Job Analysis

Job Analysis is a process to identify and determine in detail the particular job duties and
requirements and the relative importance of these duties for a given job. Job Analysis is a
process where judgements are made about data collected on a job.

The Job; not the person An important concept of Job Analysis is that the analysis is conducted
of the Job, not the person. While Job Analysis data may be collected from incumbents through
interviews or questionnaires, the product of the analysis is a description or specifications of the
job, not a description of the person.

Purpose of Job Analysis

The purpose of Job Analysis is to establish and document the 'job relatedness' of employment
procedures such as training, selection, compensation, and performance appraisal.

Determining Training Needs

Job Analysis can be used in training/"needs assessment" to identify or develop:

training content
assessment tests to measure effectiveness of training
equipment to be used in delivering the training
methods of training (i.e., small group, computer-based, video, classroom...)

Compensation
Job Analysis can be used in compensation to identify or determine:

skill levels
compensable job factors
work environment (e.g., hazards; attention; physical effort)
responsibilities (e.g., fiscal; supervisory)
required level of education (indirectly related to salary level)

Selection Procedures
Job Analysis can be used in selection procedures to identify or develop:
 job duties that should be included in advertisements of vacant positions;
appropriate salary level for the position to help determine what salary should be offered
to a candidate;
minimum requirements (education and/or experience) for screening applicants;
interview questions;
selection tests/instruments (e.g., written tests; oral tests; job simulations);
applicant appraisal/evaluation forms;
orientation materials for applicants/new hires

Performance Review
Job Analysis can be used in performance review to identify or develop:

goals and objectives

performance standards
evaluation criteria
length of probationary periods
duties to be evaluated

Methods of Job Analysis

Several methods exist that may be used individually or in combination. These include:

review of job classification systems

incumbent interviews
supervisor interviews
expert panels
structured questionnaires
task inventories
check lists
open-ended questionnaires
observation
incumbent work logs
A typical method of Job Analysis would be to give the incumbent a simple questionnaire to
identify job duties, responsibilities, equipment used, work relationships, and work environment.
The completed questionnaire would then be used to assist the Job Analyst who would then
conduct an interview of the incumbent(s). A draft of the identified job duties, responsibilities,
equipment, relationships, and work environment would be reviewed with the supervisor for
accuracy. The Job Analyst would then prepare a job description and/or job specifications.

The method that you may use in Job Analysis will depend on practical concerns such as type of
job, number of jobs, number of incumbents, and location of jobs.

What Aspects of a Job Are Analyzed?

Job Analysis should collect information on the following areas:

Duties and Tasks The basic unit of a job is the performance of specific tasks and duties.
Information to be collected about these items may include: frequency, duration, effort,
skill, complexity, equipment, standards, etc.
Environment This may have a significant impact on the physical requirements to be able
to perform a job. The work environment may include unpleasant conditions such as
offensive odors and temperature extremes. There may also be definite risks to the
incumbent such as noxious fumes, radioactive substances, hostile and aggressive people,
and dangerous explosives.
Tools and Equipment Some duties and tasks are performed using specific equipment
and tools. Equipment may include protective clothing. These items need to be specified
in a Job Analysis.
Relationships Supervision given and received. Relationships with internal or external
people.
Requirements The knowledges, skills, and abilities (KSA's) required to perform the job.
While an incumbent may have higher KSA's than those required for the job, a Job
Analysis typically only states the minimum requirements to perform the job.

Job Analysis and Job Description

Job Analysis:
In simple terms, job analysis may be understood as a process of collecting information about a
job. The process of job analysis results in two sets of data:

i) Job description and

ii) Job specification.

These data are recorded separately for references.

Let us summarise the concept of Job Analysis:

A few definitions on job analysis are quoted below

1. Job analysis is the process of studying and collecting information relating to the operations
and responsibilities of a specific job. The immediate products of this analysis are job descriptions
and job specifications.

2. Job analysis is a systematic exploration of the activities within a job. It is a basic technical
procedure, one that is used to define the duties, responsibilities and accountabilities of a job.

3. A job is a collection of tasks that can be performed by a single employee to contribute to the
production of some products or service provided by the organization. Each job has certain ability
recruitments (as well as certain rewards) associated with it. Job analysis is the process used to
identity these requirements.

