Basic Cost Terms and Concepts

R&D Project Decision Example

• Project cost: 100 m
• Estimated benefits (original): 160 m
• Amount already spent: 40 m (this year)
• Remaining spend: 60 m (next year)
• Revised estimated benefit: 90 m

Decision point:

• If you include the total cost (100 m), revenue (90 m) < cost ⇒ conclude “do not continue.”
• If you abandon now, loss = amount spent = 40 m.
• If you continue, total spend = 100 m, revenue = 90 m ⇒ loss = 10 m.

The 40 m already spent is a sunk cost (irrelevant for decision going forward).

---

What Is “Cost”?

Monetary measure of resources given up in acquiring goods or services.

---

3. Cost Classification

A. On the Basis of Time

Term	Definition	Typical Use
Historical Cost (Past)	Cost actually incurred	Financial statements
Replacement Cost (Present)	Cost to replace resource now	Decision making, insurance computation
Budgeted Cost (Future)	Planned or standard cost	Planning and control

---

B. On the Basis of Volume

• Variable Costs

  • Change in total with volume.
  • Examples: Material cost (manufacturing), Employee cost (software).

• Fixed Costs

  • Remain constant over relevant range.
  • Example: Office rent.

• Mixed Costs

  • Have both fixed and variable elements.
  • Example: Salary + commission for sales staff.

• Step Costs

  • Stay fixed over small ranges, then “step up” when capacity threshold exceeded.
  • Example: Depreciation & maintenance on machines—if capacity > 1,000 units, need a second machine ⇒ costs double.

---

C. On the Basis of Financial-Statement Classification

• Unexpired (Deferred) Costs

  • Capitalized on balance sheet initially.
  • Example: Full machine cost on acquisition day.

• Expired Costs

  • Portions of unexpired cost allocated to current period.
  • Example: Depreciation.
  • Reported on the income statement.

• Product (Inventoriable) Costs

  • Directly related to manufacturing the product.
  • Included in inventory valuation.
  • Examples: Raw materials, direct labour, factory overhead.

• Period (Non‑inventoriable) Costs

  • Not tied to production volume; expensed immediately.
  • Examples: Office rent, administrative salaries, sales‑dept. depreciation.

---

D. On the Basis of Decision‑Making Relevance

• Relevant (Incremental / Opportunity) Costs

  • Future costs or benefits that differ between alternatives.
  • Example: Discount offered ⇒ explicit cost; extended credit period ⇒ foregone interest income or extra borrowing cost.

• Irrelevant (Sunk) Costs

  • Already incurred, cannot be recovered.
  • Example: The 40 m spent on R&D so far.

---

4. Cost Flow & Cost Sheet Example (Room Air Conditioner)

Item	Amount (₹ per unit)
Direct Material Cost	10,815
Direct Labour Cost	1,646
→ Prime Cost (Material + Labour)	12,461
Manufacturing Overhead	2,970
→ Cost of Goods Manufactured	15,431
Administrative Overhead	2,028
Selling & Distribution Overhead	3,640
→ Total Cost of Sales (COGM + Admin + SDO)	21,099
Net Income per Unit	3,801
Average Sales Price	24,900
Profit Margin (3,801 ÷ 24,900 x 100) ≈ 15.27%
Conversion Cost (Labour + Mfg OH)	4,616
Conversion Margin (3,801 ÷ 4,616 x 100) ≈ 82%

---

Flowcharts