Among other things, faulty cost information can have an impact on inventory valuation (if it is a manufacturing or retail business) and/or pricing of goods and services. When you calculate your product's cost incorrectly, you end up pricing it incorrectly, and in the long run it can affect your market.

Last week we discussed cost containment, cost management, cost reduction, etc. In order to contain, manage or reduce costs, it is important to first gather and record costs as accurately as possible.

This week we learned that a cost is direct or indirect depending on whether it can be traced to a cost object in economically feasible way. Whereas a direct cost can be traced to a cost object, an indirect cost has to be allocated to a cost object. If the cost object is a unit of your product (e.g., a piece of furniture), the above becomes important because it can affect the way you determine the cost of each sofa, and hence can affect all those decisions that are based on the cost, including the pricing of each sofa.

Going forward, you will be exposed to several terms including the following. Lets make sure that we understand these terms clearly. Can you explain briefly one or more of these terms, in your own words, using an example from the business world?

Cost tracing?

Cost allocation? How is it different from cost tracing?

Cost allocation base?

Overhead allocation rate?