Basic Cost Concepts

Basic Cost Concepts

These terms are based on certain cost concepts, which are summarized below:

1. Concept of objectivity:-

It is this concept that gives direction to the activities related to cost funding, cost analyzing and cost reporting. This concept necessitates goal congruence, i.e; cost exercise has to be in harmony with objectives. Cost treatments and cost strategies are influenced by objectives, which may include internal reporting for operational decisions, internal reporting for nonrepetitive decisions and external decisions

2. Concept Of Materiality:-

This concept that stresses accuracy must be tempered by good judgment, if no distortion of product cost is likely to result. For example, overhead may include some items of direct cost, which may not be material as to justify tracing them to specific unit of production. A particular decision may be useful, but benefits may not be material enough to implement it. Materiality is determined with reference to nature of company‘s activities, managerial policies and competitors practices.

3. Concept of time span:-

All assumptions relating to different cost exercises remain valid only during related time span. The statement that cost is fixed is based on a time span under consideration. No costs will remain fixed for all the time. Time span selected by a company should be long enough to permit the procedures to record the associated cost, output, labor hours and other factors needed in the analysis. If time span is too short, leads and lags in recording the cost data may be quite troublesome. If cost resulting to a particular time span activity is recorded to another time span activity, cost results may turn out to be quite erroneous.

4. Concept of relevant range of activity:-

Relevant range of activity represents the span of volume over which the cost behavior is expected to remain valid. Different cost exercises are based on certain assumptions relating to cost behavior patterns, which are valid only within the relevant range of activity. A fixed cost is fixed only in relation to the relevant range of activity during the period. The relevant range of activity may be different between firms and for individual firm also, it may change from time to time.

5. Concept of relevant cost and benefit for operating decisions:-

This concept is vital for decision –making purposes. In evaluating alternative courses of action, management should consider only relevant cost and relevant benefit relating to alternatives under consideration.
a. Relevant costs and benefits for operating decisions: in operating decisions, concentration is on best use of existing capacity. Incremental analysis based on differential cost and differential revenue is based directly on the concept of relevant cost and benefit. The term opportunity cost also springs from the thought underlying this concept.
b. Relevance of normal and abnormal cost. The term normal cost and abnormal cost, normal working conditions and abnormal working conditions are frequently used in cost accounting discussions. Normal cost and abnormal cost cannot be treated alike. Similarly, cost accounting strategy for normal conditions will not hold good for abnormal conditions. The term normal stands for anything, which is in agreement with what is representative, usual, or regular. The term abnormal stands for anything, which is different from what is normal, ordinary or expected. Different cost accounting treatments are laid down for normal cost and abnormal cost. Different cost accounting strategies exist for normal circumstances and abnormal circumstances.