Specifically, job analysis involves the following steps:

1. Collecting and recording job information

2. Checking the job information for accuracy.

3. Writing job description based on the information

4. Using the information to determine the skills, abilities and knowledge that are required on the
job.

5. Updating the information from time to time.

Job Analysis, A process of obtaining all pertaining job facts is classified into two i.e. Job
Description and Job specification
Job Description is an important document, which is basically descriptive in nature and contains
a statement of job Analysis. It provides both organizational informations (like location in
structure, authority etc) and functional information (what the work is).

It gives information about the scope of job activities, major responsibilities and positioning of
the job in the organization. This information gives the worker, analyst, and supervisor with a
clear idea of what the worker must do to meet the demand of the job.

Who can better describe the characteristics of good job description?

Earnest Dale has developed the following hints for writing a good job description:

1) The job description should indicate the scope and nature of the work including all-important
relationships.

2) The job description should be clear regarding the work of the position, duties etc.

3) More specific words should be selected to show:-

a) The kind of work

b) The degree of complexity

c) The degree of skill required

d) The extent to which problems are standardized

e) The extent of workers responsibility for each phase of the work

So we can conclude by saying that Job description provide the information about the type of job
and not jobholders.

USES OF JOB DESCRIPTION:

Now we will see why job description is necessary in an organization,

There are several uses of job description, like

Preliminary drafts can be used as a basis for productive group discussion, particularly if the
process starts at the executive level.

It helps in the development of job specification.

 It acts as a too during the orientation of new employees, to learn duties & responsibilities. It
can act as a basic document used in developing performance standards.

Contents of Job Description :

Following are the main content of a job description it usually consist of following details or
data.,

Job Description: A statement containing items such as

Job title / Job identification / organization position

Location

Job summary

Duties

Machines, tools and equipment

Materials and forms used

Supervision given or received

Working conditions

Hazards

Job identification or Organization Position: This includes the job title, alternative title,
department, division and plant and code number of the job. The job title identifies and designates
the job properly. The department, division etc., indicate the name of the department where it is
situated and the location give the name of the place.

Job Summary: This serves two important purposes. First is it gives additional identification
information when a job title is not adequate; and secondly it gives a summary about that
particular job.

Job duties and responsibilities: This gives a total listing of duties together with some
indication of the frequency of occurrence or percentage of time devoted to each major duty.
These two are regarded as the Hear of the Job.
Relation to other jobs: This gives the particular person to locate job in the organization by
indicating the job immediately below or above in the job hierarchy.

Supervision: This will give an idea the number of person to be supervised along with their job
titles and the extent of supervision.

Machine: These will also gives information about the tool, machines and equipment to be
used.

Working Conditions: It gives us information about the environment in which a jobholder

must work.

Hazards: It gives us the nature of risks of life and limb, their possibilities of occurrence etc.

Job Specification:

Job Specification translates the job description into terms of the human qualifications, which are
required for performance of a job. They are intended to serve as a guide in hiring and job
evaluation.

Job specification is a written statement of qualifications, traits, physical and mental

characteristics that an individual must possess to perform the job duties and discharge
responsibilities effectively.

In this, job specification usually developed with the co-operation of personnel department and
various supervisors in the whole organization.

Job Specification Information:

The first step in the programme of job specification is to prepare a list of all jobs in the company
and where they are located. The second step is to secure and write up information about each of
the jobs in a company. Usually, this information about each of the jobs in a company. Usually
this information includes:

1. Physical specifications: Physical specifications include the physical qualifications or

physical capacities that vary from job to job. Physical qualifications or capacities

2. Include physical features like height, weight, chest, vision, hearing, ability to lift weight,
ability to carry weight, health, age, capacity to use or operate machines, tools, equipment etc.
3. Mental specifications: Mental specifications include ability to perform, arithmetical
calculations, to interpret data, information blue prints, to read electrical circuits, ability to plan,
reading abilities, scientific abilities, judgment, ability to concentrate, ability to handle variable
factors, general intelligence, memory etc.

4. Emotional and social specifications: Emotional and social specifications are more important
for the post of managers, supervisors, foremen etc. These include emotional stability, flexibility,
social adaptability in human relationships, personal appearance including dress, posture etc.

