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Methods of Costing

As per the nature and peculiarities of the business, different Industries follow different methods

to find out the cost of their product. There are different principles and procedure for doing thecosting. However the basic principle and procedure of costing remain the same. Some of themethods are mentioned below:

1.Unit osting!. "ob osting#. ontract osting$. %atch osting&. 'perating osting(. )rocess osting.*. +ultiple osting

. Uniform osting.

Different Methods of Costing

Unit Costing: This method also called -Single output osting-. This method of costing is usedfor products which can be epressed in identical /uantitative units and is suitable for productswhich are manufactured b0 continuous manufacturing activit0. osts are ascertained forconvenient units of output. amples: %ric2 ma2ing, mining, cement manufacturing, dair0, flourmills etc.

Job Costing: Under this method costs are ascertained for each wor2 order separatel0 as each 3ob

has its own specifications and scope. amples: )ainting, ar repair, 4ecoration, 5epair of building etc.

Contract Costing: Under this method costing is done for big 3obs which involves heav0ependiture and stretches over a long period and often it is underta2en at different sites. achcontract is treated as a separate unit for costing. This is also 2nown as Terminal osting.onstruction of bridges, roads, buildings, etc. comes under contract costing.

Batch Costing: This methods of costing is used where the units produced in a batch are uniformin nature and design. 6or the purpose of costing each batch is treated as a 3ob or separate unit.Industries li2e %a2er0, )harmaceuticals etc. usuall0 use batch costing method.

Operating Costing or Service Costing: 7here the cost of operating a service such as nursinghome, %us, railwa0 or chartered bus etc. this method of costing is used to ascertain the cost ofsuch particular service. ach particular service is treated as separate units in operating costing. Inthe case of a 8ursing Home, a unit is treated as the cost of a bed per da0 and for buses operatingcost for a 2ilometer is treated as a unit.

Process Costing: This 2ind of costing is used for the products which go through different

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 processes. 6or eample, manufacturing cloths goes through different process. 6ist process isspinning. The out put of spinning is 0arn. It is a finished product which can be sold in the mar2etto the weavers as well as use as a raw material for weaving in the same manufacturing unit. 6orthe purpose of finding out the cost of 0arn, the cost of spinning process is to be ascertained. Thesecond step is the weaving process. The out put of weaving process is cloth which also can be

sold as a finished product in the mar2et. In such case, the cost of cloth needs to be evaluated. Thethird process is converting cloth in to finished product such as shirt or trouser etc. ach processis to be evaluated separatel0 as the out put of each process can be treated as a finished good aswell as consumed as a raw material for the net process. In such industries process costing isused to ascertaining the cost at each stage of   production.

Multiple Costing: 7hen the output comprises man0 assembled parts or components such as intelevision, motor ar or electronics gadgets, costs have to be ascertained or each component aswell as the finished product. Such costing ma0 involve different methods of costing for differentcomponents. Therefore this t0pe of costing is 2nown as composite costing or multiple costing.

Uniform Costing: This is not a separate method of costing. This is a s0stem of using the samemethod of costing b0 a number of firms in the same industr0. It is treated as a common s0stem of using agreed principles and standard accounting practices in the identical firms or industr0. Thishelps in fiation of price of the product and inter9firm comparisons.

Tpes of Costing

There are different t0pes or techni/ues of costings are used in cost accounting. 4ifferent t0pes ofcosting is used in different industries to anal0e and presenting costs for the purposes of control

and managerial decisions. The generall0 used t0pes of costing are as follows:

Marginal Costing: In +arginal osting, it allocates onl0 variable costs i.e. direct materials,direct labour and other direct epenses and variable overheads to the production. It does not ta2einto account the fied cost of production. This t0pe of costing emphasies the distinction between fied and variable costs.

!bsorption Costing: The techni/ue of absorbing fied and variable costs to production is calledabsorption costing. Under absorption costing full costs, i.e. fied and variable costs are absorbedto the production.

Standard Costing: 7hen costs are determined in advance on certain predetermined standardsunder a given set of operating conditions, it is called standard costing. Standard costing is to becompared with the actual costs periodicall0 to anal0e the changes in the cost to revise thestandards to avoid an0 loss due to outdated costing.

