Costing system definition

A costing system is designed to monitor the costs incurred by a business. The system is comprised of a set of forms, processes, controls, and reports that are designed to aggregate and report to management about revenues, costs, and profitability. The areas reported upon can be any part of a company, including:

  • Customers
  • Departments
  • Facilities
  • Processes
  • Products and services
  • Research and development
  • Sales regions

The information issued by a costing system is used by management for a variety of purposes, including:

  • Fine-tuning operations to generate higher profitability
  • Deciding where to cut costs in the event of a business downturn
  • Matching actual costs incurred against budgeted cost levels for control purposes
  • Creating strategic and tactical plans for future operations

The reports of a costing system are intended for internal use, and so are not subject to the reporting requirements of any of the accounting frameworks, such as GAAP or IFRS. Instead, management can decide what types of information it prefers to see, which information to ignore, and how the results are to be formatted and distributed for its consumption. Typical reports created by a costing system include:

  • Budget-versus-actual reports for costs incurred
  • Profitability reports for customers, sales regions, stores, products, and/or product lines
  • Expense trend reports that show expenses incurred by month for many consecutive months

These reports may be accompanied by additional information assembled by the accounting department, which provide details regarding how certain costs were incurred and who authorized them.

There are two main types of costing systems. A business can accumulate information based on either one of these systems, or adopt a hybrid approach that mixes and matches systems to best meet its needs. The primary costing systems are:

  • Job costing system. Materials, labor, and overhead costs are compiled for an individual unit or job. This approach works best for unique products, such as custom-designed machines or consulting projects. The cost accumulation process is highly detailed and labor-intensive.
  • Process costing system. Materials, labor and overhead costs are compiled in aggregate for an entire production process, and are then allocated to individual production units. This approach works well for large production runs of identical items, such as a production run of 100,000 cell phones. The cost accumulation process is highly efficient and portions of it can possibly be automated.

Another costing system option is activity based costing (ABC). ABC was developed in response to concerns that overhead costs are rarely allocated in an appropriate manner, and involves a finer degree of differentiation in determining how overhead costs are assigned to different cost pools, and then how the costs in those pools are allocated to cost objects. An ABC system can be difficult to set up and operate, and so works best when designed for very specific cost allocation projects that have clearly defined boundaries.