1 COST OBJECTS & COST TRACING Principles of Accounting II AC Fall Semester, 1999

2 Costing Products, Services & Other Cost Objects Assigning (or “attaching”) costs to products, services & other cost objects is one of the principal purposes of managerial accounting

3 COST Cost is the cash or cash-equivalent sacrificed for goods and services that are expected to bring a current or future benefit to the organization A cash-equivalent sacrifice is one where a company pays for a good or service with a noncash resource – example: trade in of an old truck for a new truck

4 Clarifying The Term “Cost” The term “cost” simply refers to the making of a sacrifice Without further clarification it is difficult to discern the particular nature of the cost (or sacrifice) being considered or discussed An adjective before the word cost is necessary to clarify the nature of each cost In accounting the terms “cost” and “expense” do not have the same meaning

5 Some Key Types of Costs Which We Will Study In This Course Variable Cost Fixed Cost Semivariable Cost Direct (or Traceable) Cost Indirect Cost Expired Cost (which is an Expense) Capitalized Cost (which is an asset) Discretionary Cost Committed Cost Allocated Cost Sunk Cost Opportunity Cost Incremental Cost Downstream Cost Upstream Cost Relevant Cost

6 Cost vs. Expense A cost is simply the incurring of a sacrifice for goods and services that are expected to bring a benefit to the organization in the current or future periods Costs can be reflected on either the income statement (as an expense) or on the balance sheet (as an asset) Expenses are costs that assisted in generating the revenues of the current period Assets are unexpired costs, i.e., costs that will provide future benefits

7 Cost Objects Any item for which costs are being measured –the “thing” or “process” for which we are trying to determine its cost Common cost objects: –Products, services, customers, departments, operations, projects, activities In recent years, activities have emerged as important cost objects

8 Activities An activity is a basic unit of work perfomed within an organization An activity is described by an action verb Activities play a prominent role in assigning costs to cost objects Examples of activities: –unloading trucks, setting up a machine, typing a letter, billing customers, moving materials, inspecting product

9 Accuracy of Assignments Assigning costs accurately to cost objects is crucial Accurate refers to the reasonableness and logic of the cost assignment methods used There are many ways to determine the cost of cost objects No particular way of costing can generally be specified as determining the “true” cost Selection of which costs to include, assignment methods, cost traceabiltiy, and the purpose of the costing will all impact the calculated figure

10 Traceability of Costs (1) Costs are directly or indirectly associated with cost objects Direct costs are those costs that can be easily and accurately traced to cost objects “Easily traced” means that the costs can be assigned in an economically feasible way “Accurately traced” means that the costs are assigned using a cause-and-effect- relationship Indirect costs are costs that cannot be easily traced to cost objects

11 Traceability of Costs (2) The more costs that can be assigned to the cost object, the greater the accuracy of the cost assignments Establishing traceability is a key element in building accurate cost assignments A particular cost can be a direct cost to one cost object and an indirect costs to another cost object –Example: Cost of utilities direct cost to entire factory indirect cost to one of the products manufactured

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