Cost behavior and Cost objects

Cost behavior is an indicator of how a cost will change in total when there is a change in some activity. In cost accounting and managerial accounting.

Cost behavior is the manner in which expenses are impacted by changes in business activity. A business manager should be aware of cost behaviors when constructing the annual budget, to anticipate whether any costs will spike or decline. For example, if the usage of a production line is approaching its maximum capacity, the relevant cost behavior would be to expect a large cost increase (to pay for an equipment expansion) if the incremental demand level increases by a small additional amount. Understanding cost behavior is a critical aspect of cost-volume-profit analysis.

cost drivers provide two important roles for the management accountant:

(1) Enabling the assignment of costs to cost objects.

(2) Explaining cost behavior: how total costs change as the cost driver changes. Generally, an increase in a cost driver will cause an increase in total cost. Occasionally, the relationship is inverse; for example, assume the cost driver is degree of temperature, then in the colder times of the year, increases in this cost driver will decrease total heating cost. Cost drivers can be used to provide both the cost assignment and cost behavior roles at the same time. In the remainder of this section, we focus on the cost behavior role of cost drivers. Most firms, especially those following the cost leadership strategy, use cost management to maintain or improve their competitive position.

Cost management requires a good understanding of how the total cost of a cost object changes as the cost drivers change. The four types of cost drivers are activity-based, volume-based, structural, and executional. Activity-based cost drivers are developed at a detailed level of operations and are associated with a given manufacturing activity (or activity in providing a service), such as machine setup, product inspection, materials handling, or packaging. In contrast, volume-based cost drivers are developed at an aggregate level, such as an output level for the number of units produced. Structural and executional cost drivers involve strategic and operational decisions that affect the relationship between these cost drivers and total cost.

FOUR types of cost behavior are usually:

• Fixed costs. The total amount of a fixed cost will not change when an activity increases or decreases.
• Variable costs. The total amount of a variable cost increases in proportion to the increase in an activity. The total amount of a variable cost will also decrease in proportion to the decrease in an activity.
• Mixed or semivariable costs. These costs are partially fixed and partially variable.
• Stepped fixed costs This is a type of fixed cost that is only fixed within certain levelsof activity. Once the upper limit of an activity level is reached then anew higher level of fixed cost becomes relevant.

Cost objects

A cost object is a term used primarily in cost accounting to describe something to which costs are assigned. Common examples of cost objects are: product lines, geographic territories, customers, departments or anything else for which management would like to quantify cost. Cost object is anything for which a separate measurement of cost is required. Cost object may be a product, a service, a project, etc.

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.

Uses of Cost Object

• They help in determining the profitability and price of the product or service.
• Such objects help a company to find the money it is spending on that object.
• It also assists a company in managing and controlling costs.
• Measuring costs for cost objects at regular intervals can help a company monitor and compare the performance over time.
• They also help in the preparation of the annual reports.
• They can help in making better business decisions, such as when filing a tender, allocating budgets to departments, and more.