Cost

There are some very technical definitions of accounting terms. For example, when you start talking about assets, what makes something an asset in accounting has to do with its future utility. An automobile gives you future transportation and that's what makes it an asset. It's not listed as an asset simply because you own two thousand pounds of steel. You could get two thousand pounds of steel much more cheaply. But it's OK in accounting for day to day speaking to say an asset is something of value which you own, or in some cases control.

We're doing the same thing here. What is "cost"? A cost is what you give in return for something else. That's actually my favorite definition of a cost—what you give in return for something else. Another definition of cost is a sacrifice made for a specific purpose.

Let's review some specific examples:

1. You give $1,000 for equipment. What is your cost of that equipment? $1,000, the amount of cash you paid.
2. You sign a $100,000 mortgage note for land. What is the cost of the land? The $100,000 you gave a written promise to pay.
3. You pay factory workers $10,000 for last week's production—your cost is $10,000.
4. You pay sales staff $2,000 commissions for last month's sales—your cost is $2,000.
5. You pay office workers $5,000 salary for last month—your cost is $5,000.
6. On Saturday, you spent six hours helping a friend move. What is your cost? Your cost is six hours of your life.

There are two things you need to note from this:

First you want to note that cost does not mean expense. Only the fourth and fifth items, the sales staff commissions, which go into commissions expense, and the office workers salary, which goes into office salaries expense, are expenses at the time of payment. For the first item you've got equipment: a property, plant, and equipment asset. For the second item you've got land: a property, plant, and equipment asset. For the third item, you got work-in-process which is an inventory account among the current assets. And for the last item, where you helped your friend move, you've got an account receivable from your friend. However, if you do not have an account receivable for your friend you could have an expense, in that particular instance.

The second thing you should note from the above examples is that cost does not mean cash outlay. Take Number 2; there is no cash being paid in Number 2. There is a written promise to pay later. Yet we still have a cost. And take Number 6, where you gave up six hours of your life to help your friend move. There is a cost there, but there is no cash outlay. And in the case of Number 6, there never will be a cash outlay.

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