Cost Concepts Flashcards
Define “cost” as used in accounting.
Amount paid or obligation incurred for a good or service; may be unexpired or expired. An unexpired cost is an asset. An expired cost is an expense.
Define “expired cost.”
The benefit to an entity from the good or service that has been used up and is of no future value to the entity. An expired cost is an expense (e.g., cost of wages and salaries) or a loss (e.g., cost of goods destroyed by fire).
Define “unexpired cost.”
As asset; it has future value to the entity (e.g., the cost of a three-year insurance policy would be an asset during the period covered).
Define “sunk cost.”
Costs incurred in the past that cannot be changed by current or future decisions and, therefore, are irrelevant to current decisions.
Define “opportunity cost.”
Benefit lost from the next best opportunity as a result of choosing another opportunity. It is measured as the discontinued value of the cash flow or other benefit forgone and is relevant in making current decisions.
Define “differential cost.”
Costs which are different between two or more alternatives. Differential costs are relevant in making decisions between the alternatives. For example: in deciding whether to accept a special order for a product, only the new costs that would be incurred in accepting the order would be relevant. Fixed costs that would not change whether the order is accepted or not would not be relevant.
How is a firm’s cost of capital determined?
Cost of capital is the rate of return that must be earned by prospective investors in order for a firm to attract and retain their investments.
Investors’ expected rate of return is determined primarily by the rate of return that could be earned on other opportunities with comparable risk; in other words, it is investors’ opportunity cost.
What are the major elements of a firm’s capital (or capital structure)?
Long-term debt, preferred stock, and common stock
Define “weighted-average cost of capital.”
Cost of each element of capital weighted by the proportion (percentage) of total capital provided by each element, with the resulting products summed to get the weighted average cost for all elements of capital.
