Actual cost is the expenditures that are actually incurred by the firm in payment for the use of resources obtained from the outside such as payments for labor, material, plant, traveling and transport, fuel, and so on. An example of a traditional income statement is presented below. Cost principle is a standard accounting practice for publicly traded companies. Using cost principle follows the Generally Accepted Accounting Procedures (GAAP), which is established by the Financial Accounting Standards Board (FASB). The objective is to maximize profitability; achieving that goal depends greatly on managing costs.

Generally Accepted Accounting Principles (GAAP) and considered a more conservative (and potentially more accurate) way to value large assets. The historical cost concept, which advocates recording the asset at its original cost, is a basic accounting principle as per US GAAP (Generally Accepted Accounting Principles). As per this principle, the value of assets in the financial statements remains the same even if their market value increases or decreases.

What is Cost Concept?

Sometimes there can be an increase or decrease in the total cost of the commodity as an alternative was used in any factor of production. If a choice of alternative results in increased cost, such increased costs are termed Incremental Costs. While assessing the profitability of a proposed change, the incremental costs are related to incremental revenues. Choice of alternative resulting in decreased cost, such decrease in cost is called Decremental Cost.

All goods and services in an economy have a cost of their own and without the concept of cost, it would be impossible for us to exchange goods and services. The concept of cost is therefore a central idea in economics that help us steer economic progress. An example of opportunity cost would be the cost of planting anything else than wheat for a farmer who plants wheat instead of something else. In simpler terms, outlay costs are related to policy accepted while opportunity costs are related to policy rejected.

Characteristics of the Cost Concept of Accounting

In particular, this is because the money paid to acquire an asset is easily ascertained and recorded without too much effort. Records that are kept based on the historical cost principle are usually considered to be more consistent, reliable, verifiable, and comparable. When there is a trade-in, a company can get a great deal of a car. The car might have a value of $20,000, but they pay $15,000 for it.

The cost is the amount the company originally paid out to purchase the asset, whereas, the fair market value is the expected amount that the asset will sell for. As an illustration of how the cost principle works, consider a small manufacturer that purchased a packing machine for $100,000 in 2018. The asset is added to the company’s balance sheet with a value of $100,000. The cost principle is one of the most conservative ways to track the values of multiple large assets, but there are some notable cases where cost accounting should not be used. The cost function of a firm is derived on the basis of the actual cost and production data of the firm.

Cost Concept of Accounting FAQs

Those costs which remain in the control of management and organization are known as controllable costs. Sunk costs are those costs that are not affected by the changes in the level of business activity or nature of business of a business firm. When an investment is made in a sick unit it is a bad debt because the investment made by the business manager may be recovered or may not be recovered. The opportunity cost may also be explained with the help of the diagram. In this diagram, AB line shows various possibilities of the production of two commodities ‘X’ and ‘Y’.

What is cost concept and its functions?

Cost function refers to the functional relationship between cost and output. It studies the behaviour of cost at different levels of output when technology is assumed to be constant. It can be expressed as below: C= f(Q) (Here, C= Cost of production; and Q= Quantum of output).

An income statement also referred to as a profit and loss statement, reports an organization’s revenue and expenses for a specified period of time. If an organization has more revenue, the resulting number is positive and represents net income or profit. If an organization has more expenses, the resulting number is negative and represents a net loss.

Incremental Costs and Sunk Costs

A direct cost is a cost directly tied to a product’s production and typically includes direct materials, labor, and distribution costs. Inventory, raw materials, and employee wages for factory workers are all examples of direct costs. Cost accounting can help with internal costs, such as transfer prices for companies that transfer goods and services between divisions and subsidiaries.