LeoGlossary: Cost

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Cost is a term that is used in daily commerce. It is also an accounting term.

A cost is the monetary value that has been spent by a company in order to produce something. It is also the amount of money spent to provide a service, mostly from labor.

Many terms can be interchangeable based upon the perspective of the transaction.

From the buyer's point of view, this can be considered the price, aka the cost of acquisition. This is applicable whether the one purchasing is an individual or business.

The seller of a product such as a merchant will view the cost different from the purchase price. Under this scenario, the cost is the price less the profit.

Accounting

In accounting, the term cost refers to the monetary value of expenditures for services, supplies, raw materials, labor, products, equipment, etc. Cost is an amount that is recorded in bookkeeping records as an expense. This is located on the income statement.

A cost basis is sought from which a value is assigned. The cost depends upon the asset and how it was acquired.

Production is much different than purchase. Companies that are into manufacturing will have a different cost basis on a product.

A finished asset that is purchased will use the price as the cost basis. Buying a piece of real estate is an example.

This is a concept that holds for financial assets. There are many reason to determine the cost basis. The primary is to determine profit or loss on the investment. Taxes are also allocated based upon this number.

Depending upon the time the security is held, this is known as a capital gain or loss.

There are two types for accounting purposes:

  • Fixed - costs that do not change along with production
  • Variable - costs that will increase along with either an increase or decrease of production

Fixed costs include rent, salaries, equipment or taxes. Variable costs could be supplies, raw materials, and some forms of labor.

Business Forecasting

Costs are one of the items that are watched closely by companies.

In the case of a start up, costs are estimated to determine what level of revenue is required achieve profitability.

When cost exceed revenues, the entity is operating at a loss. This forces companies to increase their revenues by selling more of the product or service. This can offset the fixed costs incurred.

The company can also engage in cost cutting. This often involves the reduction in payroll since that is the quickest way to see the return on the moves.

Publicly traded corporations are under heavy pressure to produce profits. When expectations are not hit, Wall Street often pushes management to provide a plan to return to profitability. CEOs regularly turn to cost cutting measures as a way to improve the numbers.

If management forecasts ongoing losses, new measures are going to be required if the executive team expects to hold their positions.

Examples of Costs

There are many examples of costs that businesses will use. Some are:

  • Average cost
  • Direct cost
  • Incremental cost
  • Indirect cost
  • Life-cycle cost
  • Repugnancy costs
  • Semi-variable cost
  • Total cost

Opportunity Cost

Economics use this concept to refer to the choice between two alternatives.

When dealing with a limited number of resources, the choice in on direction means there is a cost of not pursuing the other. The value of the second is given up in return for the first.

For example, if a company has the choice between investing in a new market or expanding the existing product line, the choice not taken is the opportunity cost.

By allocating resources to a new market, those cannot be used to expand the existing line. The profitability from that expansion is the cost of choosing the alternative.

This could be viewed from a personal perspective also. The choice to spend the weekend at the office can have the opportunity cost of seeing a child's ball game or connecting with one's spouse.

General: