Manufacturers have the challenging task of setting the pricing of the product. With increasing competition in the market, the manufacturers cannot set the pricing to be too high. If the price is high, they will probably lose the customers to the competitors. And if the pricing of the product is set too low, the business will be at a loss. To solve this issue, an effective costing method is required. It is important for the business to strike a balance by providing the best value to the customers and simultaneously ensuring financial stability. In this blog, let us learn more about the costing methods in detail—
What are Costing Methods?
Costing methods are the process of determining the costs of a product or service. With this concept, several methods are developed, to ascertain the pricing. These techniques analyse various cost components such as raw materials, labour, overhead expenses and many other significant factors. It helps in calculating the total cost per unit or service accurately.
There are different methods of costing, but depending on the nature of the business, the costing method is selected. Each costing method has its own advantages and processes. Costing methods are vital for the business to make the right pricing decisions as they impact the profit margins and financial performance of the business. The right costing method is a boon for the business to achieve optimal cost control and it helps in making significant pricing strategies.
What are the different Methods of Costing?
Now we know the purpose of the costing method, let’s learn in detail about its different types of costing :
1. Job Costing
Job costing is a type of accounting where the cost of each job is taken into account and calculated. This method is applied to the production units that don’t involve more repetitive tasks.
The manufacturing units where the jobs are performed must be able to segregate each job or lot depending on the executed number of orders. Job costing is applied in commercial foundries, drop forging shops, and specialized industry equipment manufacturers.
2. Contract Costing
Based on the underlying principles job costing and contract costing are similar. However, the difference is that the contrast costing task is big and the job costing is comparatively small. Both the costing methods are referred to as terminal costing.
3. Cost-plus Costing
This method is one component of contract costing. Cost-plus costing is implemented when, in a contract, the contractor receives both the predetermined contract price and an additional mutually agreed-upon amount.
4. Batch Costing
Batch costing is the practice of grouping orders or tasks into distinct batches, considering the efficient production of items as a primary factor. Here, the cost is determined based on the group of products.
This costing method is applicable for companies such as businesses producing general engineering goods where the components are arranged in appropriate economic batches. In addition, batch costing is best utilised in pharmaceutical companies to determine the cost of goods effectively.
5. Process Costing
Process costing is applicable when a product undergoes various sequential phases, each of which is clearly defined, distinguishable, and easily separable from the others. In addition, process costing is beneficial to calculate the cost at each stage in the production process.
Process Costing is best suited for extractive industries and businesses such as chemicals, paints, food, soaps etc. All these companies find this method beneficial and effective.
6. Single Costing
Single costing involves determining the cost per unit of output or production. This costing method is also known as output costing or unit costing. Every component comprising this cost is individually calculated. Single costing method is suitable for industries such as paper mills, brick-making and flour mills.
7. Operating Costing
Operating costs are applicable to companies that provide bus, electricity and transport services. It helps in calculating the costs incurred in providing those services.
8. Multiple costing
In multiple costing, the costs incurred from multiple sections are combined after determining the expenses of each manufactured component. This costing method is very useful for the automotive industry and industries dealing with the production of assembly parts.
9. Departmental Costing
The main objective of departmental costing is to determine the cost of outputs separately for each department. If any company has multiple departments, departmental costing is the best solution to calculate and ascertain costs.
10. Operation Costing
Operation costing is an enhanced version of process costing. It is best applicable when a repetitive or mass production process is carried out. It is also used if the components are in a semi-finished stage.
Also Read : Inventory Valuation with Multiple Costing Methods
Types of Costs
Costs refer to the general expenses incurred in the business. Listed below are the types of costs in detail :
1. Variable Cost – As the production procedure and levels change, variation costs differ. Raw materials cost change as per the production volume.
2. Fixed Cost – These involve the fixed expenses of the production process. They are a stark contrast to variable costs. The salaries of the employees won’t change depending on the production volume.
3. Sunk Cost – Sunk costs are referred to the expenses that cannot be recovered in the future. For example, the costs of machines or the equipment used in the production process cannot be recovered.
4. Opportunity Cost – These costs occur when a business chooses a specific production process over the other. If a business chooses the production of dolls over the production of toy cars, considering its profit, then it is termed an opportunity cost.
Techniques of Cost Accounting
Cost accounting involves multiple procedures and depends on managerial decisions. Some of the best types of cost accounting are enumerated below :
1. Direct Cost Accounting
This technique focuses only on variable costs. Fixed costs incurred in a company are excluded from this technique. An important point to note is that this technique is applicable to short-term decision-making. This accounting method doesn’t involve all types of costs, so it cannot be used for the long term. For example, if the costs are calculated for the construction, only the material cost(variable costs) will be used for introspection.
2. Standard Cost Accounting
This method helps with the estimation of costs that are incurred in the manufacturing process. Because precise costs cannot be predetermined, manufacturers employ standard costing approaches to effectively anticipate and budget their expenditures. Standard costing technique helps in budget preparation ahead for streamlined financial management. For example, labour charges and costs of raw materials can be used with the standard costing.
3. Marginal Cost Accounting
Marginal costing ascertains the number of units to produce and a cost structure is created based on it. It is utilized to assess the effects on expenses and profits in the event that a solitary production unit surpasses the projected quantity. Take, for example, a company will ascertain the cost of 100 units of soft toys. This method will help the company determine if the production unit will exceed 140 and if the production is profitable or non-profitable.
4. Historical Cost Accounting
The historical cost accounting method documents the price of an asset as per the original costs incurred when purchasing it. As per the market records, the company won’t update the price of the figures. Suppose the company purchased property worth Rs 15 lakhs 11 years ago. Now if the worth of that property is 60 lakhs after property valuation, the historical cost is only recorded which is Rs 15 lakhs.
5. Uniform Cost Accounting
This method emerged very recently and is not similar to any other cost accounting method. This method is unique where a group of companies or industries follow the same costing principles as per mutual agreement. Oil, coal, gas industries etc. apply this method and they function by mutually agreeing to the costing method.
Also Read : Fixed Costs : What It Is and How It’s Used in Business
Advantages of Cost Accounting
Everyone involved in the business including stakeholders, customers, and the government benefits from the various cost accounting methods. Some of the advantages of cost accounting techniques are enumerated below.
- Cost accounting assists in differentiating variable and fixed expenses which helps the company to make wise decisions. Management can determine the price of a product depending on the cost incurred during the production process.
- One of the biggest advantages is for the employees as cost accounting helps in assessing the efficiency of every employee, keeping the competitive spirit high. This will help the employees to get recognition and incentives on time.
- It also helps in cost control by analysing and determining the various costs incurred in operating the business.
Conclusion
Finally, Costing methods in accounting are beneficial for determining the costs of the items manufactured in the company. And companies can adopt cost accounting tools for business efficiency. Accounting software or ERP systems can be used to determine the pricing of the products seamlessly.
