Types of costs
Direct cost
Direct cost is the Cost that is directly related to the activities of producing goods or services. The direct cost may include the cost of raw materials, labour wages, and some physical resources that are utilized to produce the product or deliver the services. Direct cost is very easy to trace and study as it directly belongs to the production of a product or service. Direct cost plays an important role in production management.
Examples
- Cost of raw material or components or spare parts used to produce or manufacture the product. For instance, Geranium oil is used as an ingredient in perfumes and cosmetics. It can also used in aromatherapy.
- Salaries and wages given to the laborers are the direct costs utilized to execute the various activities related to producing or manufacturing the product.
- Expenses spend on purchasing tools, equipment, or specific utilities to produce the product or complete the project.
- Cost of packaging material which directly belongs to the products
- Incentives or commissions are given to promote the sales
- Cost of maintenance management practice used to keep machinery in good condition. For instance, scheduled maintenance practice for machinery, and repair of physical facilities used in manufacturing or production process.
Indirect cost
Indirect cost is the cost incurred however it does not belong to the production or manufacturing of product directly. However it is not directly related to production, it plays a significant role in running all the activities of production. It may include the costs such as electricity bills, water, etc.
Examples
- Electricity bills, water, and rent are the types of costs which is difficult to include in the production cost directly. Cost per unit of the product can be determined by using direct cost easily but considering the indirect cost it makes more difficult.
- Insurance however does not belong to production or manufacturing directly but plays an important role in protecting the organization. it covers property liability and other risks associated with the whole business organization.
- Taxes on business income and property do not directly belong to the production or manufacturing of products or delivery of services.
- Depreciation which indicates gradual loss of asset value. It includes the loss of value of machinery and equipment gradually with time.
Opportunity cost
Opportunity cost belongs to managerial economics and refers to the value of another alternative that is forgone. For instance, if a company launches product A instead of product B then the opportunity cost of product A is the benefits that could have been taken if it had been launched product B.
Fixed cost
Fixed costs are the expenses incurred on factors that may or may not belong to production directly. There are no variations or changes in these expenses up to certain ranges. For instance, salaries and wages of employees, and insurance premiums are the types of fixed costs.
Examples
- Insurance of the company is often constant over a specific period say years which may be up to 10 years 20 years or more. Insurance premiums are the fixed cost for the organization.
- Instalments of loans taken by businesses are constant over a certain period up to completing the repayments of the loan.
- Permits and licenses of businesses require certain costs for a specific period. the cost associated with such business licenses and permits comes under fixed cost.
- certain amounts given as fixed salary to the permanent staff come under fixed cost
- The cost of software subscription of specific software or services required to pay for a certain period is fixed.
Average cost
Average cost is the cost per unit output or product which is obtained by dividing the whole cost by several output units produced. Average cost or cost per unit of product plays a very important role in deciding the cost efficiency of the organization. Economies of scale is the technique or method that indicates a reduction of the cost by increasing production quantity. Fixed cost is the same due to which cost per unit of the product reduces after decreasing the production quantity.
Formula Average Cost = Total cost / Total Quantity Produced
Examples
- Azum a manufacturing organization produces the total quantity per day is 500 units. The total calculated fixed cost per day is ₹5000. variable cost which is a variable cost which is calculated per day is ₹3000.
The average cost of producing the above product is calculated as follows
Average Cost = Total Cost / Total Quantity
Average cost = (5000+3000)/500
Average Cost = 8000/500
Sunk Cost
Sunk Cost is related to the expenses incurred which are nonrefundable. Business organizations may spend the expenses on various activities but later on, decide to revert from those activities. But the cost cannot be refundable from such expenses as buying a ticket for a specific event etc.
Examples
- When an organization buys a ticket to a sports event but later decides to cancel visiting that event. The costs spent on purchasing such a ticket are refundable. Search cost comes under sunk cost.
- When a businessman decides to book a hotel for a specific. And later decided to cancel in such cases come out is non-dependable. The amount spent on booking a hotel comes under sunk cost.
- Purchasing the membership of a club, gym or any other organization comes under sunk cost
Implicit cost
Implicit cost is the non-monetary and non-explicit cost that belongs to the alternative with its resources that could have been utilized but not used. For instance, if the company owns the land but is not utilized or rented for return. Implicit cost and opportunity cost are related. Implicit cost can be opportunity cost but opportunity cost can not be implicit cost as opportunity cost can be explicit cost.
The difference between implicit cost and opportunity cost is that opportunity cost is the cost of a forgone alternative which can be implicit or explicit. Whereas implicit cost is a non-explicit and forgone cost of own resources that could be used.
Examples
- Consider you are implementing a business idea to convert it into a successful business model. At the same time, you have an offer from MNC with a monthly salary of one lac rupees. You have chosen a business idea. The implicit cost is the value of a job that you could have joined instead of a business. An explicit cost is the cost of establishing a business which includes machinery, rent, raw materials, etc.
- If you have personal savings but you have not invested anywhere such as land, stock, or business that could have given earnings. The value of investing your savings into various sources of income belongs to implicit cost.
Explicit cost
All direct costs come under the explicit costs. Explicit costs are the cost that belongs to the expenses incurred on executing the business activities such as the cost of raw materials, rent, salaries, etc. These costs are recorded in the general ledger of the company.