What is Costing?
Costing refers to the process and technique of determining costs. It involves analysis of the information so as to help management identify the cost of production and selling, i.e. the total cost of various products and services, as well as to understand how the total cost is created.
Also see: Material Control
Methods of Costing
Methods of costing differ by the industry as it relies on the nature and type of manufacturing performed. These are broadly classified into job costing and process costing. Further, costing methods are the methods used for the calculation of cost per unit.These methods are:
In job costing, the cost of each job is calculated. Job costing is applicable in all the industries wherein work is carried out when a customer’s order is received such as a printing press, a motor workshop, and so forth. In this method, the job order given by the customer is unique and needs various resources for the accomplishment of the job. It is a task that is undertaken to produce a product or deliver a service that can be uniquely identifiable. In this method, the collection of costs are undertaken on the basis of each order. For Example Ship Building, Printing, Oilwell drilling, etc.
Batch costing is a variation of job costing, which is used in industries where similar items are produced in batches of large quantities. A batch indicates the consignment of goods produced in a factory at a time. In batch costing, each batch is treated as a cost unit, and thus cost is ascertained separately. Hence, cost per unit is ascertained by dividing the cost of the batch by the total number of units produced per batch. Further, it is suitable for industries that manufacture general-purpose machine tools, utility poles, bakery items, pharmaceuticals or drugs, toys, etc.
It is another version of job costing, which is associated with building and civil engineering works. Contract costing is helpful in determining the cost of each contract individually, as the costs are duly accumulated for each order. It is applicable for firms engaged in construction work of roads, buildings, flyovers, bridges, etc.
In process costing, the cost of completing each stage of work is determined. This method is appropriate for manufacturing and producing entities, wherein a series of continuous as well as repetitive activities, operations are involved. It manufactures thousands of units of the same product, during a period, such as paper, soap, textiles, bread, detergent, sugar, etc.
Those organizations which are engaged in rendering services such as transport, water supply, retail trade, railway, bus, boiler houses, hotels, power distribution, etc use this method for ascertaining cost. Here, each service is treated as a separate unit. In this method the cost of providing or operating service is determined. Cost per unit is ascertained by dividing the total cost by the units of services provided in operating costing.
Single Output Costing
Single Output Costing is applicable to the industries that produce a particular product like brick kilns, paper mills, flour mills, cement industry, steel industry. Here, the whole production cycle is costed and the cost per unit is derived by dividing total accumulated costs by the number of units produced.
Otherwise called composite costing, in this a combination of two or more methods of costing. This method is used by industries where the manufacturing process used in the production of products is complex in nature and any one method of costing cannot be used for the ascertainment of costs a combination of different costing methods is used which is called multiple costing. Industries like radio, engines, automobiles, airplanes, refrigerators, television, air conditioners, etc use this method.
Also See: Bin Card
Techniques of Costing
Techniques imply the principles to be followed for ascertaining the cost of the products manufactured or services rendered. The various techniques of costing are:
- Absorption Costing: The technique of costing in which cost is ascertained after it is incurred. In this fixed and variable costs are allocated to the units of costs and absorption of total overheads is carried out on the basis of activity level.
- Standard Costing: Technique of costing in which standards are used for costs and revenues so as to control cost by way of variance analysis. Hence, it establishes standards for each cost element and for revenues and then they are compared with the actual results to determine the variances as per the originating causes. It is used in association with budgetary control. In budgetary control, budgets are prepared and continuous comparison is made between the actual result and the budgeted result.
- Marginal Costing: A technique of costing in which all variable costs are charged to operations, processes, or products, and all fixed costs are written off against profits for the period in which they take place.
- Lifecycle costing: Evaluation of total costs of production over its economic life. In order to analyze cost, the entire useful life of the product is taken into consideration, right from the stage when the product is launched to its end. Due to this very reason, it is known as cradle to grave or womb to tomb costing. Further, along with the production costs, it also takes into account pre-production costs.
- Target Costing: This technique is used in a competitive environment so as to control the costs period to its designing. This facilitates the organization to operate with market-based prices. To put it simply, rather than developing a product and then making efforts for selling it to customers, in target costing, companies find out what will be sold in the market at what price and then designs the product accordingly. It indicates market-driven standards.
- Uniform Costing: When the same costing principles are used by various firms operating in the same industry, it is known as uniform costing. It is regarded as a common system wherein common accounting principles and practices are adopted by identical firms.
- Direct Costing: A practice of costing in which all direct costs are charged to operations, processes, or products, and all indirect costs are left to be written off against profits for the period in which they take place, is direct costing.
Also See: Sunk Cost
Objectives of Costing
- To determine the actual cost of each item, process, or operation
- To identify profitable and unprofitable activities.
- To act as a guide in fixing estimates and preparing quotations for the future.
- To present relevant information for budgetary control.
- To control costs.
- To identify sources of wastes and leakages.
- To determine the efficiency and productivity of labor and machines involved in the process of production.
An ideal costing system is one that is accurate, simple, equitable, elastic, comparable, prompt, and economic. It is one that fulfills all the objectives and provides periodical results to the firm. It also helps in the reconciliation with financial accounts.