Costs

• Author: Roman Weil
• Pages: 170-173

Page 170

The word "cost" appears in many accounting, economics, and business terms with subtle distinctions in meaning. The word by itself rarely has a clear meaning. (Likewise the word "value" has no clear meaning. Avoid using "value" without a modifying adjective, such as "market," "present," or "book.") The word cost, without modifying adjectives, typically means the sacrifice, measured by the price paid or required to be paid, to acquire goods or services. Hence, the word often carries the meaning more precisely represented by the following:

Acquisition cost; historical cost. Net price plus all expenditures to ready an item for its intended use at the time the firm acquired the item. The other expenditures might include legal fees, transportation charges, and installation costs.

Accountants can easily measure acquisition cost, but economists and managers often find it less useful in making decisions. Economists and managers more often care about some measure of current costs, which accountants find harder to measure.

Current cost. Replacement cost or net realizable value.

Replacement cost. Acquisition cost at the date of measurement, typically the present, in contrast to the earlier date of acquisition.

Net realizable value. The amount a firm can collect in cash by selling an item, less the costs (such as commissions and delivery costs) of disposition.

Accountants most often refer to current costs as fair value.

Fair value. Price negotiated at arm's length between willing buyers and willing sellers, each acting rationally in their own self-interest. Sometimes measured as the present value of expected cash flows.

Accountants often contrast (actual) historical cost with standard cost.

Standard cost. An estimate of how much cost a firm should incur to produce a good or service. This measurement plays a role in cost accounting, in situations where management needs an estimate of costs incurred before sufficient time has elapsed for computation of actual costs incurred.

The following terms desegregate historical cost into components.

Variable cost. Costs that change as activity levels change. (The term "cost driver" refers to the activity that causes cost to change.) Strictly speaking, variable costs are zero when the activity level is zero. Careful writers use the term "semivariable costs" to mean costs that increase strictly linearly with activity but have a positive value at zero activity level. Royalty fees of 2 percent of sales are variable; royalty fees of $1,000 per year plus 2 percent of sales are semivariable.

Page 171

Fixed cost. A cost that does not change as activity levels change, at least for some time period. In the long run, all costs can vary.

In accounting for the costs of product or services or segments of a business, accountants sometimes desegregate total costs into those that benefit a specific product and those that benefit all products jointly produced.

Traceable cost; direct cost. A cost the firm can identify with a specific product, such as the cost of a computer chip installed in a given personal computer, or with some activity.

Common cost; joint cost; indirect cost. A cost incurred to...