It refers to the monetary expenditure which a firm has to incur in order to purchase or hire the factors of production. It is the expense of purchasing or hiring factor services for production and other business activities.

Classification of Cost / Types of Cost

There are various types of cost:

On the basis of Nature of Costs –

• Fixed Cost – It is the cost of fixed inputs used in production. These costs do not vary with the change in volume of production.
• Variable Cost – It is the cost of variable inputs used in production. These costs vary with the change in volume of production.
• Semi Variable Cost – It refers to costs which are partly fixed and partly variable. These types of cost do not directly affect the level of production but may vary with change in production facilities e.g. administrative cost, maintenance cost, depreciation cost etc.
• Total Cost – It refers to the total cost of production.

Total cost = Fixed cost + Variable Cost

• Marginal Cost – It refers to the cost of producing one extra unit of a product.

MC = TC_n – TC_n-1

TC_n = Total cost of producing n products, TC_n-1 = Total cost of producing n-1 products

On the basis of Expense –

• Material Cost – It refers to the cost of procurement and use of any raw material used for production.
• Labour Cost – It refers to the payments made to permanent and temporary workers for their services.
• Overhead cost – It refers to costs which are semi-variable and vary with the level of production like administrative expenses, cost of indirect material and labour, indirect expenses etc.

On the Basis of Control:

• Controllable cost – It refers to costs which can be influenced or controlled by the actions of the organization members.
• Uncontrollable cost – It refers to costs which cannot be controlled by the actions of the organizations members.

According to Functions or Operations of a Business:

• Preliminary Cost – costs incurred before the commencement of the actual business e.g. rent, interest, product trial, underwriting costs etc.
• Cost of Production – cost of material, labour, overheads etc.
• Cost of Marketing and Selling – cost of marketing, selling promotion, advertising, distribution etc.
• Cost Research and Development – cost of innovation, new or improved products, advance production facilities etc.

According to behaviour of cost:

• Direct Cost – It refers to costs which involve a direct expense and are easily traceable.
• Indirect Cost – It refers to costs which are indirect and not easily traceable.
• Explicit or Accounting Cost – It refers to the payments made in monetary terms by a firm, to the owners of factor services required for production.
• Implicit or Economic Cost – It refers to the estimated value of all the inputs owned and put to use for production by a firm.

On the basis of relevance in Decision Making:

• Opportunity Cost – It refers to the cost of the next best alternative action that is sacrificed in order to pursue the chosen action.
• Sunk Cost – It is the cost which is not altered by a change in current business activity. It can be understood as an irrevocable cost of the past business activity which has to be incurred now and is irrelevant to the current business scenario.
• Replacement Cost – It is the cost of replacing an asset, plant, machinery, equipment etc.
• Imputed cost – These are hypothetical costs which are considered just for the purpose of decision making and do not involve any actual cash outflow.
• Real Cost – It refers to the cost of all efforts and sacrifices made by the owners of factors of production in production of a commodity.
• Social Cost – It refers to the cost of hardships and sacrifices that a society has to bear due to operation of business activities.
• Conversion Cost – It refers to the cost involved in transforming raw materials into finished products. These types of cost do not include the actual cost of raw material. It includes the cost of direct and indirect labour, overheads and expenses.

Other Types of Cost:

• Historical Cost – It refers to the actual cost of acquiring an asset or producing a product or service.
• Normal Cost – It is a cost which normally incurred in achieving a certain level of output under certain conditions.
• Abnormal Cost – It is the cost which is not normally incurred at a given level of output under normal conditions. It is an irregular cost which would not exist in ideal conditions.
• Differential Cost – It is the change in cost due to change in level of production.
• Incremental Cost – It is the additional cost in relation to a change in the level or nature of business activity.

IC = TC2 – TC1

TC2 = Cost after change, TC1 = Cost before change

The post Types of Cost / Classification of Costs appeared first on BBA|mantra.

Zero Based Budgeting was originally developed by Peter A Pyhrr at Texas instruments.  He defined Zero Based Budgeting as “an operating, planning and budgeting process which require each manager to justify his entire budget request in detail from scratch and shifts the burden of proof to each manager to justify why he should spend any money at all.”

Features of Zero Based Budgeting

→ It reviews a project from `scratch’ on an assumption that noting is to be allowed.

→ It deals with all aspects of budget requests of managers. Managers have to justify that a project is essential and of high priority.

→ It reviews critically both existing and newly proposed activities.

→ It sets priorities in respect of different activities and re-deploys the resources accordingly.

Process of Zero Based Budgeting

Zero Based Budgeting involves the following steps –

(i) Identification of decision unit – Decision units are identified in terms of responsibility centres. They should have a meaningful identification and evaluation.The amount of expenditure, scope, direction and quality of task are bases to justify a meaningful decision unit.

(ii) Preparation and development of decision packages – Formulation of decision package is a set of documents which identify and describe activities of the unit in such a way that management can evaluate and rank them against others competing for limited resources and decide to approve or disapprove it.

(iii) Ranking of priority – Decision packages are ranked by operational, departmental or executive managers on the basis organizational needs, availability of funds and other related factors. Ranking can be done by the following approaches or combinations of them – Judgmental approach, Comparison approach, Delphi method, voting approach.

(iv) Funding – The availability of resources of the organization is kept in mind and allocation of resources to various decision units is made. The resources should be adequate enough to meet the requirements of the selected alternatives.

Advantages of Zero Based Budgeting →

◊ It ensures optimum use of financial resources

◊ It weeds out wastage and inefficient units resulting in reduced costs and better productivity

◊ All activities are justified on cost benefit considerations

◊ It adds psychological push to managers to avoid wasteful expenditure, increases participation.

◊ It provides flexibility in the budget

◊ It links departmental objectives to corporate goals

Disadvantages of Zero Bases Budgeting →

◊ It is a lengthy and time consuming process

◊ It demands high degree of managerial skills and understanding of the organizational system

◊ Managers may resist new ideas and changes as everything cannot be justified

◊ Danger of emphasizing on short term gains at the expense of long term benefits

◊ Ranking the decision packages and cost benefit analysis require expertise and leads to high administration cost and responsibility

The post Zero Based Budgeting – Features, Process, Advantages and Disadvantages appeared first on BBA|mantra.