ANSWER

COST OBJECT

A cost object is any item for which costs are being separately measured. It is a key concept used in managing the costs of a business. Here are some types of cost objects:

• Output. The most common cost objects are a company's products and services, since it wants to know the cost of its output for profitability analysis and price setting.

• Operational. A cost object can be within a company, such as a department, machining operation, production line, or process. For example, you could track the cost of designing a new product, or a customer service call, or of reworking a returned product.

• Business relationship. A cost object can be outside of a company - there may be a need to accumulate costs for a supplier or a customer, to determine the cost of dealing with that entity. Another variation on the concept is the cost of renewing a license with a government agency.

COST DRIVERS

In a traditional system of accounting, the indirect costs or manufacturing overheads are allocated to the production cost based on a predetermined rate. In some accounting systems, cost drivers are almost irrelevant in determining the contribution.

• Number of set-ups
• Number of machine hours
• Number of processed orders
• Number of orders completed
• Number of labor hours
• Number of orders packed and delivered

A cost driver is the direct cause of a cost and its effect is on the total cost incurred. For example, if you are to determine the amount of electricity consumed in a particular period, the number of units consumed determines the total bill for electricity. In such a scenario, the number of units of electricity consumed is a cost driver.

A direct cost is a price that can be directly tied to the production of specific goods or services. A direct cost can be traced to the cost object, which can be a service, product, or department. Direct and indirect costs are the two major types of expenses or costs that companies can incur.

Indirect costs are costs used by multiple activities, and which cannot therefore be assigned to specific cost objects. Examples of cost objects are products, services, geographical regions, distribution channels, and customers. Instead, indirect costs are needed to operate the business as a whole. It is useful to identify indirect costs, so that they can be excluded from short-term pricing decisions where management wants to set prices just above the variable costs of products.

RELATIONSHIP BETWEEN DIRECT AND INDIRECT COST

Some direct and indirect costs are tax-deductible. Examples of tax-deductible direct costs include repairs to your business equipment, such as your production line. Tax-deductible indirect costs may include rent payments, utilities and certain insurance costs.

Explain when a company should pursue price versus cost analytic approaches.

• Perform a general Internet search on the item using various shopping sites and search engines to get an idea of the market and published prices.

• Contact the manufacturer directly for a suggested retail price, or seek pricing quotes on the same item from competitor brands or manufacturers and seek price indices. Hauht also suggests seeking advice from industry peers, to get a better sense of what others have paid for the same item.

• Using the aforementioned strategies can help identify whether there has been any escalation in the price.

Once these strategies have been applied, the purchaser may assess whether a specific product has been priced fairly and if necessary, negotiate a reasonable cost.