Costing is any system for assigning costs to an element of a business. Costing is typically used to develop costs for any or all of the following:
- Distribution channels
- Geographic regions
- Product lines
- Entire companies
Costing may involve only the assignment of variable costs, which are those costs that vary with some form of activity (such as sales or the number of employees). This type of costing is called direct costing. For example, the cost of materials varies with the number of units produced, and so is a variable cost.
Costing can also include the assignment of fixed costs, which are those costs that stay the same, irrespective of the level of activity. This type of costing is called absorption costing. Examples of fixed costs are rent, insurance, and property taxes.
Costing is used for two purposes:
- Internal reporting. Management uses costing to learn about the cost of operations, so that it can work on refining operations to improve profitability. This information can also be used as the basis for developing product prices.
- External reporting. The various accounting frameworks require that costs be allocated to the inventory recorded in a company's balance sheet at the end of a reporting period. This calls for the use of a cost allocation system, consistently applied.
Within the areas of both internal and external reporting, costing is most heavily utilized in the area of assigning costs to products. This can be done with job costing, which requires the detailed assignment of individual costs to production jobs (which are small product batches). Another alternative is to use process costing, where costs are aggregated and charged to a large number of uniform products, such as are found on a production line. An efficiency improvement on either concept is to use standard costing, where costs are estimated in advance and then assigned to products, followed by variance analysis to determine the differences between actual and standard costs.