5. Behavioral Specifications: Behavioral specifications play an important role in selecting the

candidates for higher-level jobs in the organizational hierarchy. This specification seeks to
describe the acts of managers rather than the traits that cause the acts. These specifications
include judgments, research, creativity, teaching ability, maturity trial of conciliation, self-
reliance, dominance etc.

Employee Specification:

Job specifications information must be converted into employee specification information in

order to know what kind of person is needed to fill a job. Employee specification is a like a brand
name which spells that the candidate with a particular employee specification generally possess
the qualities specified under job specification.

Employee specification is useful to find out the suitability of particular class of candidates to a
particular job. Thus, employee specification is useful to find out prospective employees (target
group) whereas job specification is useful to select the right candidate for a job.

Uses of job specification:

Uses of this job specification;

Physical characteristics, which include health, strength, age range, body size, weight, vision,
poise etc.

Psychological characteristics or special aptitudes:- This include such qualities as manual

dexterity, mechanical aptitude, ingenuity, judgment etc.

Personal characteristics or fruits of temperament such as personal appearance, good and

pleasing manners, emotional stability, aggressiveness or submissiveness.
 Responsibilities: Which include supervision of others, responsibility for production, process
and equipment, responsibility for the safety of others and responsibility for preventing monetary
loss.

Other features of a demographic nature: Which are age, sex, education, experience and
language ability.

Job specifications are mostly based on the educated gneisses of supervisors and personnel
managers. They give their opinion as to who do they think should be considered for a job in
terms of education, intelligence, training etc.

Job specifications may also be based on statistical analysis. This is done to determine the
relationship between

1. Some characteristics or traits.

2. Some performance as rated by the supervisor

Psychological Test?

Suppose that you are a psychologist. A new client walks into your office reporting trouble
concentrating, fatigue, feelings of guilt, loss of interest in hobbies and loss of appetite. You
automatically think that your client may be describing symptoms of depression. However, you
note that there are several other disorders that also have similar symptoms. For example, your
client could be describing post-traumatic stress disorder (PTSD), insomnia or a list of other
psychological disorders. There are also some physical conditions, such as diabetes or congestive
heart failure, which could result in the mental symptoms that your client is reporting.

So, how do you determine which diagnosis, if any, you give your client? One tool that can help
you is a psychological test or psychological assessments. These are instruments used to
measure how much of a specific psychological construct an individual has. Psychological tests
are used to assess many areas, including:

Traits such as introversion and extroversion

Certain conditions such as depression and anxiety
 Intelligence, aptitude and achievement such as verbal intelligence and reading
achievement
Attitudes and feelings such as how individuals feel about the treatment that they received
from their therapists
Interests such as the careers and activities that a person is interested in
Specific abilities, knowledge or skills such as cognitive ability, memory and problem-
solving skills

It is important to note that not everyone can administer a psychological test. Each test has its own
requirements that a qualified professional must meet in order for a person to purchase and
administer the test to someone else.

Psychological tests provide a way to formally and accurately measure different factors that can
contribute to people's problems. Before a psychological test is administered, the individual being
tested is usually interviewed. In addition, it is common for more than one psychological test to be
administered in certain settings.

Let's look at an example involving a new client. You might decide that the best way to narrow
down your client's diagnosis is to administer the Beck Depression Inventory (BDI), PTSD
Symptom Scale Interview (PSSI) and an insomnia questionnaire. You may be able to rule out a
diagnosis or two based on the test results. These assessments may be given to your client in one
visit, since they all take less than 20 minutes on average to complete.

All businesses lose good people. Whether its for personal or professional reasons, planned on
unplanned, losing talented employees can leave a large gap in any organization. Filling critical
vacancies can prove to be challenging, expensive and time consuming. Thats why succession
planning is vital. It ensures businesses are well-positioned to continue growing and performing,
minimizing the impact of losing key talent and leaders.
What is succession planning?

The 2015 State of Succession Planning Report describes succession planning as, Any effort
designed to ensure the continued effective performance of an organization, division, department,
or work group by making provisions for the development, replacement and strategic application
of key people over time.

Succession planning is part of a broader talent management program. Succession planning aims
to attract the best talent, retain those individuals, and develop them through well-targeted
development efforts. Succession planning helps build the bench strength of an organization to
ensure the long-term health, growth and stability.

How to ensure effective succession planning

Based on the State of Succession Planning Report, here are eight steps to ensure effective
succession planning:

1. Establish measurable goals to guide the succession planning program. Closely align the
measurable goals of your succession planning program to the organizations measurable strategic
goals.

