[Q.11] How do you calculate opportunity costs?

First, you will not find opportunity costs in the general ledger. The reason is that opportunity costs are the profits associated with a missed or lost opportunity. For example, if a company has a limited number of machine hours available on its large specialized machine and the setup time is four hours, the company is losing the opportunity of producing profits during those four hours.

Opportunity costs are often thought of as the lost contribution margin, which is revenues minus variable costs. If the large specialized machine is billed out to customers at $200 per hour and the variable costs of operating the machine are $80 per hour, the contribution margin and the opportunity cost is $120 per machine hour. During the four-hour setup time, the company is losing or foregoing the contribution margin of $480. In other words, its opportunity cost for the setup time is $480.

While this opportunity cost of $480 per setup cannot be recorded in the general ledger accounts, it should be considered in quoting or setting prices for customers. It should also motivate the company to look for ways to reduce the time needed to set up the machine.

Posted in: accounting,Q.11-20