Accounting Business Reporting for Decision Making

464 Accounting: Business Reporting for Decision Making

such as information technology and human resources that also support the production process. So,

due to an increasingly competitive business environment, coupled with an increase in the level of

costs common to many cost objects, entities were forced to take a more contemporary view when

developing costing systems. To remain competitive, entities now needed to understand the costs

incurred at all stages of the internal value chain — from research and development, design, pro-

duction and distribution, to customer service. This internal value chain represents all the linked

activities undertaken within an entity — from the inception of the product or service, to the final

delivery to customers.

Geographic regions

Business units

Services

Products

Business processes

Customers

Costs in the

accounting information

system

F I G U R E 11.1 Cost objects

As a consequence, costing systems were developed to support internal management rather than

simply to measure the inventoriable product cost. Such costing systems take a more contemporary

approach by enabling an entity to capture costs at any stage in the value chain, and are suitable

for measuring the cost of any cost object. The focus is on aligning the cost to activities in the

first instance and then to cost objects. For example, consider an entity that follows the traditional

approach of allocating salary costs to individual departments (e.g. allocating the salary costs of

accounts payable employees to the accounts payable department). While this provides management

with information about total departmental salary cost, it gives no insight into why the costs have

been incurred. Such salary costs represent the employee effort in undertaking a variety of activities.

For accounts payable staff, these activities would include processing invoices, assessing credit and

reconciling payments against the bank account. More insight into the cost of these activities will be

gained if the salary costs are assigned to the activities that make use of the costs rather than to the

department.

We will now discuss how to develop a costing system to measure the full cost (direct costs plus allo-

cated indirect costs) of a cost object. Before we do this, it is necessary to understand the classification of

costs as either direct or indirect in relation to the cost object of interest.

11.2 Direct costs

LEARNING OBJECTIVE 11.2 Classify costs into direct costs and indirect costs for individual cost objects.

Direct costs are those costs that can be linked directly to the cost object. Figure 11.2 shows the relation-

ship between a direct cost and the cost object. To establish this link, an entity needs some type of

tracking system to trace the cost directly to the cost object. Source documentation (whether compu-

terised or manual) enables identification of the specific cost object that has made use of a particular