Costing methods
Costing methods assigns costs to products or services made in a manufacturing process. This helps to measure the cost of production and figure out the profitability and pricing of the products or services. Costing methods are important for allocating and reporting production costs, evaluating and improving production performance, and providing information for planning, budgeting, and decision making. By using costing method you can:
Track and control the costs of production
Calculate and compare the profit margins of different products or services
Set and adjust the prices of the products or services
Identify and eliminate the sources of inefficiency, waste, or error in the production process
Optimise the production process and product mix
Forecast the future costs and revenues of production
There are several types of costing methods, including job order costing, process costing, standard costing, and activity-based costing. The choice of method depends on the nature and complexity of the production process, the type and variety of products or services, and the purpose and use of costing information.
Costing method
Definition
Example
Job order costing
Costing method used when products are manufactured in batches or on order.
A furniture manufacturer creating custom-made furniture for a client.
Process costing
Costing method used when products are manufactured in a continuous process.
A chemical plant producing industrial-grade chemicals.
Standard costing
Costing method used to decide the cost of producing a product or providing a service.
A car manufacturer setting standard costs for each component of a vehicle and comparing actual costs to the standards.
Activity-based costing
Costing method used to allocate costs to products or services based on the activities that drive those costs.
A semiconductor manufacturer allocating costs to a particular microchip based on the activities needed, such as the use of equipment and staff time.
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To choose the best costing method for your manufacturing process and product mix, you need to consider the nature and complexity of the production process, the type and variety of the products or services, the cost and revenue structure of the production process, and the purpose and use of the costing information. The general guidelines for choosing the costing method are:
If the production process is simple and uniform, process costing or standard costing can be used.
If the production process is complex and diverse, job order costing or activity-based costing can be used.
If production is mixed and varied, a combination of methods can be used.