2. Recalibrate succession planning program goals on an annual basis. Assess changing

competitive and organizational conditions and priorities.

3. Prepare current job descriptions so that the work to be performed is clear.

4. Prepare competency models by level on the organization chart. Use a rigorous

examination of objective performance requirements. Plan for future competencies that are
necessary to achieve future strategic goals. Ensure all competency models are clear and
measurable.
5. Carefully define the roles to be played by each key stakeholder group in the succession
planning process. Key stakeholders include the board, CEO, senior executives, middle
managers, supervisors, and even workers. Keep senior managers and other stakeholders
engaged in the succession planning program by establishing clear, measurable accountabilities.

6. Establish talent pools by levels based on the strategic strengths of the organization.

7. Take an inventory of your talent. Ensure that individual strengths and areas for
improvement are recognized. Conduct talent reviews on a continuing basis to ensure that
promotable individuals are being properly developed over time.

8. Evaluate the entire succession planning program on a regular (usually annual)

basis. Compare processes and results against the measurable succession planning goals
established at the beginning of the yearly planning cycle.

Morale and Productivity

Generally it is considered that there is a direct relationship between Morale and Productivity. It is
assumed that the person having high morale will have high productivity but this is not always true.

An increase in 20% morale does not guarantee 20% increase in productivity. An increase in morale
may lead to favorable or unfavorable shift in productivity as morale is just one factor which
influences productivity. Therefore there may be chance that high morale related to low
productivity and low morale related to high productivity. There are four types of Relationship
between morale and productivity.
 High morale and high productivity.

High morale and low productivity.

Low morale and low productivity.

Low morale and low productivity.

High morale

High productivity

High morale

Low productivityLow morale

Low productivityLow morale

Low productivity.

High morale with high productivity means that workers are highly motivated and human resources
can be best possibly used. The total opposite of this situation is low morale and low productivity.

High morale and low productivity means that employees are not properly motivated.

Thus, the relationship between morale and productivity is unpredictable and differ from
organization to organization.
 Performance appraisal

With a diverse range of clients it is always interesting to see the changes in the requests made
upon us when we are developing a performance appraisal solution for a client. The requests
come from the HR team, the senior leadership team, or from the facilitated sessions we run with
appraisers/appraisees. So, we get industry trends that HR may have picked up on, the business
drivers from leaders, as well as the grass roots requirements that evolve from practical
requirements for appraisers/appraisees. Here are the top 5 trends in performance appraisal that
we have seen in the last few years.

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1. A desire to gain feedback from a range of people.

Distinct from traditional developmental 360 feedback around a competency framework we often
see appraisal feedback being sought from a range of people. We have gone from this
requirement being rare to it being common. The changing nature of the workplace, of teams, and
of the manager-employee relationship has driven this requirement. The common aim is to ensure
a rounded and accurate picture of performance is gained.

2. A move away from the annual grade.

In the early days of Bowland this was sacrosanct. Now, we are either asked to remove it or in
our consultation sessions we come under great pressure from the appraisers and appraisees to
encourage the HR team to drop the grade. With inevitable conflicts for those organisations who
link pay to appraisal, this is a hot topic.

3. Simplify

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Letting the system and process get out of the way and allowing the conversation to take pride of
place has been a Bowland mantra. New clients and our existing clients are increasingly looking
to simplify the form, particularly around objective setting, to quieten down the appraisal process
and leave appraisers and appraisees with the energy to have a great and meaningful conversation.

4. Continuous feedback and continuous recording

The twitter and facebook factor. While not yet being seen as a mainstream activity we are now
regularly implementing the ability to keep the process alive throughout the year by providing
performance logs, update sections, and other continuous recording methods.

5. Focusing on the future

Appraisals were very backward focused. What happened? What went well? What did you do
wrong? What is your grade? Increasingly (and its a good thing!) there is a focus on the objective
setting, development plan, and the future. How will we improve? How do we achieve more in
the coming year? This is a particularly positive change that leads to improved conversations.

Carefully implemented I see all of the above as positive trends. While at Bowland we will
always support the culture, requirements, and particular drivers of a client we look to share best
practice and ideas to help each client make the best decisions for them.

