Cost Object

Cost Object is the method of measuring the cost of the product, segment, customer, etc., separately so as to determine the exact cost along with the determination of the selling price. Sometimes, there is a requirement of law to maintain the cost records of the product based on the type of product or the turnover of the product.

A cost object accounting is the cost allocation related to the product, services, department and to decide and justify the selling price. It is used in large organizations. It is different from the cost driver as it deals with managing the cost by improving efficiency.

A cost object refers to anything for which costs are measured and accumulated, typically for the purpose of determining the total cost incurred in producing goods or delivering services. Cost objects can vary widely depending on the context and requirements of the organization, and they serve as focal points for cost analysis and allocation.

Cost objects can be tangible items such as products, services, projects, or departments, as well as intangible entities like customers, distribution channels, or geographic regions. Essentially, any entity that consumes resources or drives costs within an organization can be designated as a cost object.

The identification of cost objects is critical for accurately assigning costs to specific activities, products, or services, enabling organizations to track and analyze the cost behavior of various operations. By associating costs with specific cost objects, management gains insights into the cost drivers and profitability of different aspects of the business, helping them make decisions related to pricing, resource allocation, product mix, and performance evaluation.

For example, in a manufacturing company, the cost object approval may be related to a specific product line, allowing management to determine the total cost of producing each product and evaluate its profitability. In a service-oriented business, the cost object could be a particular client or project, helping management assess the profitability of individual contracts or customer relationships.

Overall, cost objects play a fundamental role in cost accounting and management by providing a framework for analyzing and understanding the costs associated with various aspects of the business. By effectively identifying and defining cost objects, organizations can improve cost transparency, optimize resource allocation, and make more strategic decisions to enhance profitability and efficiency.

Let us understand the objectives of seeking cost object approvals through the points below.

• The primary objective of cost objects is to facilitate the allocation of costs to specific activities, products, services, projects, or departments within an organization.
• By associating costs with specific cost objects, organizations can track and analyze cost behavior, identify areas of inefficiency or overspending, and implement measures to control costs effectively.
• They enable the management to evaluate the profitability and performance of different aspects of the business, such as products, services, projects, or departments, by assessing their respective costs and revenues.
• Cost objects provide valuable information for decision-making processes related to pricing, resource allocation, product mix, and strategic planning, enabling management to make informed decisions that enhance profitability and efficiency.
• By assigning costs to specific cost objects, organizations enhance cost transparency and accountability, allowing stakeholders to understand the cost structure of the business and make better decisions.

There are three types of  cost object accounting. Let us understand each of them through the detailed explanation below.

#1 - Output Cost

Output cost refers to the cost of product or services so as to decide the selling price as well as the total profitability from product or service along with a percentage of profit margin on the product or services.

#2 - Operational Cost

Operational cost related to the cost of a particular department, function, event or customer. For example, if the organization is in the event management business, the total cost allocated to the organization of the whole event is the operational cost for the organization.

#3- Business Relationship Cost

Business Relationship cost refers to the cost to promote or survive in the business, like free gifts to the customers, licence fees, trade membership fees etc. the cost which is necessary or relates to external persons for the promotion of business is termed as business relationship cost.

Now that we understand the basics, objectives, and types of cost object approvals, let us understand the practicality of the concept through the examples below.

Example #1

For the Production process, the direct cost is the material cost, labour cost, electricity cost, maintenance cost and indirect cost include packing cost, carriage outward, salaries of employees engaged in accounting and managing the production process etc.

Similarly, if the cost is assigned to a customer, then the direct cost is material cost, labour cost, proportionate power consumption, designing cost, storage cost and indirect cost is salaries of persons engaged in management and accounting, packaging, commitment cost etc.

Example #2

A Ltd. is engaged in interior designing of properties like homes, hotels, marriage halls etc. and they design as per convenience and requirements of the customers. One of the customers, Mr Z, approach A Ltd. for interior decoration of their hotel. The cost involved is as under -

A Ltd. employs full-time designer. The salary per month of a designer is $ 60,000, and for designing of Mr Z he took 10 days to customize the design as per the requirements of the client. Also, A Ltd. took various machinery of its own for fittings for which the cost allocated to the client is $ 5,000. Apart from material cost mentioned above A Ltd. uses some of its own material which was in stock of A Ltd. Where the market value of the material used is $ 7,000. Compute the Cost Allocated to the client?

Solution

The calculation of the cost allocated to the client is as below -

Cost allocated to the client Mr Z is $1,732,000. Here consulting fees is the revenue of A Ltd. hence it is not to be included in calculating the cost allocation.

In budgeting, the cost object is very useful, as the price of products is fluctuating as per the market situations. Hence large organizations prepare the budgets so as to draw the line between profits and cost. Budgeting enables effective cost management. There is also a margin for price fluctuations in the budgeting. For example, Organization engaged in event management prepares the budget for each type of event so that optimum utilization of resources can be achieved and profit can be maximized.

It is used in the following circumstances -

• If the size of the organization is too large.
• If the organization deals with multiple products and services.
• If the organization is in necessity goods or defense production where cost and the selling price matters defense production where cost and the selling price matter, so is to justify the selling price.
• If each department of the organization is managed separately so as to determine the profit or loss from each organization.

Some of the benefits of cost object approvals are as follows -

• The cost can be measured accurately so as to determine the selling price.
• The selling price can be justified if the cost object is used.
• The profit margin can be easily decided and fluctuated.
• Effective cost management is to be done to minimize the cost.
• Resources are to be properly allocated to maximize profit from each function.

Some of the limitations of cost object accounting are as follows -

• Due to a fluctuating market, sometimes the cost can be increased, and the profit margin is to be decreased.
• The cost involved in drawing the cost object is also to be included in the operational cost; hence, the overall cost can be increased.
• It involves the experienced staff; also, time involvement is higher.
• Difficulty in the allocation of common expenses.

Some of the differences are as follows:

• Cost object approvals deal with the overall cost of the product or services, whereas cost driver deals with the quantity of resources consumed by the enterprise.
• A cost object is more of accounting and budgeting, whereas cost driver is more of the management.
• Cost object increases the transparency in cost allocation whereas cost driver increases the efficiency of employees.
• The cost object tries to reduce cost by budgeting methods, whereas cost driver reduces the cost by incentives and motivation to employee’s method.

Let us understand the distinctions between cost object accounting and cost unit through the comparison below.

Cost Object

• A cost object refers to anything for which costs are measured and accumulated in cost accounting.
• It serves as a focal point for cost analysis and allocation within an organization.
• Cost objects can be tangible items such as products, services, projects, or departments.
• They can also include intangible entities like customers, distribution channels, or geographic regions.
• Cost objects are used to track and analyze the cost behavior of various operations within an organization.
• They enable management to assess the profitability and performance of different aspects of the business.

Cost Unit

• A cost unit is the unit of product or service for which costs are calculated.
• It represents the quantity or measurement used to express the cost of producing a single unit of output.
• In manufacturing, the cost unit may be a single product or a specific batch of products.
• In service industries, the cost unit could be an hour of service or a completed project.
• Cost units provide a basis for calculating the cost per unit of output, allowing for cost control and decision-making.
• They help determine the total cost of producing goods or delivering services, aiding in pricing decisions and performance evaluation.

This has been a guide to what is a Cost Object. Here, we explain its types, examples, benefits, and limitations, and compare it with cost driver & cost unit. You can learn more about from the following articles –

• Committed Cost
• Contract
• Step Cost
• Semi-Fixed Cost