Theme of the lecture №9. Costs of production and production realization

1. Concept of costs and gross income

2. Classification of production costs

3. Foreign experience of determining the cost of production

1. In production, research, retail and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production.

More generalized in the field of economics, cost is a metric that is totaling up as a result of a process or as a differential for the result of a decision. Hence cost is the metric used in the standard modeling paradigm applied to economic processes.

2. Components of Economic Costs

• Total cost (TC): Total Cost equal fixed cost plus variable costs. TC = FC + VC.

  • Variable cost (VC): Variable costs are the costs paid to the variable input. Inputs include labor, capital, materials, power and land and buildings. Variable inputs are inputs whose use vary with output. Conventionally the variable input is assumed to be labor.

    • Total variable cost (TVC) or (VC) total variable costs is the same as variable costs.

  • Fixed cost (FC) fixed costs are the costs of the fixed assets those that do not vary with production.

    • Total fixed cost (TFC) or (FC)

• Average cost (AC) average cost are total costs divided by output. AC = FC/q + VC/q

  • Average fixed cost (AFC) = fixed costs divided by output. AFC = FC/q. The average fixed cost function continuously declines as production increases.

  • Average variable cost (AVC) = variable costs divided by output. AVC = VC/q. The average variable cost curve is typically U-shaped. It lies below the average cost curve and generally has the same shape - the vertical distance between the average cost curve and average variable cost curve equals average fixed costs. The curve normally starts to the right of the y axis because with zero production

• Marginal cost (MC)

• Cost curves

3. Accuracy in product costing is an important issue in managerial accounting and control. For purposes of product profitability analysis and continuous cost improvement, it is no longer considered sufficient to obtain aggregate cost figures only that are used for external financial reporting. With increasing global competition in the marketplace, the trend is towards setting a target selling price with a target product quality as a first step in new product planning. This is very different from the traditional approach where the selling price is set by estimating the product cost and adding to it a desired profit margin and where an acceptable level of quality is the aim. The new trend is to attain the highest product quality or at least to meet the target quality level at the target price. Thus, if the estimated product cost is below the target cost obtained by deducting a profit margin from the target price, the task is to increase quality further rather than to accept a higher profit margin. If the estimated product cost is higher than the target cost, then alternative product designs are sought or the profit margin reduced, rather than increasing the target selling price or reducing target quality. This is the currently proven way to obtain a desirable market share for the product. As a consequence, it is more important than ever to accurately determine product costs.

Basic literature: 1,2,3,4,5,6,7,8,9.

Additional literature: 10,11,12,13,14,15,16.

Periodicals: 17-60

Internet sources and the optional list of electronic sources: 1-6