Methods of securing workers participation in Management

For higher productivity and sound industrial relations, it is extremely important to give the
workers the place of partners in industry. The workers must be increasingly associated with the
management of industrial undertakings so that they develop an awareness of the problems of
industry and begin to feel that they have a positive contribution to make to the operation of their
units.

Such association with management should gradually give place to labour participation in
management. The principle of participation seeks to meet the psychological needs of the
workers, brings them closer to the management, promotes their interest in self-education, gives
them an insight into the economic and technical conditions and purposes of the undertaking
where they work and serves to bridge the gulf between the management and the workers.

Methods:
1. Co-partnership:
Co-partnership makes the workers shareholders in the company for which they are working. In
this way, the workers become part-owners of the concern and acquire some hand in its internal
management. They may be able to elect their representatives to the Board of Directors and
participate in the management of the concern.

2. Suggestions Scheme:
To arouse and maintain employees interest in the problems of their concern and its
management, suggestions scheme can be used with advantage. The management may invite
suggestions from the workers for improvement in the existing set-up and agree to pay suitable
sums of money by way of rewards to the workers whose suggestions prove really useful.

The payment may bear some proportion to the value of the suggestions in terms of improvement
brought about or profit reaped. Such schemes are useful because they provide not only some new
ideas to the management but also feeling of importance to the workers. Experience has shown
that many of the suggestions thus made by the workers prove quite useful.

3. Joint Consultation:
Joint consultation involves the setting up of joint committees comprising the representatives of
management and workers to discuss various matters concerning working conditions of the
workers.

The decisions of such joint committees are usually advisory in character though the management
will have little reason to reject the advice because it is the outcome of deliberations between the
representatives of the management and labour.

Generally, questions relating to wages, bonus and piece-rates are excluded from the scope of the
committees. These matters are considered to be the subject-matter of collective bargaining.
The long list of matters dealt with by joint committees includes accident prevention,
management of canteens and other questions of physical welfare like meals, drinking water,
safety, first-aid, issue and revision of work rules, avoidance of waste of time and materials,
absenteeism and lateness, questions of discipline, training of apprentices, improvements in the
production set-up, removal of grievances, adjustment of festival and national holidays,
administration of welfare and fine funds, etc.

4. Employee Representation on the Board of Directors:

The measures which have been outlined in the foregoing pages imply some measure of
participation in an association with limited parts of the management of the affairs of an industrial
undertaking. Ultimately, however, full- fledged participation of workers in management can be
ensured only through their participation in the chief organ of management.

In the long run, the workers would be satisfied with nothing short of their representation-on the
body responsible for managing the affairs of the concern in all aspects, i.e., the Board of
Directors.

The practice of allowing workers elected representatives to sit on the Board of Directors has
been adopted in several countries of the world. On the other hand, many others believe that the
workers representatives of the Board of Directors can serve to create an understanding of the
problems of a going concern. It is claimed that the management will be able to inspire
confidence in the minds of the workers in this way.
Human Resource accounting

Replacement Cost

A replacement cost is the cost to replace an asset of a company at the same or equal value, and
the asset to be replaced could be a building, investment securities, accounts receivable or liens.
The replacement cost can change, depending on changes in market value of the asset and any
other costs required to prepare the asset for use. Accountants use depreciation to expense the cost
of the asset over its useful life.
Replacing an asset can be an expensive decision, and companies analyze the net present value
(NPV) of the future cash inflows and outflows to make purchasing decisions. Once an asset is
purchased, the company determines a useful life for the asset and depreciates the asset's cost over
the useful life.

How Net Present Value Is Used

To make a decision about an expensive asset purchase, companies first decide on a discount rate,
which is an assumption about a minimum rate of return on any company investment. A business
then considers the cash outflow for the purchase and the cash inflows generated based on the
increased productivity of using a new and more productive asset. The cash inflows and outflow
are adjusted to present value using the discount rate, and if the net total of all present values is a
positive amount, the company makes the purchase.

Factoring in Depreciation

A business capitalizes an asset purchase by posting the cost of a new asset to an asset account,
and the asset account is depreciated over the assets useful life. Depreciation matches the
revenue earned by using the asset with the expense of using the asset over time. The cost of the
asset includes all costs to prepare the asset for use, such as insurance costs and the cost of setup.
Some assets are depreciated on a straight-line basis, meaning the cost of the asset is divided by
the useful life to determine the annual depreciation amount. Other assets are depreciated on an
accelerated basis so more depreciation is recognized in early years and less in later years. The
total depreciation expense recognized over the assets useful life is the same, regardless of which
method is used.

