Methods of Costing

Costing refers to the technique used to determine the cost of products or services. The method used depends on:
→ Nature of the product

→ Scale of production

→ Type of industry

✨ Classification of Costing Methods

Costing methods are broadly divided into:

1. Specific Order Costing
   ↳ Job Costing
   ↳ Contract Costing
   ↳ Batch Costing

2. Continuous Operation Costing
   ↳ Process Costing
   ↳ Unit/Single Costing
   ↳ Operating Costing
   ↳ Multiple/Composite Costing
   ↳ Operation Costing
   ↳ Activity-Based Costing (ABC)

🔹 1. Job Costing 🌟(Expanded)

Used when work is done as per specific customer order and every job is unique.

✅ Industries: Road construction, automobile repair, custom furniture

🔑 Key Features:
→ Each job is treated as a separate cost unit

→ Costs are collected individually for every job

→ Labour, material & overhead tracked per job

→ Helps in finding the profit/loss for each job

🛠️ Example:

A customer orders a custom wardrobe. The cost of wood, labour, polish, and design are tracked only for that order.

📊 Advantages:
→ Accurate costing per client

→ Useful in pricing and profit analysis

→ Avoids over/under costing

🔹 2. Process Costing 🌟(Expanded)

Used in industries with continuous production of homogeneous products.

✅ Industries: Cement, textiles, sugar, paper

🔑 Key Features:
→ Production passes through multiple processes/stages

→ Costs are assigned to each process

→ Final cost = Sum of costs from all processes

→ Unit cost is found by dividing total process cost by output quantity

🔄 Example:

In sugar manufacturing:

• Process 1: Crushing sugarcane

• Process 2: Filtering juice

• Process 3: Crystallisation
  
  → Costs calculated at every stage.

📊 Advantages:
→ Helps track cost at each level

→ Suitable for mass production

→ Easy to compute per-unit cost

🔹 3. Activity-Based Costing (ABC) 🌟(Expanded)

A modern method that assigns overheads based on actual activities performed.

✅ Industries: IT firms, telecom, product design, complex manufacturing

🔑 Key Features:
→ Identifies activities (e.g., designing, testing, packing)

→ Costs are assigned to products based on activity usage

→ More accurate than traditional costing

⚙️ Example:

Product A requires:

• 3 hours of testing

• 1 hour of packing
  
  → Testing is more costly than packing. ABC assigns more cost to testing.

📊 Advantages:
→ Accurate cost of complex products

→ Helps eliminate non-value activities

→ Improves pricing and budgeting decisions

🔸 Other Costing Methods (Summarised)

🔹 Contract Costing

→ Large-scale version of job costing

→ Long-term, site-based jobs like buildings, bridges

→ Cost centre = Each contract

🔹 Batch Costing

→ Costing is done per batch of identical items

→ Common in pharma, garments

→ Unit cost = Total cost ÷ number of items in batch

🔹 Unit/Single Costing

→ Suitable for uniform, mass production (e.g., bricks, oil)

→ Cost is calculated per unit

🔹 Operating Costing

→ For services like transport, hotels, cinemas

→ Cost unit = Passenger km, room night, etc.

🔹 Multiple/Composite Costing

→ Used when a product involves multiple components/processes

→ Example: Cars, electronics, watches

🔹 Operation Costing

→ Combination of job & process costing

→ Cost is calculated per operation, not per process

→ Common in assembly line products

Difference Between Marginal and Absorption Costing

📚 Introduction to Costing Methods

👉 Costing is the method of calculating the total cost of producing goods or services.

There are two key approaches:

🔹 Marginal Costing = Variable Costing

✔ Only variable costs are included in product cost.

✔ Fixed costs are treated as period costs → charged directly to P&L.

🔹 Absorption Costing = Full Costing

✔ Both variable + fixed costs are included in product cost.

✔ Fixed costs are absorbed into units → cost per unit increases.

🆚 Marginal vs Absorption Costing – 10 Key Differences

✏ Example: Furniture Company

📌 Marginal Costing

➤ Only counts:

→ Direct materials (wood)

→ Direct labor (carpenter wages)

→ Variable overheads (electricity)

📌 Absorption Costing

➤ Counts all above +

→ Factory rent

→ Admin staff salaries

→ Fixed overheads like insurance

💡 Which One to Choose?