"istorical costing: 7hen costs are determined in terms of actual costs and not in terms of predetermined standards cost is called Historical costing. In this s0stem of cost accounting, costs

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are determined onl0 after the0 have been incurred. Almost all organiations use historical costings0stem of accounting for costs.

# tpes of costing used for ascertaining cost

6or ascertaining cost, following t0pes of costing are usuall0 used.

$% Uniform Costing

7hen a number of firms in an industr0 agree among themselves to follow the same s0stem of 

costing in detail, adopting common terminolog0 for various items and processes the0 are said to

follow a s0stem of uniform costing. In such a case, a comparison of the performance of each of 

the firms can be made with that of another, or with the average performance in the industr0.

Under such a s0stem it is also possible to determine the cost of production of goods which is true

for the industr0 as a whole. It is found useful when ta9relief or protection is sought from the

;overnment.

&% Marginal Costing:

It is defined as the ascertainment of marginal cost b0 differentiating between fied and variable

costs. It is used to ascertain effect of changes in volume or t0pe of output on profit.

'% Standard Costing and variance analsis

It is the name given to the techni/ue whereb0 standard costs are pre9determined and

subse/uentl0 compared with the recorded actual costs. It is thus a techni/ue of costascertainment and cost control. This techni/ue ma0 be used in con3unction with an0 method of 

costing. However, it is especiall0 suitable where the manufacturing method involves production

of standardied goods of repetitive nature.

(% "istorical Costing

It is the ascertainment of costs after the0 have been incurred. This t0pe of costing has limited

utilit0.

)% Direct Costing

It is the practice of charging all direct costs to operations, processes or products leaving all

indirect costs to be written off against profits in which the0 arise.

#% !bsorption Costing

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It is the practice of charging all costs, both variable and fied to operations, processes or 

 products. This differs from marginal costing where fied costs are ecluded.

T*!D+T+O,!- COST+,. !PP*O!C"

Understanding Traditional Costing

+an0 manufacturing companies use the traditional costing s0stem to assign manufacturing

overhead to units produced. Users of the traditional costing method ma2e the assumption that the

volume metric is the underl0ing driver of manufacturing overhead cost. Under traditional

costing, accountants assign manufacturing costs onl0 to products. Traditional accounting fails to

allocate nonmanufacturing costs that also are associated with the production of an item, such as

administrative epenses. ompanies commonl0 use traditional accounting in eternal financialreports because it provides a value for the cost of goods sold.

Pros and Cons of Traditional Costing

An advantage of using traditional9based costing is that it aligns with ;enerall0 Accepted

Accounting )rinciples, or ;AA). as0 implementation for companies that provide one product

also is a plus. However, traditional costing is an outdated costing s0stem in man0 companies

 because those manufacturing companies now use machines and computers for much of their 

 production. omputers and machines ma2e the s0stem outdated because it often uses direct labor 

hours to calculate cost. ost is not appropriatel0 assigned because direct labor hours is not the best cost driver to use. Traditional costing negates other cost drivers that ma0 contribute to the

cost of an item. Another disadvantage of solel0 using the traditional costing s0stem is that it can

lead to bad management decisions because it ecludes certain nonmanufacturing costs.

Understanding Activity-Based Costing

Activit09based costing provides a more accurate view of product cost, but companies t0picall0

use it as a supplemental costing s0stem. The allocation bases used in activit09based costing differ 

from those used in traditional costing. Activit09based costing determines ever0 activit0

associated with producing an item and allocates a cost to the activit0. The cost assigned to theactivit0 is then assigned to products that re/uire the activit0 for production.

Pros and Cons of Activity-Based Costing

;reater costing accurac0 is the primar0 benefit of activit09based costing. ompanies assign cost

onl0 to the products that re/uire the activit0 for production. This method eliminates allocating

irrelevant costs to a product. 'ther advantages of activit09based costing include an eas0

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interpretation of cost for internal management, the abilit0 to enable benchmar2ing and a greater 

understanding of overhead costs. Implementing an activit09based costing s0stem within a

compan0 re/uires substantial resources. This can prove a disadvantage for companies with

limited funds. Another disadvantage of using activit09based costing is that it is easil0

misinterpreted b0 some users.

