What is the preferred sequence for assigning costs?

The preferred sequence for assigning costs is based on the principles of cost management and the need for accuracy and relevance in financial reporting. Starting with direct tracing allows for the most precise identification of costs directly attributable to a specific cost object. Direct costs can be traced explicitly to the cost object without needing estimation or allocation.

Following direct tracing, the cause-and-effect approach provides a logical means to allocate indirect costs to cost objects based on the activities that drive those costs. This step is more accurate than simple allocation methods because it looks at the relationship between costs and the specific cost object.

Finally, allocation is the last step in this sequence. Allocation refers to the process of spreading costs over multiple cost objects when costs cannot be directly traced or linked through a cause-and-effect relationship. This is generally used for overhead or indirect costs where a straightforward assignment isn’t feasible.

Hence, the sequence of direct tracing, followed by cause-and-effect, and then allocation, maximizes the accuracy and relevance of cost assignments. This approach is consistent with best practices in costing methodologies and financial reporting.