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Costing methods refer to the systems of collating and presenting costs for the purpose of product costing (or service costing). Several methods of costing have been designed to suit the needs of individual business conditions. In other words, different methods of costing are used because business enterprises vary in their nature and in the type of the products they produce (or services) they render. The basic principles of ascertaining costs are the same in all methods, but the way of analyzing and presenting such costs vary from industry to industry.
Costing methods
Costing methods determine how the cost should be identified, accumulated and charged to the cost object. Costing methods also termed as Cost Accumulation Procedures. There are three types of costing methods. These are: 1 Job order Costing; 2 Process Costing; and 3 Operation Costing.
The following are the important objectives of Job Costing: (1) Job costing provides accurate cost information for each job or product.
(2) It enables management to reduce the cost by making comparison of each elements of actual costs with estimated ones. (3) It helps management to measure the operational efficiency and inefficiency for each job or works to take effective decision making. (4) This method enables management to providing proper valuation of work in progress.
PROCESS COSTING
Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes. Examples of this include the manufacture of erasers, chemicals or processed food. The method used is to take the total cost of the process and average it over the units of production.
(1) Continuous or mass production where products which passes through distinct process or operations. (2) Each process is deemed as a separate operations or production centers. (3) Products produced are completely homogenous and standardized. (4) Output and cost of one process are transferred to the next process till the finished product completed. (5) Cost of raw materials, labor and overheads are collected for each process. (6) The cost of a finished unit is determined by accumulated of all costs incurred in all the process divided by the number of units produced.
(7) The cost of normal and abnormal losses usually incurred at different stages of production is added to finished goods. (8) The interconnected processes make the final output of by-product or joint products possible.
(4) Valuation of work in progress is done on estimated basis, it leads to inaccuracies in total costs. (5) It is difficult to measure the performance of individual workers and supervisors.
3) Costs are determined by job or batches of 3) Costs are compiled on a time basis. i.e. products. production for a given accounting period, for each process or department 4) Unit cost of a job is calculated by dividing 4) The unit cost of a process is computed by the total cost incurred into the units produced in dividing the total cost for the period into he the lot or batch. 5) Costs are calculated when a job is completed. output of the process during that period 5) Costs are calculated at the end of the cost period. 6) There may or may not be any work in 6) Production being continuous, there is process at the beginning or end of an accounting usually some work in process at the beginning period. as well as at the end of the period.
7) There are usually no transfers from one job 7) As a product moves from one process to another unless it is necessary to transfer surplus another, transfers of cost from process to work or excess production. process are made.
8) As each product unit is different and 8) Process production is standardized and is production is not continuous, more managerial more stable. Hence, control of process attention is needed if proper control is to be activities is comparatively easy. exercised.
A job order cost accumulation system is most suitable where a single product or batch of products is manufactured according to a customer's specifications. A process cost accumulation system is used when products are manufactured by either mass production techniques or continuous processing. Process costing is suitable when homogenous are manufactured in large volumes. A customized cabinet builder would use a job order cost system whereas a manufacturer of 8-ounce jars of peanut butter would use a process cost system. Under a job order cost accumulation system, the three elements of a product's cost (direct materials, direct labor and factory overhead) are accumulated according to identifiable jobs. Individual work-in-process inventory subsidiary cost sheets are set up for each job and are charged with the cost incurred in the production of the specifically ordered unit. Upon completion of each job, its cost is transferred from work-in-process to finished goods inventory. Under a process cost accumulation system, the three elements of a product's cost are accumulated according to department of cost center. Individual work-in-process inventory accounts are set up for each department and are charged with the costs incurred in the processing of the units that pass through them. Upon completion of the process, the cost of work-in-process inventory in the last department is transferred to finished goods inventory.
OPERATION COSTING
Operation costing is a hybrid of job-order and process costing. Job-order costing is generally used for products that are differentiated and processed in batches. These batches are then treated as a group for costing purposes, separate from other batches of products. Process costing is used for homogenous (identical) products. In process costing, costs are spread out over all products in an equal manner because they are all undifferentiated. Operation costing combines these two methods for products that are very similar, yet are somewhat differentiated in batches. An example of a product that may use operation costing would be clothes or electronics. These products are similar, yet can be differentiated. For example, a manufacturer of LCD televisions may use essentially the same process for making all of their TV sets, but each size may require a different amount of raw materials. In this case, conversion costs could be set up in a way similar to process costing (since the process is the same regardless of the television size), but direct materials costs would be better distributed in a job-order costing manner (costs distributed to batches of televisions based on actual direct costs).
A product initially uses different raw materials, and is then finished using a common process that is the same for a group of products; or
A product initially has identical processing for a group of products, and is then finished using more product-specific procedures. In both cases, we use a mix of job costing and process costing to compile the cost of a product; this mixed costing environment is called operation costing.
To make cost and profit statement using operation costing for a gas cylinder manufacturing company. We are giving the following raw data.
Stock of material on 1-1-2011 Stock of material on 31-12-2011 Purchase of materials Direct Wages Factory expenses Establishment expenses Completed stock in hand on 1-1-2011 Completed stock in hand on 31-12-2011 Sales
Tk. 35000 Tk. 4900 Tk. 52500 Tk. 95000 Tk. 17500 Tk. 10000 Tk. Nil Tk. 35000 Tk. 189000
The number of gas cylinder manufactured during the year 2011 was 4000. The company wants to quote for a contract for the supply of 1000 gas cylinders during the year 2012. The gas cylinder to be quoted are of uniform quality and make and similar to those manufacturing in the previous year
Prepare a statement showing the price to be quoted to give the same percentage of net profit on turnover as was realized during the year 2011. Assuming that the cost per unit overhead will be same as in the previous year.
Conclusion
Businesses or industries are different from each other according to their nature of operation and characteristics of finished products produced or service rendered by them. It is natural that the job of building a house is quite different from running a motor vehicle for a kilometer. Though, in all cases, the basic principles and procedure of costing remain the same, different industries follow different methods and techniques to ascertain cost of their products or services. For example: Specific order or job costing is used for specific jobs, batches or contracts each of which is undertaken by specific order. Process costing is used mainly in manufacturing where units are continuously mass-produced through one or more processes. On the other hand, Operation costing is used for standardized products produced or service rendered continuously in a repetitive manner. So we can conclude that there is no universally recognized method of costing to be used in the organization. Rather it depends on the nature of the products produced/services rendered as well as information needed for the organization.