Examples of Budgeting for Asset Purchases

Given the cost of replacing expensive assets, well-managed firms create a capital
expenditure budget to plan future asset purchases and how the firm generates cash inflows to pay
for the new assets. Budgeting for asset purchases is critical, because replacing assets is required
to operate the business. A manufacturer, for example, budgets for equipment and machine
replacement, and a retailer budgets to update the look of each store.

Opportunity Cost

Opportunity cost refers to a benefit that a person could have received, but gave up, to take
another course of action. Stated differently, an opportunity cost represents an alternative given
up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive
events. In investing, it is the difference in return between a chosen investment and one that is
necessarily passed up.
When assessing the potential profitability of various investments, businesses look for the option
that is likely to yield the greatest return. Often, this can be determined by looking at the
expected rate of return for a given investment vehicle. However, businesses must also consider
the opportunity cost of each option. Assume that, given a set amount of money for investment, a
business must choose between investing funds in securities or using it to purchase new
equipment. No matter which option is chosen, the potential profit that is forfeited by not
investing in the other option is called the opportunity cost. This is often expressed as the
difference between the expected returns of each option:

Opportunity Cost = Return of Most Lucrative Option - Return of Chosen Option

Option A in the above example is to invest in the stock market in hopes of generating returns.
Option B is to reinvest the money back into the business with the expectation that newer
equipment will increase production efficiency, leading to lower operational expenses and a
higher profit margin. Assume the expected return on investment in the stock market is 12%, and
the equipment update is expected to generate a 10% return. The opportunity cost of choosing the
equipment over the stock market is 12% - 10%, or 2%.

Opportunity cost analysis also plays a crucial role in determining a business's capital structure.
While both debt and equity require some degree of expense to
compensate lenders and shareholders for the risk of investment, each also carries an opportunity
cost. Funds that are used to make payments on loans, for example, are therefore not being
invested in stocks or bonds which offer the potential for investment income. The company must
decide if the expansion made possible by the leveraging power of debt will generate greater
profits than could be made through investments.

Because opportunity cost is a forward-looking calculation, the actual rate of return for both
options is unknown. Assume the company in the above example decides to forgo new equipment
and invests in the stock market instead. If the selected securities decrease in value, the company
could end up losing money rather than enjoying the anticipated 12% return. For the sake of
simplicity, assume the investment simply yields a return of 0%, meaning the company gets out
exactly what it put in. The actual opportunity cost of choosing this option is 10% - 0%, or 10%.
It is equally possible that, had the company chosen new equipment, there would be no effect on
production efficiency and profits would remain stable. The opportunity cost of choosing this
option is then 12% rather than the anticipated 2%.

It is important to compare investment options that have a similar degree of risk. Comparing
a Treasury bill (T-bill)which is virtually risk-freeto investment in a highly volatile stock can
result in a misleading calculation. Both options may have anticipated returns of 5%, but the rate
of return of the T-bill is backed by the U.S. government while there is no such guarantee in the
stock market. While the opportunity cost of either option is 0%, the T-bill is clearly the safer bet
when the relative risk of each investment is considered.

Using Opportunity Costs in Our Daily Lives

When making big decisions like buying a home or starting a business, you will likely
scrupulously research the pros and cons of your financial decision, but most of our day-to-day
choices aren't made with a full understanding of the potential opportunity costs. If they're
cautious about a purchase, most people just look at their savings account and check their balance
before spending money. For the most part, we don't think about the things that we must give up
when we make those decisions.

However, that kind of thinking could be dangerous. The problem lies when you never look at
what else you could do with your money or buy things blindly without considering the lost
opportunities. Buying takeout for lunch occasionally can be a wise decision, especially if it gets
you out of the office when your boss is throwing a fit. However, buying one cheeseburger every
day for the next 25 years could lead to several missed opportunities. Aside from the potentially
harmful health effects of high cholesterol, investing that $4.50 on a burger could add up to just
over $52,000 in that time frame, assuming a very doable rate of return of 5%.

