Using Cost Object to Better Understand Your Costs

3 Types of Cost Objects

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Cost allocation is an important topic to every business owner because many of the costs associated with designing, producing and distributing products and services are not easily identified with the products and services that are created and sold.

A cost object is a financial term used in cost accounting to indicate something to which costs are assigned. For instance, a product produced by a company is the cost object for direct materials, direct labor and manufacturing overhead.

A cost object can also be a project, a service, a territory, a department or a customer - whenever management would like to quantify a cost. A cost object is a management accounting or cost accounting term and is used when allocating direct and indirect costs. Costs are allocated to the cost object and they are either direct or indirect costs. Cost may be determined by direct measurement, or by allocation or apportionment.  

3 Types of Cost Objects

Here are 3 types of cost objects, output, operational and business relationship:

  1. Output. The most common cost objects are a company's products and services. Assigning a cost enables profitability analysis and price setting.
  2. Operational. A cost object can be an area or function within a company, such as a department, tooling operation, production line, or process. For instance, you could track the cost of introducing a new product, or service call, or of refurbishing a returned product.
  1. Business relationship. A cost object can be external to the company, such as a supplier or a customer, to determine the cost of dealing with that entity. Another variation on the concept is the cost of renewing permits or licenses.

It may be necessary to have a cost object in order to derive pricing from a baseline cost, or to see if costs are reasonable, or to derive the full cost of a relationship with another entity.

 

Commonly, a company will focus on a cost object only occasionally, to see if there have been significant changes since the last analysis. Of course, a cost object can undergo considerable ongoing scrutiny if warranted. An annual review is common for many cost objects. If an analysis is especially complex, the review may be at an even longer interval.

Usage

Identifying and assigning accurate costing to cost objects is basic to budgetary planning, and should be accompanied by a review of actual historical costs for the same cost objects. This will assist in the accuracy of planning. It also supports the preparation of financial accounting reports, determining which accounts are impacted and the figures reported. 

Remember, a cost object is not the same thing as an account from the organization's chart of accounts. Each account is a placeholder for a category of financial transactions, for instance, an expense category account for raw materials. Transactions are entered into these accounts as debits or credits.

Examples: XYZ company produces a line of 10-speed bicycles which is a cost object in their product line. This line of products is the cost object for all direct materials, direct labor and overhead.