Alternative product costing methods

Product costing methods are used to assign a cost to a manufactured product. The main costing methods available are process costing, job costing, direct costing, and throughput costing. Each of these methods applies to different production and decision environments. The type of costing method used can result in substantial differences in costs, so be careful to use the information only for its intended purpose; for example, a costing method designed for incremental pricing decisions may not be suitable for long-term decision making.

General categories of costs are noted below, along with the main costing methodologies ascribed to each one:

Mandated by Accounting Standards

If a company is creating financial statements, it must record all costs associated with products in the inventory line item on its balance sheet. The general types of costs to include are noted in the applicable accounting framework, which is likely to be either GAAP or IFRS. The key element in these cost inclusions is an allocation of factory overhead, which means that product costing that is designed to meet accounting standards is likely to result in the highest cost per unit. The main product costing methods in this category are:

  • Job costing. This is the assignment of costs to a specific manufacturing job. Employees are expected to track their time by job, and all materials are assigned to jobs. Overhead is allocated to jobs, as well. This method is used when individual products or batches of products are unique, and especially when jobs are being billed directly to customers or are likely to be audited by customers.
  • Process costing. This is the accumulation of labor, material, and overhead costs across entire departments or entities, with the total production cost then being allocated to individual units. Process costing is used when large quantities of the same product are manufactured, usually in long production runs.

Incremental Costing

Within a business, managers are much less concerned with the allocated cost of overhead, and more concerned with the incremental cost to manufacture a product. They want to make sure that some profit margin is being produced with each incremental product sale, and so are only concerned with those costs that are incurred when one additional unit is produced. The main product costing methods in this category are:

  • Direct costing. This is a compilation of all costs directly attributable to the production and sale of a product, which includes direct materials, piece rate labor, and commissions. The resulting cost may be used to establish the minimum price at which a product can be sold and still generate a profit.
  • Throughput costing. This is an analysis of how one additional unit passing through the bottleneck operation will impact the throughput (sales minus totally variable costs) of the entire business. In brief, product costing focuses on the amount of throughput generated per minute of production time at the bottleneck operation.