This is just one simple example, but the core message holds true for a variety of situations. From
choosing whether to invest in "safe" treasury bonds or deciding to attend a public college over a
private one in order to get a degree, there are plenty of things to consider when making a
decision in your personal finance life.

While it may sound like overkill to have to think about opportunity costs every time you want to
buy a candy bar or go on vacation, it's an important tool to use to make the best use of your
money.

What is the Difference Between a Sunk Cost and an Opportunity Cost?

The difference between a sunk cost and an opportunity cost is the difference between money
already spent and potential returns not earned on an investment because capital was invested
elsewhere. Buying 1,000 shares of company A at $10 a share, for instance, represents a sunk cost
of $10,000. This is the amount of money paid out to make an investment, and getting that money
back requires liquidating stock at or above the purchase price.

Opportunity cost describes the returns that could have been earned if the money was invested in
another instrument. Thus, while 1,000 shares in company A might eventually sell for $12
each, netting a profit of $2 a share, or $2,000, during the same period, company B rose in value
from $10 a share to $15. In this scenario, investing $10,000 in company A netted a yield of
$2,000, while the same amount invested in company B would have netted $5,000. The
difference, $3,000, is the opportunity cost of having chosen company A over company B.

The easiest way to remember the difference is to imagine "sinking" money into an investment,
which ties up the capital and deprives an investor of the "opportunity" to make more money
elsewhere. Investors must take both concepts into account when deciding whether to hold or sell
current investments. Money has already been sunk into investments, but if another investment
promises greater returns, the opportunity cost of holding the underperforming asset may rise to
the point where the rational investment option is to sell and invest in a more promising
investment elsewhere.

What is the Difference Between Risk and Opportunity Cost?

In economics, risk describes the possibility that an investment's actual and projected returns are
different and that some or all of the principle is lost as a result. Opportunity cost concerns the
possibility that the returns of a chosen investment are lower than the returns of a necessarily
forgone investment. The key difference is that risk compares the actual performance of an
investment against the projected performance of the same investment, while opportunity cost
compares the actual performance of an investment against the actual performance of a different
investment.

Historical Cost

A historical cost is a measure of value used in accounting in which the price of an asset on
the balance sheet is based on its nominal or original cost when acquired by the company. The
historical-cost method is used for assets in the United States under generally accepted
accounting principles (GAAP).

For example, say the main headquarters of a company, which includes the land and building, was
bought for $100,000 in 1925, and its expected market value today is $20 million. The asset is
still recorded on the balance sheet at $100,000.
Based on the historical-cost principle, under GAAP, most assets held on the balance sheet are to
be recorded at the historical cost even if they have significantly changed in value over time. Not
all assets are held at historical cost. For example, marketable securities are held at market value
on the balance sheet.

Asset Depreciation

The historical-cost principle is one of the four basic accounting principles. Valuing assets at
historical cost prevents overstating an asset's value when asset appreciation may be the result of
volatile market conditions. Furthermore, observing the conservatism constraint in accounting,
any asset depreciation must be noted and compared to the asset's historical cost. This is true for
many long-lived fixed assets such as buildings and machinery. On the balance sheet, annual
depreciation is accumulated over time and recorded below an asset's historical cost. The
subtraction of the total depreciation from the historical cost results in a lower net asset value,
ensuring no overstatement of an asset's true value.

Asset Impairment

Independent of asset depreciation from physical wear and tear over long periods of asset uses,
asset impairment may occur to certain assets, including intangibles such as goodwill. With asset
impairment, an asset's market value has become worth less than what is originally listed on the
balance sheet. Asset impairment charge is a typical restructuring cost as companies reevaluate
the value of certain assets and make business changes. In this case, the devaluation of an asset
based on present market conditions would be a more conservative accounting practice than
keeping the historical cost intact. When an asset is written off due to asset impairment, the loss
directly reduces a company's profits.

Mark-to-Market

The mark-to-market practice is known as fair value accounting whereby certain assets are
recorded at their market value. This means that when the market moves, the value of an asset as
reported in the balance sheet may go up or down. The deviation of the mark-to-market
accounting from the historical-cost principle is actually helpful to report on held-for-sales assets.
An asset's market value can be used to predict future cash flow from potential sales. A common
example of mark-to-market assets would be marketable securities held for trading purposes. As
the market swings, securities are marked upward or downward to reflect their true value under a
given market condition.