Costing Methods and Techniques
Costing is the technique and process of ascertaining costs. Keeping this definition in view, various methods have been developed to ascertain costs. A few of the important methods are listed below:
- Job Costing
- Contract Costing
- Cost-plus Costing
- Batch Costing
- Process Costing
- Single (unit or output) Costing
- Operating Costing
- Departmental Costing
- Multiple or Composite Costing
- Operation Costing
Important Costing Methods
1. Job Costing
In job costing, the costing of each job undertaken and executed is calculated. This method is adapted in production units that do not involve highly repetitive work.
Production units in which job costing is performed should be able to separate each job or lot based on the number of orders executed. In commercial foundries, drop forging shops, and specialized industrial equipment manufacturers, job costing is commonly used.
2. Contract Costing
Job costing and contract costing are the same in terms of their underlying principles. A contract is a big job, whereas a job is typically small. Job costing and contract costing are also frequently referred to as terminal costing.
3. Cost-plus Costing
This is an aspect of contract costing. Cost-plus costing occurs when, for a contract, both the contract price and an extra agreed sum are paid to the contractor.
4. Batch Costing
When orders or jobs are arranged into different batches, after taking into account the convenience of producing items, it is known as batch costing. Under batch costing, the cost of a group of products is ascertained.
Batch costing is suitable for companies producing general engineering goods, in which the components can be easily arranged in convenient economic batches. In pharmaceutical companies, batch costing is also used advantageously and effectively.
5. Process Costing
When a product passes through different stages, each of which is distinct, well-defined, and easily separable, process costing can be applied. Process costing helps to calculate the cost of production at each stage.
Extractive industries, including companies dealing in chemicals, paints, foods, or soaps, can effectively and advantageously use the process costing method.
6. Single Costing
Single costing is also known as unit costing or output costing. Under single costing, the cost per unit of output or production is ascertained. Each element constituting such a cost is determined separately.
This costing method is suitable in industries such as brick-making, paper mills, and flour mills.
7. Operating Costing
When expenses are incurred to provide services such as those rendered by bus companies, transport agencies, and electricity companies, the operating costing method is used to good effect.
8. Multiple Costing
In this costing method, the costs of different sections of production are combined after ascertaining the cost of each and every part manufactured.
In the automotive industry, as well as other industries in which products are comprised of many assembled parts, multiple costing is frequently applied.
9. Departmental Costing
In this method, the main objective is to ascertain separately the cost of outputs for each department. Whenever an organization consists of several departments, departmental costing is a reasonable option to adopt.
10. Operation Costing
Operation costing is a refinement of process costing. When mass production or repetitive production are carried out. or where components must be stocked in a semi-finished stage, operation costing is suitable and used with advantage.
Types/Techniques of Costing
In addition to the above-mentioned costing systems, there are different types/techniques of costing. These refer to the various systems that are used to ascertain and analyze costs. They include the following:
1. Historical Costing
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.
Since this approach is conventional, it is known as conventional costing or actual costing. Actual costs can be ascertained in two ways: first, post costing; and second, concurrent or continuous costing.
Under this system, costs are ascertained after production is completed. This is achieved by analyzing financial data in such a way as to disclose the cost of the units that have been produced.
The main advantage of this procedure is that the figures analyzed are the actual figures. For this reason, the cost arrived at is correct.
However, a serious drawback of post costing is that it is historical in nature. 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.
Under this system, costs are ascertained by recording expenditures and allocating these to production as and when they are incurred. The result is that costs are ascertained as soon the job is completed or even when the job is in progress.
Continuous costing necessarily involves estimates, especially in terms of overheads. Therefore, the cost figures may not be exact.
Nevertheless, since continuous costing makes costing data available promptly, it enables the management to take corrective actions.
A core weakness of continuous costing is that it does not provide a standard that can be used to evaluate the efficiency of the current operations. Additionally, continuous costing does not disclose what the cost of the job ought to have been.
2. Standard Costing
According to the Terminology of Cost Accountancy published by the Institute of Cost and Management Accountants, standard costing is defined as follows:
The preparation and use of standard costs, their comparison with actual costs, and the analysis of variances to their causes and points of incidence.
Under standard costing, costs are calculated in advance based on normal or probable expectations. These costs are known as standards or standard costs. They are compared to actual costs when incurred to ascertain the variances or differences.
These variances or differences are analyzed in terms of their causes later on. As a result, management can take corrective action when necessary.
3. Marginal Costing
Marginal costing, also known as variable costing, is defined as follows:
The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.
Under marginal costing, costs are classified as fixed or variable. Fixed costs tend to remain fixed or constant with changes in the volume of output, whereas variable costs typically vary in a directly proportional way based on changes in the volume of output.
The main objective of marginal costing is to deal with the effects of changes in the volume or range of output on the costs or profit of a business concern.
4. Direct Costing
According to the Terminology of Cost Accountancy published by the Institute of Cost and Management Accountants, direct costing is defined as follows:
The practice of charging of all direct costs to operations, processes, or products, leaving all indirect costs to be written off against profits in the period in which they arise.
This differs from marginal costing in that some fixed costs could be considered to be direct costs in appropriate circumstances.
5. Absorption Costing
The Institute of Cost and Management Accountants defined absorption costing as follows: “The practice of charging all costs, both variable and fixed, to operations, processes or products.”
Under absorption costing, no distinction is made between fixed costs and variable costs. Furthermore, all costs, whether fixed or variable, are considered to determine the cost of production. Absorption costing is also known as full costing.
6. Uniform Costing
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.”
Thus, when a number of undertakings, whether under the same management or otherwise, decide to adhere to one set of accepted costing principles (particularly in matters where there can be two opinions), they are said to be following uniform costing.
Uniform costing seeks to establish uniform costing methods. This enables the performance comparison of different undertakings to be undertaken easily and effectively, leading to the common advantage of all participating undertakings.