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  Classification of Costs for Decision Making

Introduction to Classification of costs for Management decision making

One of the significant functions of cost accounting is to represent information to the Management for the reason of decision making. For decision making specific types of costs are appropriate. Classification of costs for Management decision making can be done in the following manner

I. Marginal Cost

Marginal cost is the alteration in the aggregate costs because of change in the volume of output by one unit. For instance, suppose a manufacturing company makes 10,000 units and the aggregate costs are Rs. 25,000, if 10,001 units are made the aggregate costs might be Rs. 25,020 that means that the marginal cost is Rs. 20. 

Marginal cost is also known as variable cost and therefore per unit marginal cost is all the time same that is per unit marginal cost is all the time fixed. Marginal cost could be efficiently employed for decision making in several areas.

II. Differential Costs

Differential costs are also termed as incremental cost. This cost is the variation in total cost that will take place from the selection of one alternative to the other. Other words, it is an added cost of a change in the level of activity. This kind of analysis is helpful for taking several decisions such as adding or dropping a product, change in the level of activity, make or buy decisions, change in product mix, accepting an export offer and so on.

III. Opportunity Costs

It is the value of benefit sacrificed in favor of a substitute course of action. It is the greatest amount that could be obtained at any specific point of time if a resource was sold or put to the very valuable substitute use that would be practicable. Opportunity cost of services or goods is computed in terms of revenue that could have been earned through employing that goods or services in some other substitute uses.

IV. Relevant Cost

The relevant cost is a cost that is relevant in several decisions of management. Decision making includes consideration of various alternative courses of action. In this process, whatever costs are appropriate are to be taken into consideration. Other words, costs that are going to be influenced matter the most and these costs are termed as relevant costs. Relevant cost is a future cost that is differs for different alternatives. It can also be described as any cost that is affected through the decision on hand. So in decision making relevant costs play a important role.

V. Replacement Cost

The costs at which existing items of material or fixed assets can be replaced are known as replacement cost. So this is the cost of replacing existing assets at present or at a future date.

VI. Abnormal Costs

It is a not usual or a typical cost whose occurrence is generally not regular and is not expected. This cost arises because of some unusual situation of production. Abnormal cost arises because of idle time, might be because of some unexpected heavy breakdown of machinery. They are not taken into consideration when computing cost of production or for decision making.

VII. Controllable Costs

In cost accounting, cost control and cost reduction are very important. Actually, in the competitive environment, cost control and reduction are the key words. Therefore it is necessary to recognize the controllable and uncontrollable costs. Controllable costs are those that can be controlled or affected through a conscious management action. For instance, costs such as telephone, printing stationery etc can be controlled when costs such as salaries etc cannot be controlled at least in the short run.

Usually, direct costs are controllable when uncontrollable costs are across the control of an individual in a specified period of time.

VIII. Shutdown Cost

If the operations are continued these costs are the costs that are acquired if the operations are shut down and they will disappear. Instances of these costs are costs of covering the plant and machinery and construction of sheds for storing exposed property. Computation of shutdown costs is very significant for taking a decision of continuing or shutting down operations.

IX. Capacity Cost

 These costs are generally fixed costs. The cost acquired through a company for providing production, administration and selling and distribution capabilities to perform several functions. Capacity costs involve the costs of machinery, plant and building for production, vehicles and warehouses for distribution and key persons for administration. These costs are of long-term costs and are acquired like a result of planning decisions.

X. Urgent Costs

These costs are those that must be acquired in order to continue operations of the firm. For instance, cost of material and labor must be acquired if production is to occur.

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