Opportunity Production Costs

Opportunity cost refers to the advantage, in measurable terms, which has been foregone building is proposed to be utilized for housing a new project plant, the likely revenue which the building could fetch, if rented out is the opportunity cost which should be taken into account while evaluating the profitability of the project. Similarly, if a manufacturer is confronted with the problem of selecting anyone of the following two alternatives:

(a) Selling a semi-finished product as $ 2 per unit, and

(b) Introducing it into a further process to make it more refined and valuable; alternative (b) will prove to be remunerative only when after paying the cost of further processing the amount realized by the sale of the product is more than $ 2 per unit-the revenue which could have been otherwise realized. The revenue of $ 2 per unit is foregone in case alternative (b) is adopted. The term ‘opportunity cost’ refers to this alternative revenue foregone.

A business organisation performs a number of functions e.g. production, administration, selling and distribution, research and development. Costs are to be ascertained for each of these functions. The Chartered Institute of Management Accountants, London has defined each of the above costs as follows:

(i) Production cost: The cost of the sequence of operations which begins with supplying materials, labour and services and ends with the primary packing of the product. Thus, it includes the cost of direct material, direct labour, direct expenses and factory overheads.

(ii) Administration cost: the cost of formulating the policy, directing the organisation and controlling the operations of an undertaking, which is not related directly to a production, selling, distribution, research or development activity or function.

(iii) Selling cost: The cost of seeking to create and stimulate demand and of securing orders.

(iv) Distribution cost: The cost of sequence of operations which begins with making the packed product available for dispatch and ends with making the reconditioned returned empty package, if any, available for re-use.

(v) Research cost: The cost of searching for new or improved products, new application of materials, or new or improved methods.

(vi) Development cost: The cost of the process which begins with the implementation of the decision to produce a new or improved product or to employ a new or improved method and ends with commencement of formal production of that product or by the method.

(vii) Pre-production cost: That part of development cost incurred in making a trial production rum preliminary to formal production.

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