486 Accounting: Business Reporting for Decision Making
Summary of learning objectives
11.1 Define a cost object and explain how cost information is used.
A cost object is anything for which a separate measurement of cost is required. Examples are cus-
tomers and individual business units. Cost information is used for a variety of purposes to assist in
day-to-day management and strategic management — in determining inventory values, analysing
product profitability, identifying relevant costs for outsourcing decisions and so on.11.2 Classify costs into direct costs and indirect costs for individual cost objects.
A direct cost is traceable to a particular cost object. The tracing is made possible by the implemen-
tation of a tracking system to link the cost to the cost object. An indirect cost is used for the benefit
of multiple cost objects, and the cost is linked to the individual cost objects by the identification of
an appropriate cost driver.11.3 Discuss the allocation process for indirect costs.
An indirect cost is used for the benefit of multiple cost objects. Therefore, an allocation of costs is
necessary to enable the cost to be assigned to the many cost objects that make use of the resource.
By allocating indirect costs, an entity is able to determine the full cost of the cost object.11.4 Calculate the full cost of a cost object.
Full cost is equal to direct costs plus indirect costs. The accuracy of the cost is strengthened by
the choice of cost driver for indirect cost allocation. Cost drivers can be based on either volume or
activity. Volume drivers assign indirect costs based on some measure of the volume of output; for
example, units of output, direct labour hours or machine hours. In contrast, activity drivers recog-
nise that factors other than volume will cause indirect costs to be consumed; for example, number
of invoices processed, number of orders processed, or time taken to set up machines.11.5 Calculate an inventoriable product cost.
An inventoriable product cost is calculated by manufacturing entities to satisfy the require-
ments of having an inventory value in the financial reports, in line with International Financial
Reporting Standards (IFRS). An inventoriable product cost includes only manufacturing costs. All
non-manufacturing costs are expensed in the current accounting period.11.6 Discuss pricing issues for products and services.
An entity has the option of applying either a cost-based or market-based pricing strategy for its
products or services. A cost-based price will add a markup to a calculated cost of the product or
service. A market-based price will be set at the highest possible price that a customer will pay and
this will be dependent on the degree of product differentiation and competition.Key terms
Activity drivers Cost drivers that can be either volume or non-volume related.
Activity hierarchy Framework that describes how overhead costs change with various activities.
Allocation base Variable used to allocate costs from a cost pool to a cost object.
Collusive pricing When two or more organisations conspire to set prices above a competitive price.
Conversion costs Direct labour and overhead incurred to convert the direct materials to a finished
product.
Cost Resource, usually measured in monetary terms, used to achieve a particular organisational
objective.
Cost allocation Assignment of indirect costs to the many cost objects that make use of the resource.
Cost-based pricing Pricing method that applies a mark-up to some calculations of the product or
services cost.