!ctivit/based costing  <!BC= is a costing methodolog0 that identifies activities in an

organiation and assigns the cost of each activit0 with resources to all products and services

according to the actual consumption b0 each. This model assigns more indirect costs <overhead=

into direct costs compared to conventional costing.

!ims of model

7ith A%, a compan0 can soundl0 estimate the cost elements of entire products and services.That ma0 help inform a compan0-s decision to either:

• Identif0 and eliminate those products and services that are unprofitable and lower the

 prices of those that are overpriced <product and service portfolio aim=

• 'r identif0 and eliminate production or service processes that are ineffective and allocate

 processing concepts that lead to the ver0 same product at a better 0ield <process re9engineering aim=.

In a business organiation, the A% methodolog0 assigns an organiation-s resource costs

through activities to the products and services provided to its customers. A% is generall0 usedas a tool for understanding product and customer cost and profitabilit0 based on the productionor performing processes. As such, A% has predominantl0 been used to support strategicdecisions such as pricing, outsourcing, identification and measurement of process improvementinitiatives.

0+12D COST

A periodic  cost  that remains more or less  unchanged  irrespective of the output  level  or salesrevenue, such as depreciation, insurance, interest, rent, salaries, and wages.

7hile in practice, all costs var0 over time and no cost is a purel0 fied cost, the concept of fiedcosts  is necessar0 in short term  cost accounting. 'rganiations  with high  fied costs aresignificantl0 different from those with high variable costs. This difference affects  the financialstructure  of the organiation as well as its  pricing  and  profits. The   brea2even point  in suchorganiations <in comparison with high variable cost organiations= is t0picall0 at a much higher level of output, and their marginal profit <rate of contribution= is also much higher.

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In economics, fi3ed costs are business epenses that are not dependent on the level of goods or

services produced b0 the business. The0 tend to be time9related, such as salaries or rents being

 paid per month, and are often referred to as overhead costs. This is in contrast to variable costs,

which are volume9related <and are paid per /uantit0 produced=.

In management accounting, fied costs are defined as epenses that do not change as a function

of the activit0 of a business, within the relevant period. 6or eample, a retailer  must pa0 rent and

utilit0 bills irrespective of sales.

In mar2eting, it is necessar0 to 2now how costs divide between variable and fied. This

distinction is crucial in forecasting the earnings generated b0 various changes in unit sales and

thus the financial impact of proposed mar2eting campaigns. In a surve0 of nearl0 !>> senior

mar2eting managers, (> percent responded that the0 found the ?variable and fied costs? metric

ver0 useful.

4!*+!B-2 COST

4ariable costs are epenses that change in proportion to the activit0 of a business. @ariable cost

is the sum of marginal costs over all units produced. It can also be considered normal costs.

6ied costs and variable costs ma2e up the two components of total cost. Direct Costs, however,

are costs that can easil0 be associated with a particular  cost ob3ect. However, not all variable

costs are direct costs. 6or eample, variable manufacturing overhead costs are variable costs that

are indirect costs, not direct costs. @ariable costs are sometimes called unit9level costs as the0

var0 with the number of units produced.

4irect labor and overhead are often called conversion cost, while direct material and direct labor 

are often referred to as prime cost.

In mar2eting, it is necessar0 to 2now how costs divide between variable and fied. This

distinction is crucial in forecasting the earnings generated b0 various changes in unit sales and

thus the financial impact of proposed mar2eting campaigns. In a surve0 of nearl0 !>> senior

mar2eting managers, (> percent responded that the0 found the ?variable and fied costs? metric

ver0 useful.

M!*.+,!- COST

In economics  and finance, marginal cost  is the change in the total cost  that arises when the

/uantit0 produced changes b0 one unit. That is, it is the cost of producing one more unit of a

good. In general terms, marginal cost at each level of production includes an0 additional costs

re/uired to produce the net unit. 6or eample, if producing additional vehicles re/uires building

a new factor0, the marginal cost of the extra vehicles includes the cost of the new factor0. In

 practice, this anal0sis is segregated into short and long9run cases, so that over the longest run, all

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costs become marginal. At each level of production and time period being considered, marginal

costs include all costs that var0 with the level of production, whereas other costs that do not var0

with production are considered fied.

