Costing definition
/What is Costing?
Costing is any system for assigning costs to an element of a business. Costing is typically used to develop costs for customers, distribution channels, employees, geographic regions, products, product lines, processes, subsidiaries, and 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.
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How to Use Costing
Costing is used for internal and external reporting, as described below.
Costing in Internal Reporting
Management uses costing to learn about the cost of operations, so that it can work on refining operations to improve profitability. This can be done through ongoing and robust cost reduction programs, which are especially important in highly-competitive industries or when a business wants to be the cost leader in its market. This information can also be used as the basis for developing product prices; this is a particular concern when selling in highly competitive markets where goods are commoditized and so primarily compete on price.
Costing in 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. This rarely means that an overly complex cost allocation system is needed, since the goal of the business is only to allocation costs sufficiently to meet the requirements of the applicable accounting framework.
Costing Methodologies
Within the areas of both internal and external reporting, costing is most heavily utilized in the area of assigning costs to products. There are several costing methodologies that can be used for this purpose, which are as follows:
Job costing. This costing approach is used to track and allocate costs to specific jobs or projects, allowing businesses to determine the exact expenses associated with each task. It involves recording direct materials, direct labor, and applied overhead for individual jobs, rather than averaging costs across all work. This approach is commonly used in industries like construction, manufacturing, and custom services where each job may vary significantly in scope and cost.
Process costing. This costing approach is used to assign costs to mass-produced, homogeneous products by averaging costs over all units produced during a period. It accumulates costs for each stage of production, known as a process or department, and then allocates those costs evenly across all completed and in-process units. This approach is commonly used in industries like chemicals, food production, and textiles where individual units are indistinguishable.
Standard costing. This costing approach assigns predetermined costs to products or services, based on expected material, labor, and overhead expenses. These standard costs serve as benchmarks against which actual costs are compared, helping identify variances for analysis and corrective action. It is widely used for budgeting, performance evaluation, and cost control in manufacturing environments.
Hybrid costing. This costing approach is a blend of job costing and process costing, and is used when the production process is comprised of a mix of high-volume production for some phases of work and more individualized tasks for others. This is a more complex costing environment, and so is only warranted when there is a clear need for the resulting information.