Cost Object

Cost Object Definition

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

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Examples of Cost Object

Example #1

For the Production process, the direct costDirect Cost Direct costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more is the material costMaterial Cost Direct Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components including packaging, freight and storage costs, taxes, etc. that are related directly to the manufacturing and production of various products of the company.read more, labour costLabour Cost Cost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, 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 – Practical Example

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

Calculation of 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.

Types

There are three types of a cost object, each of them is described as under –

#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 profitabilityProfitability Profitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more 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.

#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.

Cost Object in Budgeting

In budgetingBudgeting Budgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time.read more, 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 managementCost Management Cost management is an integral part of business management that works on the basis of estimates, where various activities such as data collection, data analysis and mechanisms, process evaluation, and event reporting are carried out so that the decision-maker can plan and control the organization's budget requirements, allowing the decision-maker to make informed decisions.read more. 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.

When is Cost Object Used?

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 defence production where cost and the selling price matters so as 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.

Cost Object vs Cost Driver

Some of the differences are as follows:

Cost object deals 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 allocationCost Allocation Cost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more whereas cost driver increases the efficiency of employees.
The cost object tries to reduce cost by budgeting methods, whereas cost driverCost Driver A cost driver is a unit that derives the expenses and sets a basis on which a particular cost is to be allocated between the different departments and on the basis of that driver’s activity completed in that particular period the cost is allocated. These are the structural determinants of the activities on which cost is being incurred and determine the behavior of the costs on an activity.read more reduces the cost by incentives and motivation to employee’s method.

Benefits

Some of the benefits 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 marginProfit Margin Profit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more 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.

Limitations

Some of the limitations are as follows –

Due to fluctuating market, sometimes the cost can be increased, and the profit margin is to be decreased.
The cost involved drawing the cost object also to be included in 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.

Conclusion

A cost object is the cost allocation related to the product, services, department etc. it enables to determine the proper cost so as to identify the loss-making products or department and to decide and justify the selling price. It is used in large organizations. It is different from cost driver as it deals with managing the cost by improving efficiency. To determine the cost allocation, the experienced staff is required; hence the cost of hiring will be higher.

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