P*+C+,. P*!CT+C2

0U-- COST P*+C+,.

Selling price arrived at b0 adding overheads and profit margin to the direct cost per unit of a product. In a manufacturer-s overheads computation, less than full capacit0 utiliation of the plant is factored in to allow for fluctuations in the output. The profit margin is computed as afied percentage of the average total cost of the product

6ull cost pricing is a practice where the price of a product is calculated b0 a firm on the basis ofits direct costs per unit of output plus a mar2up to cover overhead costs and profits. Theoverhead costs are generall0 calculated assuming less than full capacit0 operation of a plant inorder to allow for fluctuating levels of production and costs. IMPLEMENTING FULL COST PRICING  

This section focuses on the practical considerations of implementing full cost pricing.

The concepts of costing and pricingB

omponents of a full cost price and how the0 are valuedB

Treatment of communit0 service obligationsB

Structural reforms re/uiredB and

5eporting and compliance measures.

M!*.+,!- COST P*+C+,.

marginal/cost pricing5 in economics, the practice of setting the price of a product to e/ual the

etra cost of producing an etra unit of output. %0 this polic0, a producer charges, for each

 product unit sold, onl0 the addition to total cost resulting from materials and direct labour.

%usinesses often set prices close to marginal cost during periods of poor sales. If, for eample, an

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item has a marginal cost of C1.>> and a normal selling price is C!.>>, the firm selling the item

might wish to lower the price to C1.1> if demand has waned. The business would choose this

approach because the incremental profit of 1> cents from the transaction is better than no sale at

all.

In the mid9!>th centur0, proponents of the ideal of perfect competitionDa scenario in which

firms produce nearl0 identical products and charge the same priceDfavoured the efficienc0

inherent in the concept of marginal9cost pricing. conomists such as 5onald oase, however,

upheld the mar2etEs abilit0 to determine prices. The0 supported the wa0 in which mar2et pricing

signals information about the goods being sold to bu0ers and sellers, and the0 observed that

sellers who were re/uired to price at marginal cost would ris2 failing to cover their fied costs.

.O+,. *!T2 P*+C+,.

Setting a price for a product or service using the prevailing mar2et price as a basis. ;oing rate pricing is a common  practice with homogeneous  products with ver0 little variation from one producer  to another, such as aluminum or steel.

B+D P*+C+,.

The price a bu0er is willing to pa0 for a securit0. This is one part of the bid with the other beingthe bid sie, which details the amount of shares the investor is willing to purchase at the bid price. The opposite of the bid is the as2 price, which is the price a seller is loo2ing to get for hisor her shares.

The use of bid and as2 is a fundamental part of the mar2et s0stem, as it details the eact amountthat 0ou could bu0 or sell at an0 point in time. 5emember that the current price is not the price

for which 0ou can purchase the securit0, but the price at which the shares last traded hands. If 

0ou want to get an idea of the price for which 0ou can bu0 a securit0, 0ou need to loo2 at the bid

and as2 prices because the0 will often differ from the current price.

A bid price is the highest price that a bu0er <i.e., bidder= is willing to pa0 for a good. It is usuall0

referred to simpl0 as the ?bid.?

In bid and as2 , the bid price stands in contrast to the as2 price or ?offer?, and the difference

 between the two is called the bidFas2 spread.

An unsolicited bid or purchase offer is when a person or compan0 receives a bid even though

the0 are not loo2ing to sell. A bidding war is said to occur when a large number of bids are

 placed in rapid succession b0 two or more entities, especiall0 when the price paid is much

greater than the as2 price, or greater than the first bid in the case of unsolicited bidding.

