Question

Explain the relationship among cost, cost objective, cost accumulation, and cost allocation.

Answer 1

Cost

A cost is the value of money that has been used up to produce something or deliver a service.

Cost objective

In the production process of any manufacturer, accountants and managers want to be trace costs back to the thing that creates them in order to streamline operations and increase efficiencies. These traceable costs or direct costs are expenses that can be traced back to a single cost object. Accountants can look at the expenses or outlays of cash and figure out where it was spent and why.

Managerial accountants use all of these costs and their cost objects to analyze activity based costing models and identify ways that the company can be more efficient.

Cost Accumulation

Cost accumulation involves the use of a formal cost accounting system to collect cost information. By collecting and analyzing cost information, management can make more informed decisions about the operations of a business. Cost accumulation systems fall into two main categories, which are:

• Job cost system. Accumulates materials, labour, and overhead costs about individual jobs.
• Process system. Accumulates costs by cost center and then assigns average costs to products.

Cost Allocation

Cost allocation is the assigning of a cost to several cost objects such as products or departments. The cost allocation is needed because the cost is not directly traceable to a specific object. Since the cost is not directly traceable, the resulting allocation is somewhat arbitrary. Because of the arbitrariness, some people describe cost allocation as the spreading of a cost.

· Accountants have made efforts to improve the cost allocation techniques. Over time, manufacturers' overhead allocations have moved from a plant-wide rates to departmental rates. Some allocations that were allocated on the basis of direct labor hours are now based on machine hours. In order to improve those bases of allocations, some accountants are implementing activity based costing. The goal is to reduce the arbitrariness by identifying the various root causes of the overhead costs.

Direct material and direct labour are easily traced to a product or service. Overhead, on the other hand, must be accumulated over a period and allocated to the products manufactured or services rendered during that time. Cost allocation refers to the assignment of an indirect cost to one or more cost objects using some reasonable basis.

Many accounting procedures are based on allocations. Cost allocations can be made over several time periods or within a single time period.

For example: in financial accounting, a building’s cost is allocated through depreciation charges over its useful or service life. This process is necessary to fulfill the matching principle. In cost accounting, production overhead costs are allocated within a period through the use of predictors or cost drivers to products or services. This process reflects application of the cost principle, which requires that all production or acquisition costs attach to the units produced, services rendered, or units purchased.

Overhead costs are allocated to cost objects for three reasons:

(1) to determine a full cost of the cost object.

(2) to motivate the manager in charge of the cost object to manage it efficiently.

(3) to compare alternative courses of action for management planning, controlling, and decision making.