Opportunity Cost

Definition

An opportunity cost is a cost that results from a foregone opportunity. Opportunity cost is the concept used for the evaluation of alternative uses of resources. Decision makers select that alternative use of resources from which they expect the maximum net return. Opportunity cost is the net return that could be obtained from the second best alternative that has been rejected.

this cost is referred to as “the advantage, in measurable terms, which has been foregone on account of non-utilisation of facilities available in the manner in which it has been originally planned”. If owned building is utilised for housing a new project the likely rent which the building could have fetched is the opportunity cost and it must be considered at the project evaluation time, particularly the evaluation of profitability of the project.

Explanation

In choosing between alternatives, management desires to select the alternative with the smallest total cost. By selecting one opportunity, management foregoes an alternative. The benefit from a rejected alternative is known as the opportunity cost of the alternative accepted. Also, since there are no cash receipts or cash expenditures incurred in connection with a foregone opportunity, opportunity costs are not entered in the accounting records. However, they are a significant part in the decision-making process.


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