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In the contet of stoc2  trading on a stoc2 echange, the bid price is the highest price a bu0er of a

stoc2 is willing to pa0 for a share of that given stoc2. The bid price displa0ed in most /uote

services is the highest bid price in the mar2et. The as2 or offer price on the other hand is the

lowest price a seller of a particular stoc2 is willing to sell a share of that given stoc2. The as2 or

offer price displa0ed is the lowest as2Foffer price in the mar2et <Stoc2 mar2et=.

*!T2 O0 *2TU*, P*+C+,.

5ate of return pricing is practiced b0 businesses that set specific goals for the capital that the0

spend and the revenue the0 wish to generate. A business can set prices to ensure that these goals

will be achieved. The concept of rate of return pricing is similar to the investment concept of

return on investment, ecept that the business owner can manipulate prices to help achieve this

goal. This method of pricing is most effectivel0 achieved when a compan0 has little or no

competition in the mar2et, since the actions of competitors will li2el0 affect the rate of return.

"ust as investors wish to generate a certain amount of return on their investment, so to do

 businesses have ideal goals in mind for their income on the sale of goods and services. %othinvestors and businesses ali2e have to be concerned with the amount of ris2 involved with the

capital the0 spend. Since the similarities are so obvious, man0 business owners ta2e an

investment9st0led approach to how much their goods cost b0 practicing rate of return pricing.

P*OJ2CT !PP*!+S!-

)ro3ect appraisal methodologies are methods used to access a proposed pro3ect-s potential

success and viabilit0. These methods chec2 the appropriateness of a pro3ect considering things

such as available funds and the economic climate. A good pro3ect will service debt and maimie

shareholders- wealth.

Net Present Value

A pro3ect-s net present value is determined b0 summing the net annual cash flow, discounted at

the pro3ect-s cost of capital and deducting the initial outla0. 4ecision criteria is to accept a pro3ect

with a positive net present value. Advantages of this method are that it reflects the time value of

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mone0 and maimies shareholder-s wealth. Its wea2ness is that its ran2ings depend on the cost

of capitalB present value will decline as the discount rate increases.

Payback Method

A compan0 chooses the epected number of 0ears re/uired to recover an original investment.)ro3ects will onl0 be selected if initial outla0 can be recovered within a predetermined period.

This method is relativel0 eas0 since the cash flow doesn-t need to be discounted. Its ma3or

wea2ness is that it ignores the cash inflows after the pa0bac2 period, and does not consider the

timing of cash flows.

Internal ate of eturn

This method e/uates the net present value of the pro3ect to ero. The pro3ect is evaluated b0

comparing the calculated Internal rate of return to the predetermined re/uired rate of return.

)ro3ects with Internal rate of return that eceed the predetermined rate are accepted. The ma3orwea2ness is that when evaluating mutuall0 eclusive pro3ects, use of Internal rate of return ma0

lead to selecting a pro3ect that does not maimie the shareholders- wealth.

Pro!tability Inde"

This is the ratio of the present value of pro3ect cash inflow to the present value of initial cost.

)ro3ects with a )rofitabilit0 Inde of greater than 1.> are acceptable. The ma3or disadvantage in

this method is that it re/uires cost of capital to calculate and it cannot be used when there are

une/ual cash flows. The advantage of this method is that it considers all cash flows of the

 pro3ect.

02!S+B+-+T6 *2PO*TS

7hen to use a 0easibilit Stud8

The purpose of a 6easibilit0 Stud0 is to identif0 the li2elihood of one or more solutions meetingthe stated business re/uirements. In other words, if 0ou are unsure whether 0our solution willdeliver the outcome 0ou want, then a )ro3ect 6easibilit0 Stud0 will help gain that clarit0. 4uring

the 6easibilit0 Stud0, a variet0 of -assessment- methods are underta2en. The outcome of the6easibilit0 Stud0 is a confirmed solution for implementation

A )ro3ect 6easibilit0 Stud0 is an eercise that involves documenting each of the potentialsolutions to a particular business problem or opportunit0. 6easibilit0 Studies can be underta2en b0 an0 t0pe of business, pro3ect or team and the0 are a critical part of the )ro3ect Gife 0cle.

