Costing method: choosing the right one carefully

method of costing

To calculate the cost of a process, you add up all the direct expenses incurred in that specific production stage — including the materials used and wages of your operators. You then allocate a portion of the indirect costs based on how much the process uses the resources. So it will be necessary to ascertain the cost of each component. To ascertain the cost of the final product batch costing may be applied.

Then, you allocate a portion of the indirect costs based on how much resources are consumed for the assignment. For example, if a job took up 50% of the factory space for a day, you would allocate 50% of the day’s rent to that task. Job costing is for tracking the costs when every project is different, and the cost of each job varies.

Difference between job costing and process costing

Setting the right price for a product is vital for any manufacturer. Price your item too high, and you could drive potential customers straight to your competitors. But price the item too low, and your accountant may experience heart palpitations whenever they look at the balance sheet. Costing is the technique and process of ascertaining costs. Uniform costing was defined by the Institute of Cost and Management Accountants as “the use by several undertakings of the same costing principles and/or practices.” They are compared to actual costs when incurred to ascertain the variances or differences.

  • The final product can either be physical goods or services.
  • It is adopted in industries where the products pass through different processes or stages before completion.
  • This method is suitable for chemical works, sugar, paint manufacturers, oil refineries, bottling companies, breweries, rubber and tanning industries.
  • In this costing method, the costs of different sections of production are combined after ascertaining the cost of each and every part manufactured.

This method is used by firms engaged in ship building, construction of buildings, bridges, dams and roads. If you’re manufacturing different products, you need to calculate each product’s overhead cost per unit. This is because each product will have different production costs, so the overhead cost per unit won’t be the same. In all these industries there is natural or standard unit of cost, for example, tonne of coal in collieries, tonne of cement, one thousands of bricks, etc. The object of this method is to ascertain the cost per unit of output and the cost of each element of such cost. This method is suitable for industries where the manufacture is continuous and units are identical.

1.2 Operation Costing

Under this method cost per unit is ascertained by dividing the cost by number of units produced. It is applied where orders for identical products are placed in convenient lots or batches. I.C.M.A. defines it as “that form of specific order costing which applies where similar articles are produced in batches either for sale or for use within an undertaking.

method of costing

This method is good for a comparative study of the identical costs of different departments. The method of costing, which is used in service rendering undertakings is called operating costing. For example – transport, water supply, electric undertakings, telephone services, hospitals, nursing homes, etc. use this method of costing. A special feature of operating costing is that the unit of cost is generally a compound unit.

Costing methods and the importance of choosing the correct one

Now that you understand the costs involved and how to calculate these, let’s take a closer look at the costing methodologies to see the advantages and disadvantages of each method. In this article, we’ll focus on the accounting method used to determine the cost of a product. Under this system, costs are ascertained by recording expenditures and allocating these to production as and when they are incurred. Under this method costs are collected and accumulated for each job or work order or project separately. Each job can be identified separately and hence becomes essential to analyze the costs according to each job.

  • For example, if a job took up 50% of the factory space for a day, you would allocate 50% of the day’s rent to that task.
  • For example the unit of cost in electricity supply is kilowatt hour.
  • Job costing is adopted in concerns where the work done is analysed into different jobs, each job being considered as separate unit of cost.
  • Cost estimation and cost accounting system is referred to as the costing method.

Target costing is a method used to ensure that products are designed and priced to meet customer needs. The disadvantages of standard costing are that it can be inaccurate if circumstances change significantly from the time the business established the standards. It can also be challenging to update the standards on a timely basis. This type of costing is probably the most common method due to its simplicity. The predetermined costs are derived from the company’s historical experience and are updated periodically to reflect changing conditions.

Types/Techniques of Costing

This is because the information is obtained after the events have already taken place. As such, this procedure does not enable the manufacturer to take corrective action in time. Ascertaining and recording costs after they have been incurred is known as historical costing. It provides the management with a record of what has happened and, therefore, is a postmortem of the actual costs. Costing methods works with the assumption that production capacity is fully utilized. If this is not the case, then the results presented at the end of the year will be misleading.