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Cost Accounting

Not all states permit formation of limited-liability more characteristics in common may be accumulated into
companies. They are neither a partnership nor a corpora- cost pools. Costs are then reassigned, differently for spec-
tion. They generally have a limited life span. Management ified purposes, from these cost pools to one or more cost
must be by a small group. States do not restrict the num- objects. A cost object is an activity, a unit of product or
ber or the type of members. Unlimited transferability of service, a customer, another cost pool, or a segment of an
ownership is not permitted. organization for which management needs a separate
measurement and accumulation of costs. Costs assigned
S Corporations. S corporations’ major benefit is that they to a cost object are either direct or indirect. A direct cost
are taxed like partnerships. The owners’ income tax is can be traced and assigned to the cost object in an unbi-
based on their share of the firm’s total net income, ased, cost-effective manner. The incurrence of an indirect
whether or not it is distributed to them. The second huge cost cannot be so easily traced. Without such a direct rela-
benefit is limited liability. tionship to the cost object, an indirect cost requires an in-
between activity to help establish a formula relationship.
However, an S corporation is limited to thirty-five
When the indirect cost is assigned through the use of this
shareholders, none of whom can be nonresident aliens.
formula, the cost is considered allocated. The activity used
Only one class of stock may be issued or outstanding. The
S corporation may own only 80 percent of a subsidiary to establish the in-between linkage is called the basis of
business firm. allocation.

TYPES OF ALLOCATIONS
BIBLIOGRAPHY
Dicks, J. W. (1995). “Corporation.” In J. W. Dicks, The Small Cost allocations can be made both within and across time
Business Legal Kit and Disk. Holbrook, MA: Adams Medica periods. If two or more cost objects share a common facil-
Corporation. ity or program, the cost pool of the shared unit is a com-
Sniffen, Carl R. J. (2001). The Essential Corporation Handbook mon cost to the users and must be divided or allocated to
(3rd ed.). Central Point, OR: Oasis Press/PSI Research. them. Bases of allocation typically are based on one of the
Spadaccini, Michael (2005). The Essential Corporation Handbook following criteria: cause-and-effect, benefits derived, fair-
(4th ed.). Irvine, CA: Entrepreneur Media. ness, or ability to bear. The selection of a criterion can
affect the selection of a basis. For example, the allocation
of the costs of a common service activity across product
G. W. Maxwell
lines or programs based on relative amounts of revenue is
an ability to bear basis, whereas the same allocation based
on the relative number of service units consumed by each
product line or program would reflect either the benefits
COST ACCOUNTING
derived or the cause-and-effect criteria. Cost allocation
SEE Accounting then is the assignment of an indirect cost to one or more
cost objects according to some formula. Because this
process is not a direct assignment and results in different
amounts allocated depending on either the basis of alloca-
COST ALLOCATION tion or the method (formula) selected, some consider cost
A cost is generally understood to be that sacrifice incurred allocation to be of an arbitrary nature, to some extent.
in an economic activity to achieve a specific objective, Costs of long-lived assets are allocated and reclassified
such as to consume, exchange, or produce. All types of as an expense across two or more time periods. For any-
organizations—businesses, not-for-profits, governmen- thing other than land, which is not allocated, the reclassi-
tal—incur costs. To achieve missions and objectives, an fication of tangible assets is called depreciation (for
organization acquires resources, transforms them in some anything other than natural resources) or depletion (for
manner, and delivers units of product or service to its cus- natural resources) expense. The bases for these allocations
tomers or clients. Costs are incurred to perform these are normally either time or volume of activity. Different
activities. For planning and control, decisions are made methods of depreciation and depletion are available. The
about areas such as pricing, program evaluation, product costs of long-lived intangible assets, such as patents, are
costing, outsourcing, and investment. Different costs are allocated across time periods and reclassified as amortiza-
needed for different purposes. In each instance, costs are tion expense. The basis for these allocations is normally
determined to help management make better decisions. time.
When incurred, costs are initially reviewed and accu- Cost allocations within a time period are typically
mulated by some classification system. Costs with one or across either organizational segments known as responsi-

164 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION