can be defined as the costswhich involves actual payment to otherparties.


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Economic costs

Economic cost refers to the costsinvolved for all factors of productionincluding those purchased from

outside as well as those owned by thefirm.

Its basically a normal payment for all

the factors of production , includingmanagerial and entrepreneurial skillsand capital provided by the owners of

the firm.


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Marginal, incremental, sunk costs

Marginal costs can be defined as the change inthe total cost of a firm as a result of change in oneunit of input.

Incremental cost is addition of a new product line ,

acquiring a company or hiring an in house legalstaff. Thus, it can be said that marginal cost issubset of incremental cost.

Sunk costs are those which incurred in the past orthat have to be incurred in the future as a result ofcontractual agreement- exthe cost of inventoryand future rent charges for a warehouse


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Direct and Indirect Costs

Direct costs are the costs that can bedirectly associated to the productionof a given product-ex use of raw

materials, labour input etcIndirect costs are such expenses thatcan not be separated and directlyattributed to individual units ofproduction ex electricity charges,depreciation of plants and building


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Fixed and variable costs

Fixed costs are those costs which do notvary with the changes in the output of aproduct, and has to be paid even if the

firms level of output is zero.ex interest onborrowed capital, contractualrent,depreciation charges, salaries of toplevel management and others.

Variable costs are those costs that varywith the level of output.ex-payment of rawmaterials, wages and salaries


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Cost and production functions

A cost function determines thebehavior of costs with the change inoutput. It can be a schedule, graph, or

a mathematical relationship showingthe minimum achievable cost forproducing various quantities of output.

If C represents total cost and Qrepresents the level of output, thenthe cost function is represented as

C=C(Q)


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COST AND PRODUCTIONFUNCTIONS

Cost functions are derived functionsfrom production functions. Within thenon-inferior zone of the factors of

production, their total employment willalso increase as we move along theexpansion path.


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Equations

L= amount of labour

K= amount of capital

r= rate of interestw= wages

C=Lw+Kr where C= total cost


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Short run cost functions

Short run cost functions help in determining therelationship between output and costs in the

short run .

The short run average total costs(SRATC) andaverage variable costs are slightly U shaped.

The marginal cost(MC) curve intersects both

the average variable cost curve and short runaverage total cost curve at their lowest point andfrom below.


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Short run cost functions

Short run cost functions help in determining therelationship between output and costs in the

short run .

The short run average total costs(SRATC) andaverage variable costs are slightly U shaped.

The marginal cost(MC) curve intersects both

the average variable cost curve and short runaverage total cost curve at their lowest point andfrom below.


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The short run cost curve

MC SRATC

AVC

C

O

S

T

S

QUANTITY

MINIMU

M atc

analysis of costs-12

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