CHAPTER 2: AN INTRODUCTION TO COST TERMS AND PURPOSES
Cost in General
Cost Objects
•Cost is a resource sacrificed or foregone to achieve a specific objective.
•Cost object is anything for which a separate measure of cost is desired.
Cost Accumulation and Cost Assignment
•A costing system typically accounts for costs in two basic stages:
1. It accumulates costs by some ‘natural’ classification
2. It assigns these costs to cost objects
•Cost Accumulation is the collection of cost data in some organised way through an accounting
system,
•Cost Assignment is a general term that encompasses both tracing accumulated costs to a cost
object and allocating accumulated costs to cost a object.
‣Cost that are traced to a cost object are direct costs
‣Cost that are allocated to a cost object are indirect costs.
•Actual Cost are the costs incurred, as distinguished from budgeted and forecasted costs.
•Managers assign costs to the particular cost objects to help decision making.
•Costs may also be assigned to a product or a customer to facilitate product or customer
profitability analysis.
Direct Cost and Indirect Costs
Cost Tracing and Cost Allocation
•Direct costs of a cost object are cost that are related to the particular cost object that can be
traced to it in an economically feasible way.
•Indirect costs of a cost object are costs that are related to the particular cost object but cannot
be traced to it in an economically feasible way. Indirect costs are allocate dip the cost object
using a cost-allocation method.
•Managers prefers to make decisions on the basis of direct costs rather than indirect costs
because direct costs are more accurate than indirect costs.
•Cost tracing is the assigning of direct costs to the chosen cost object.
•Cost allocation is the assigning of indirect cost to the chosen cost object.
Factors affecting direct/indirect cost classifications
1. The materiality of the cost - the higher the cost in question, the more likely the economy
feasibility of tracing that cost to a particular cost object.
2. Available information-gathering technology - improvements in this area are enabling an
increasing percentage of costs to be clarified as direct.
3. Design of operations - facility design can impact in cost classification.
•The direct/indirect classification depends on the choice of the cost object.
