A transaction cost is the term that refers to the cost incurred in the process of carrying out a transaction. To understand the term better, here is an example: if you are in a shop purchasing a television set, you will need to research on the various vendors and different television sets. You will need to visit various stores, collect information, other consumers’ preference, ratings of the products, etc. Apart from the cost of the television set, all this effort and energy you put in the purchase process is the transaction cost.
In the terms of accounting and other related disciplines, a transaction cost is the cost you pay to close a transaction. Without paying this cost, you cannot complete a transaction. The amount you pay to your broker or agent as a commission can be classified as a transaction cost.
In accounting, when in the budgeting or forecasting mode, transaction costs have a deep impact. The company needs to quantify these transaction costs as they play a significant part in the decision-making process. If the transaction costs of a project are too high, this will cut the profits short and the project may have to be dropped no matter how high returns it might produce. Contrarily, if the transaction costs are low, the management may decide to continue with the project, as it will yield high returns.
Transaction types have different kinds that are as follows:
Search and information costs
These costs are those that are incurred in the market research phase to determine if the product is available in the market, and if they are what the price of the alternatives, etc., is.
Bargaining costs are the costs that are required for the bargaining process with the other party of the transaction. These costs are incurred to come to an acceptable agreement with the other party, drafting and finalizing the contract and so on.
Policing and enforcement costsThe company incurs policing and enforcement costs to make sure that other party do not breach the terms of the contract and to take appropriate actions (through the legal system) if that is not the case.