Costing

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on September 15, 2021

Definition of Costing

The Institute of Cost and Management Accountants (ICMA) defines costing as the technique and process of ascertaining costs.

This is a reasonable definition, but it only addresses the dimensions of technique and process. To elaborate on this, costing can also be defined as a systematic process for determining the unit cost of output produced or service rendered.

That is to say, costing involves analyzing the expenditure incurred in manufacturing an item or rendering a service. This enables an organization’s managers to know not only the total cost but also its constituents.

Therefore, costing, as a technique, is the body of principles and rules used to ascertain cost. As a process, it is the procedure used to ascertain costs.

The question of what technique and process to use depends on the nature of the industry, the type of product, and the method of production.

Objectives of Costing

The objectives of costing are broadly divided into the following three areas.

1. Ascertainment of Cost

Ascertainment of cost is the first and most important objective of costing.

The aim is to determine the cost of each product, process, or operation, and to ensure that all expenses are absorbed into the cost of the products, the techniques, and the process of costing used.

To ascertain the cost of management, with the help of the costing department, it is worthwhile to make preliminary investigations and introduce a system for recording costs.

A proper and complete record is maintained for materials, labor, and other expenses (referred to as covered heads).

Thus, the management periodically collects cost data, which is used as the basis for determining the selling price. As such, the costs and sales are matched. This matching process helps to determine and improve the profitability of the product.

Significantly, costing not only enables managers to ascertain costs, but it also provides a basis for ascertaining the profitability of the product being produced or any services rendered.

2. Cost Control

Ascertaining costs alone is not sufficient. Naturally, it is not enough because it is the cost that determines the selling price and, in turn, the profitability. As such, the norm that everyone attempts to follow is “the lower the cost, the greater to profit.”

To fulfill the underlying idea behind this norm, it is important to control the cost so as to reduce the cost of a product or service.

Budgets are prepared, standards are established, actuals are ascertained, and then a comparison is made. If any deviation between the actuals and the budget and the standards is identified, corrective measures are taken.

This helps to control the cost and enables managers to earn more or reduce the selling price. In turn, this allows the customer to benefit from better quality, which can build goodwill for the product and firm.

3. Guidelines for Management

Costing is a faithful servant for managers within an organization. It aids managerial decision-making from all practical points of view.

Cost data obtained from costing enable managers to strive toward efficiency for the whole organization. Cost data provide organizational guidelines for various managerial decisions.

For example, the use of cost data can guide the introduction of a new product line, lead to the identification of unused capacity, or highlight expansion opportunities.

Advantages of Costing

Costing provides valuable cost data. Therefore, it plays a vital role in managerial decision-making.

To deliver good services, it is also necessary to have a sound costing system. The advantages that managers derive from costing depend on the costing department, particularly along the following dimensions:

  1. Type of costing department
  2. Adequacy of costing department
  3. Efficiency of costing department
  4. Objectives of costing department

Another influencing factor is the cooperation that the costing department can receive from other departments in the organization.

According to this viewpoint, it is not costing but how costing functions, as well as how much it delivers, that is important. With this in mind, a sound system of costing helps to derive various advantages. Some of these are discussed in the remainder of this article.

An important advantage of costing is that it provides cost data for managerial decisions. Costing also provides information that may help in making estimates and then in calling for tenders.

Costing reveals the losses that a particular unit is incurring. It reveals the inefficiencies at various levels, and it also helps to identify the exact cause of a decrease or increase in the profit or loss of a business (as a whole or unit-wise, as required).

Further advantages of costing are that it can assist in identifying profitable or unprofitable units and ventures. As such, costing guides future policies.

Significantly, costing also provides an independent but reliable check on financial accounting. This is because costing plays a role in the reconciliation of the two activities.

Fundamentally, costing also controls costs. Costing also compares the respective costs of different methods, machines, and systems, and it helps in decision-making in this regard.

Costing provides a tool for price fixation as well as price control. Costing can help the government make decisions about tariff protection, and it can also offer information relating to wage policy.

A final advantage of costing is that it helps managers within an organization make decisions about wages. More broadly, costing provides a solid foundation for the efficient and smooth functioning of the enterprise as a whole.

Worth the Cost

We hope reading this article has been worthwhile. If you have some more clarifications, it would be worth it to reach out to a financial advisor in Memphis, TN or browse through our financial advisor page to check on the list of areas we are currently working with.

 

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