CHAPTER 11 Costing and pricing in an entity 463Chapter 11 preview
In this chapter, we look at how an entity can determine the costs incurred for specific objects, such
as products, services, customers, business units or geographic regions. Identifying why costs are
incurred is important for cost management and decision making. Cost information is used for many
purposes including price setting, profitability analysis and performance evaluation. In this chapter, we
will also look at an important cost for manufacturing entities — the inventoriable product cost (the
inventory value of manufactured products) which is used for financial reporting purposes. As well as
costs, managers and accountants also have to manage income, and one important consideration is the
price charged for goods and services. It is important that the price is both competitive and allows for
profit maximisation. Later in the chapter we will look at issues relating to the pricing of goods and
services.
11.1 Use of cost information
LEARNING OBJECTIVE 11.1 Define a cost object and explain how cost information is used.
A cost is a resource, commonly measured in monetary terms, used to achieve a particular objective. In
previous chapters, we looked at the financial accounting responsibilities of an entity, where costs are
classified as either expenses in the statement of profit or loss or assets in the balance sheet. However,
costs recorded in the financial statements are aggregated and do not provide sufficiently detailed infor-
mation to assist in both day-to-day management and strategic management. For a moment reflect on
the financial statements discussed in previous chapters and determine if you could answer the following
questions.
- What is the profitability of individual products, services, customers or departments?
- How much does each product or service contribute to overall profit?
- How efficient are daily operations?
- Where are the opportunities for cost reduction?
- How much does it cost to service particular customer groups?
- Which product or service should be dropped?
When such questions are posed, it becomes clear that the cost information in the financial statements
is too aggregated to be used for the internal management of entity activities.
It is important for an entity to understand why costs are incurred as this allows costs to be man-
aged and also leads to more informed decision making. This requires the costs to be assigned to the
specific objects of interest to management. Consider the example of Nokia Corporation, a market leader
in the mobile telephone industry in the Asia–Pacific region. Nokia Corporation provides innovative,
industry-leading and market-relevant technology and products to around 20 diverse markets in the
region. To determine the profitability of each market, Nokia Corporation would be required to under-
stand the revenue and costs of each of those markets.
Whatever it is that an entity requires a separate measurement of cost for is called a cost object.
Examples of cost objects are products, services, customers, departments, business units and geographic
regions. In the case of Nokia Corporation, the 20 markets could be considered individual cost objects for
the purpose of determining each market’s profitability. You should note that, although an entity can view
costs through these different lenses, the total costs of the entity do not change. Costs will only change if
management takes action to alter the level of costs incurred by the cost object.
Figure 11.1 illustrates some of the many cost objects for which an entity needs to record costs in the
accounting information system.
The system used by entities to collect and report the cost of resources used by particular cost
objects is known as a costing system. Traditionally, costing systems focused on determining the
inventory value of manufactured products (the inventoriable product cost) for external financial
reporting. Such systems focused on production costs only and ignored other non-production costs