🧠 Business Strategy Impact

🔹 Marginal Costing:

➡ Helps with:

• Short-term decisions

• Launch pricing

• Discount offers

• Survival in competitive markets

🔹 Absorption Costing:

➡ Helps with:

• Expansion plans

• Long-term pricing

• Investor trust (compliance)

• Transparent reporting

👨‍💼 Managerial Implications

🔹 Marginal Costing:

→ Focus = Contribution Margin = Sales – Variable Costs

→ Helps in profit-maximizing decisions.

🔹 Absorption Costing:

→ Focus = Total Cost Picture

→ Helps in finding optimal production levels for maximum profit.

🛠️ Other Costing Methods at a Glance

📌 What is a Cost Sheet?

➡️ A Cost Sheet is a statement that records all expenses from production to sale of a product.

➡️ It helps in:

• Fixing the selling price

• Analyzing cost efficiency

• Comparing past vs present costs

• Controlling costs

➡️ Two types of cost sheets:

• 📄 Historical Cost Sheet: Based on actual past expenses

• 📊 Estimated Cost Sheet: Based on projected or future expenses

🧩 Components of a Cost Sheet

1️⃣ Prime Cost (🛠 Basic Production Cost)

  = 🔹Direct Materials

  + 🔹Direct Labour

  + 🔹Direct Expenses

2️⃣ Works/Factory Cost

  = Prime Cost

  + 🔹Factory Overheads (e.g. electricity, factory rent)

  + 🔹Opening WIP – Closing WIP

3️⃣ Cost of Production

  = Works Cost

  + 🔹Administrative Overheads

  + 🔹Opening Finished Goods – Closing Finished Goods

4️⃣ Total Cost / Cost of Sales

  = Cost of Production

  + 🔹Selling & Distribution Overheads

5️⃣ Profit

  = Sales – Total Cost

🧾 Format of Cost Sheet

Company Name
COST SHEET for the period ______

1. Prime Cost:
   🔸 Direct Materials (OP Stock + Purchases – CL Stock)
   🔸 Direct Wages
   🔸 Direct Expenses
   ➡️ Total Prime Cost

2. Works Cost:
   ➕ Factory Overheads
   ➕ OP Work in Progress – CL WIP
   ➡️ Total Works Cost

3. Cost of Production:
   ➕ Administration Overheads
   ➕ OP Finished Goods – CL Finished Goods
   ➡️ Cost of Production

4. Cost of Sales:
   ➕ Selling & Distribution Overheads
   ➡️ Total Cost or Cost of Sales

5. Profit:
   ➡️ Sales – Total Cost

📊 Types of Costs in a Cost Sheet

🧮 Step-by-Step: How to Prepare a Cost Sheet?

👉 Step 1:

 Prime Cost = Direct Material Consumed + Direct Wages + Direct Expenses

  ➡️ Direct Material Consumed = Purchased + OP Stock – CL Stock

👉 Step 2:

 Works Cost = Prime Cost + Factory Overheads + OP WIP – CL WIP

👉 Step 3:

 Cost of Production = Works Cost + Admin Overhead + OP FG – CL FG

👉 Step 4:

 Total Cost = Cost of Production + Selling & Distribution Overheads

👉 Step 5:

 Profit = Sales – Total Cost

🎯 Purpose of Preparing a Cost Sheet

✅ Cost Control

 ➡️ Identifies areas to reduce unnecessary expenses.

✅ Pricing Decisions

 ➡️ Helps set profitable selling prices.

✅ Budgeting & Planning

 ➡️ Assists in preparing financial plans & forecasts.

✅ Performance Evaluation

 ➡️ Compares actual vs expected costs for improvement.

✅ Profitability Analysis

 ➡️ Tracks how cost affects overall business profits.

🌟 Advantages of a Cost Sheet

✔️ Clear cost breakup for better understanding

✔️ Helps in price fixing & bidding

✔️ Tracks efficiency across departments

✔️ Reduces chances of loss due to poor cost control

✔️ Supports strategic planning & decision-making

✨ Final Summary:

A cost sheet is a powerful tool for businesses to track, control, and evaluate costs. It ensures transparency, aids in pricing, and supports profitability—making it an essential concept for BBA, UGC NET, and management students

Types of Costs in Business

In any organization, understanding how to classify and manage different types of costs is crucial for financial planning, pricing, and profitability. All costs must be assigned to a specific category to ensure accurate budgeting and decision-making.

1. Direct Costs

Direct costs are clearly traceable to a specific product, service, or job. These costs vary directly with the level of production.