At this stage the clientEs business needs are anal0ed, information about pro3ect participants is

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collected, and the re/uirements for the s0stem are gathered and anal0ed. The clientEsepectations for s0stem implementation are studied and the proposed solution is offered. 4uringthe 6easibilit0 Stud0 stage, the pro3ectEs goals, parameters and restraints are agreed upon withthe client including:

•)ro3ect budget and rules for its ad3ustmentB

• )ro3ect time frameB

• onceptual problem solution.

The follo9ing tass are performed at this stage: 

• The pro3ect feasibilit0 is estimated and the pro3ect scope is definedB

• 5is2s and benefits are identifiedB

• The pro3ect structure is elaboratedB

• The pro3ect is roughl0 plannedB

• The net pro3ect stage is planned precisel0B

• ost of the net phase is evaluated precisel0 and cost of the other phases D

approimatel0B

• 6unctionalit0 development priorities are definedB

• S0stem creation ris2s are estimated.

!t the end of this phase the follo9ing documents are available: 

• 0easibilit *eport D description of the proposed solution and list of high9level

functional re/uirementsB

• Pro;ect Structure< D description of the pro3ect organiationB

• Pro;ect Plan D pro3ect scheduleB

• *iss -ist D list of potential pro3ect ris2s and possibilities of their elimination.

6easibilit0 studies address things li2e location, raw material availabilit0, connectivit0,availabilit0 of natural resources, li2e water etc. The0 provide in9depth details about the business

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to determine if and how it can succeed, and serve as a valuable tool for developing a winning business plan.

The information 9e gather and present in our feasibilit stud 9ill help ou:

•Gist in detail all the things 0ou need to ma2e the business wor2B

• Identif0 logistical and other business9related problems and solutionsB

• Serve as a solid foundation for developing 0our business plan.

6easibilit0 stud0 will help to find a cost9effective wa0 to set up the plant. This is especiall0important when operating cost pla0s the dominant role for survival.

The Components of a 0easibilit Stud: 

• Description of the Business: The product or services to be offered and how the0 will bedelivered.

• Maret 0easibilit: Includes a description of the industr0, current mar2et, anticipated

future mar2et potential, competition, sales pro3ections, potential bu0ers, etc.

• Technical 0easibilit: Technolog0 selection, 5aw material availabilit0, ;rid

connectivit0, 7ater availabilit0, 5oad and rail connectivit0 etc.

• 0inancial 0easibilit: )ro3ects how much start9up capital is needed, sources of capital,

returns on investment, etc.

Maret 0easibilit

The client-s business needs are anal0ed, information about pro3ect participants is collected, andthe re/uirements for the s0stem are gathered and anal0ed. The client-s epectations for s0stemimplementation are studied and the proposed solution is offered. 4uring the 6easibilit0 Stud0stage, the pro3ect-s goals, parameters and restraints are agreed upon with the client including:

• )ro3ect budget and rules for its ad3ustmentB

•)ro3ect time frameB

• onceptual problem solution.

The follo9ing tass are performed at this stage:

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• The pro3ect feasibilit0 is estimated and the pro3ect scope is definedB

• 5is2s and benefits are identifiedB

• The pro3ect structure is elaboratedB

• The pro3ect is roughl0 plannedB

• The net pro3ect stage is planned precisel0B

• ost of the net phase is evaluated precisel0 and cost of the other phases 9

approimatel0B

• 6unctionalit0 development priorities are definedB

• S0stem creation ris2s are estimated.

Technical 0easibilit

Technolog0 selection, 5aw material availabilit0, ;rid connectivit0, 7ater availabilit0, 5oad andrail connectivit0 etc.

6easibilit0 studies address things li2e location, raw material availabilit0, connectivit0,availabilit0 of natural resources, li2e water etc. The0 provide in9depth details about the businessto determine if and how it can succeed, and serve as a valuable tool for developing a winning business plan. 6easibilit0 stud0 will help to find a cost9effective wa0 to set up the plant. This isespeciall0 important when operating cost pla0s the dominant role for survival.

The information 9e gather and present in our feasibilit stud 9ill help ou:

• Gist in detail all the things 0ou need to ma2e the business wor2B

• Identif0 logistical and other business9related problems and solutionsB

• Serve as a solid foundation for developing 0our business plan.