Cost objects and cost assignment in accounting

In this article, we will define cost objects and discuss how the choice of a cost object affects the cost assignment process and hence outcome.

1. Cost object definition

A cost object is anything we want to determine the cost of.

Examples of cost objects are: a product, a product line, a brand category, a service, a project, an activity or task, a process, a department, a business segment, a channel, a customer, a supplier, a geographic area, etc.

For reporting purposes, organizations usually have to determine the cost of their products or services. But, internally the organizations can create additional reports where they try to measure costs of various cost objects (e.g., departments, product lines, segments, suppliers) in order to get more insights into operations, performance, risks, and opportunities.

2. Cost object choice and cost assignment

The choice of the cost object impacts whether a specific cost can be directly traced to it or not. For example, raw materials that are part of a product usually can be traced to specific products via materials requisition forms. But, it might be more challenging to trace the same information (about raw materials used) to product lines when different products use the same raw materials. The ability to trace specific costs to cost objects in an economically feasible (i.e., cost effective) way determines whether a specific cost is a “direct cost” or “indirect cost”.

Direct costs of a cost object can be traced to that cost object in an economically feasible (cost-effective) way.

Indirect costs of a cost object cannot be traced to that cost object in an economically feasible (cost-effective) way. As the result, indirect costs are allocated to cost objects using some kind of allocation rule.

The ability to (directly) trace costs to cost objects usually depends on:

  • The design of operations
  • The availability of technology for information gathering and processing
  • The materiality of the cost

Complex operations make it more challenging to trace costs to cost objects. The lack of information gathering and processing technology or poorly organized information systems (e.g., accounting, operations) also make it more difficult to trace costs to cost objects. Finally, immaterial costs (e.g., relatively small costs) are often not directly traced to cost objects because the benefit from tracing immaterial costs is lower than the cost associated with tracing that information. We have to remember that in a reporting process the benefits from reporting should outweigh the costs associated with preparing those reports.

Ideally, we want to be able to directly trace costs to the cost objects. But in practice, often available data does not allow cost tracing, and the result, organizations need to allocate costs to cost objects. The issue with cost allocation is that it is less accurate and can be subjective depending on the allocation process and rules.

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