Types and classifications of cost. The cost may be classified as follows:
1) Future cost versus historical cost:
Future costs are the basis on which financial decisions are taken. although they are only projections of what may or may not happen in the future, they are more important as compared to the historical cost, which is nothing but frozen a figure. However, historical costs are like guiding tools for future forecasting.
2) Specific Cost versus Composite Cost:
‘Specific Cost’ is the cost of an individual source of capital, whereas the ‘Composite Cost’, also known as “Overall Cost’ is the cost of capital of all the sources taken together. To start with, the costs of individual sources, like debentures, preference shares, equity shares, retained earnings, etc. are computed individually (specific costs) and thereafter calculation of ‘Composite Cost’ may be undertaken. Bond by
As the ‘Composite Cost’ thus arrived at, takes into account the source of capital received through each of the specific sources, it is also termed as ‘Weighted Cost’.
3) Average Cost versus Marginal Cost: ( Classification of Cost. )
After the calculation of the cost of an individual source of capital (specific cost), weights are assigned to each of them in the ratio of their share. The average of this is termed as weighted average cost or “average cost.” In contrast, “marginal cost” is defined as “the change in total cost that occurs when the quantity produced increases by one unit.” That is, it is the cost of producing one more unit of a good. When the company raises additional capital from only one source, then the ‘Specific Cost’ is the ‘Marginal Cost.
In capital budgeting. ‘Marginal Cost is considered to be more significant. It increases in equal proportion with the increase in the quantum of debt.