Examples:

• Raw materials used in manufacturing

• Wages of workers directly involved in production

• Parts and components used in assembly

Example: In a car manufacturing company, the cost of steel used to build the car and the wages paid to assembly line workers are direct costs.

2. Indirect Costs

Indirect costs are not directly attributable to a specific product but are necessary for the production process or overall business operation. These are also called overheads.

Types of Indirect Costs:

• Indirect Materials: Materials used in production but not directly traceable to a product (e.g., lubricants, cleaning supplies)

• Indirect Labor: Wages of personnel not directly involved in production (e.g., maintenance staff, supervisors)

• Indirect Expenses: General expenses not linked to specific products (e.g., rent, utilities, depreciation)

3. Fixed Costs

Fixed costs remain constant regardless of production volume. They do not change with the level of goods or services produced within a certain range.

Examples:

• Rent or lease payments

• Insurance premiums

• Depreciation

• Property taxes

4. Variable Costs

Variable costs change in direct proportion to production or sales volume. As production increases, these costs rise.

Examples:

• Raw material costs

• Packaging costs

• Sales commissions

• Shipping and delivery expenses

5. Semi-Variable Costs

Also called mixed costs, these include a fixed component and a variable component.

Example:

• Utility bills (fixed monthly charge + variable amount based on usage)

• Maintenance contracts with a base fee plus additional charges based on service calls

Overheads

Overheads refer to ongoing expenses not directly attributed to a specific product or service. These are necessary to run the business but do not directly generate revenue.

Overheads can be categorized into the following types:

1. Factory Overheads (Also called Manufacturing or Production Overheads)

These are indirect costs incurred within the production facility, not directly linked to a specific product.

Includes:

• Indirect materials (e.g., lubricants, cleaning supplies)

• Indirect labor (e.g., supervisors, janitors)

• Factory rent and utilities

• Maintenance of machinery

• Depreciation of factory equipment

2. Office and Administration Overheads

These are costs associated with the general administration of the business.

Includes:

• Salaries of administrative staff

• Office rent and utilities

• Stationery and office supplies

• Legal and accounting services

• Depreciation on office equipment

3. Selling and Distribution Overheads

These are costs related to marketing, selling, and delivering products to customers.

Includes:

• Advertising and promotional expenses

• Salaries of sales staff

• Sales commissions

• Delivery vehicle costs and fuel

• Freight and shipping charges

• Warehousing

Summary Table

Introduction to Cost Accounting

🔹 Meaning of Cost Accounting

Cost accounting is a branch of accounting that helps in:
→ Recording, analyzing, and allocating costs

→ Assisting management in planning, decision-making, and control

🧾 Definition by Experts:

• Harold James:
  
  “Costing is the proper allocation of expenditure… to guide producers in controlling their business.”

• Harold J. Wheldon:
  
  “Costing is the classification, recording & allocation of expenses to determine cost of products/services.”

• Jeremiah Lockwood:
  
  “Cost accounting ensures detailed recording and analysis of expenditures to measure performance and control.”

🎯 Objectives of Cost Accounting

→ Determine cost of products/services

→ Assist management in cost control

→ Help in decision-making (e.g. pricing, budgeting)

→ Increase efficiency through internal reporting

🆚 Cost Accounting vs Financial Accounting

1. Technique & Process of Costing
   
   → Classify costs (e.g. direct, indirect)
   
   → Allocate and apportion indirect costs
   
   → Example: Job costing, contract costing, batch costing

2. Cost Control
   
   → Executive action to regulate expenses
   
   → Techniques:
   
   ▸ Inventory Control
   
   ▸ Budgetary Control
   
   ▸ Standard Costing
   
   ▸ Quality Control

3. Ascertainment of Cost
   
   → Historical Cost
   
   → Estimated Cost
   
   → Standard Cost
   
   → Output/Job/Contract Costing
   
   → Marginal & Absorption Costing

4. Cost Audit
   
   → Verifies correctness of cost accounts
   
   → Ensures adherence to costing methods
   
   → Highlights system shortcomings

5. Budgetary Control
   
   → Plan of operation in financial terms
   
   → Includes budgeting, comparing actual vs estimated, planning actions

🔁 Relationship Between Financial & Cost Accounting

→ Both are interdependent

→ Can be integrated in a unified system

→ Should function as a coordinated service under common control

📝 Example:

Clerks may handle both to understand total expenses & detailed cost breakdowns