fixed cost

For example, suppose a company leases a machine for production for two years. The company has to pay $2,000 per month to cover the cost of the lease, no matter how many products that machine is used to make. The lease payment is considered a fixed cost as it remains unchanged.

Explicit and implicit cost is the main difference between accounting cost and economic cost. While economic cost takes into account explicit and implicit costs, accounting cost only considers actual expenses and capital depreciation. Traditionally, overhead costs are assigned based on one generic measure, such as machine hours. Under ABC, an activity analysis is performed where appropriate measures are identified as the cost drivers.

More explanations about Production Cost

Although a firm might experience high revenues, if the cost of production is high, it will shrink the firm's profit. Since cost-accounting methods are developed by and tailored to a specific firm, they are highly customizable and adaptable. Managers appreciate cost accounting because it can be adapted, tinkered with, and implemented according to the changing needs of the business.

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The price that's set during the pricing process is what the customer will pay for that product or service. Pricing, as the term is used in economics and finance, is the act of establishing a value for a product or service. In other words, pricing occurs when a business decides how much a customer must pay for a product or service. An example of cost principle is a business purchasing a plot of land for $40,000 in 2019 that it planned to use as a parking lot.

What are Product Costs?

However, the company may use other resources, some of which have expenses that are not as readily apparent but are still significant. These are the concept of fixed cost and the concept of variable cost. When it comes to the cost concept in accounting, determining these two variables is crucial.

Product costs are treated as inventory on the balance sheet and do not appear on the income statement as costs of goods sold until the product is sold. The records may reflect either actual values or estimated amounts based on standard costs and are adjusted later. Also, many companies today use backflush costing and activity-based costing. Only a few costs can actually be dropped without causing any short-term harm to an organization. Examples of these discretionary costs are employee training and facility maintenance.

Overview of Total Cost Concept

These will vary from industry to industry and firm to firm, however certain cost categories will typically be included , such as direct costs, indirect costs, variable costs, fixed costs, and operating costs. Marginal costing (sometimes called cost-volume-profit analysis) is the impact on the cost of a product by adding one additional unit into production. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit.

expense in the economy are scarce, and the allocation of them in an efficient manner is an essential step toward maximizing the firm's profit. The cost concept of accounting states that all assets are recorded at cost in the books of account. That is assets are recorded at the cost that is paid to acquire them rather than their market value. On the contrary, variable costs keep changing based on the quantity of production.

In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. Fixed costs and variable costs are also important types of economic costs.

Cost Object in Budgeting

Cost concept is important, especially when it comes to financial decision making for your business. The study of the cost concept in accounting provides the base for understanding pricing. On the professional level, it helps managers in taking correct decisions like the concept of fixed cost, the concept of variable cost, price quotation, and others. As the term predicts, fixed costs don't change in the volume of output.

direct and indirect

Labour CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. Suppose a business buys a plot of land for Rs 10,00,000 in the year 2016. This plot of land will be recorded in the books of account at the price paid to acquire it. Now suppose in 2017, the market value of the land rises to 12,00,000. But the land will be recorded in the books of account at Rs. 10,00,000.

For example, the costs of materials and labour which must be incurred if production is to take place. Social costs on the other hand, refer to the total cost to the society on account of production of a commodity. The expenditures of this nature are incremental costs and not the marginal cost .

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Now, the market value of machinery is $20,000, but as per books, after applying depreciation, the value is showing as $ 30,000. The difference between the two values is that the organisation follows the cost principle for its assets and has not considered the change in market value. Actual Costs or Outlay Costs means the actual amount of expenses incurred to produce or acquire a good or service.

The distinction primarily shows how cost affects the cash position. Book costs can be converted into out-of-pocket costs by selling the assets and having them on hire. If he is a profit maximizing investor, he would invest his money in printing machine and forego the expected income from the lathe.

For example, a wheat farmer sets a price that's paid by a food wholesaler. After buying wheat, the food wholesaler will set a price to sell to a bakery. There may be common mark-up rates among industries, but ultimately, the decision comes down to individual retailers.

Standard costing assigns "standard" costs, rather than actual costs, to its cost of goods sold and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard cost and the actual cost incurred is called variance analysis. Cost principle, also referred to as historical cost principle, is an accounting practice that records the original purchase price of assets on financial statements despite fluctuating market changes.

For example, in the context of inflation, the bookkeeping services concept of accounting would lead to an overstatement of net profit. Fixed costs demand the fixed expenditure of funds without considering the level of output like interest on loans, rents, depreciation, and others. Overhead refers to the ongoing business expenses not directly attributed to creating a product or service. A fixed cost is a cost that does not vary with the level of production or sales.

As per this principle, the value of assets in the financial statements remains the same even if their market value increases or decreases. The assets are recorded at their original cost after accounting for depreciation, if any. The monthly salary of the general manager, when one of the divisions is a costing unit, would be an Indirect Cost. The salary of the manager of the other division is neither a direct nor an indirect cost. Thus, whether a specific cost is direct or indirect depends upon the costing unit under consideration. The concepts of direct and indirect costs are meaning-less without identification of the relevant costing unit.

Under the circumstances, costs are classified into three broad categories Material, Labour and Overhead. For example, Material may be subdivided into raw materials, packing materials, consumable stores etc. This classification is very useful in order to ascertain the total cost and its components. Cost Concept – By this concept, the value of an asset is to be determined on the basis of historical cost, in other words, acquisition cost. Hence, All the fixed assets are recorded at Historical Cost only and market value of fixed assets is ignored.