Some of the most popular costing techniques are as follows:- 1. Historical Costing 2. Uniform Costing 3. Marginal Costing 4. Absorption Costing 5. Direct Costing 6. Incremental Costing and 7. Standard Costing
(i) Historical Costing:
As the name suggests, under this method first the expenditure is incurred and then it is recorded and accounted for calculating cost of production per unit and total cost of the product or service. But this method is like a post-mortem of cost of production. This method cannot be applied for measuring efficiency of the cost centre and of the organisation. This method even fails to guide in cost control.
(ii) Uniform Costing:
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When several firms in the same industry adopt the same principles of cost accounting for comparison, consultation and guidance it is known as uniform costing. Under this method the same method of absorbing overheads, same method of charging depreciation, same method of valuation of stock etc. are adopted by all the firms those have agreed to apply uniform costing.
The technique helps in comparison of performance of one firm with another or the results of a firm with industry as a whole. This method of uniform costing can help to put forward the case of the industry as a whole for tax relief, subsidy or protection etc.
(iii) Marginal Costing:
Marginal cost may be defined as the change in the total cost due to the change in output by one unit. It means the variable cost of a product is marginal cost. Fixed costs are charged from contribution. If the contribution (Sales-Variable cost) is more them fixed cost the difference is profit and if the contribution is less than fixed cost then the difference is a loss.
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Thus, we can say that margined costing is not a method of costing but it is a special technique which helps the management in taking various managerial decisions like the effect of change in output on profit, the effect of increase or decrease in the selling price, level of operation for break-even point, etc.
The marginal costing regards only the variable cost as the cost of production. Fixed costs are considered as period cost and these are not allocated or apportioned to individual costs centre or cost unit. Hence the fixed costs are deducted from contribution.
(iv) Absorption Costing:
Under this system both variable cost and fixed cost are charged to the cost centre or cost unit on some appropriate basis. Under this technique both fixed and variable costs are allocated to the product, process, operation, etc.
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(v) Direct Costing:
Under this technique all costs which are direct to the product, process or operation whether fixed or variable are charged to the cost centre. All those costs which are not direct (or directly related to the product) are transferred to or written off against costing profit and loss account. All indirect costs which take place during the period are transferred to profit and loss account of that period.
(vi) Incremental Costing:
It is a technique of cost accounting which studies the change in cost and change in revenue due to change in level of output or production or in the method of production. The additional cost and additional revenue are analysed for decision making by the management.
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(vii) Standard Costing:
Standard means a measuring yardstick against which the actual performance is measured and remedial action is taken in case of variance (difference) between actual and standard. Under standard costing system standards for each element of cost are set in advance before the production takes place.
Variance are calculated and then these variances are analysed for taking corrective action. These standards are set on the basis of scientific study of product and its elements of cost or on the basis of past experience. Standard costing thus is a technique of the cost ascertainment and cost control of the product.
Costing Techniques: Historical Costing, Uniform Costing, Marginal Costing, Absorption Costing, Direct Costing, Incremental Costing and Standard Costing
Top 7 Most Popular Costing Techniques
The types (or techniques) of costing are briefly describe/defined below:
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1. Historical Costing:
In this, product costs (material, labour and overheads) are ascertained after they have been incurred.
2. Normal Costing:
This is an improvement over historical costing. In this, product cost can be ascertained even before all the costs have been incurred. This is done by using historical (actual) costs of material and labour and predetermined rates for overhead costs.
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Thus normal costing differs from historical costing only in the treatment of overheads. It is termed normal costing because the overheads are applied to products on an average or normalised basis, i.e., using budgeted overheads rates. The product cost so determined is called normal cost.
3. Standard Costing:
It involves the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence.
4. Absorption Costing:
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This follows the practice of charging all costs, variable and fixed to operations, processes or products.
5. Marginal Costing:
It is a technique of costing which considers only variable costs for decision-making. In this, an ascertainment is made of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.
In this, only variable costs are charged to products, processes or operations while fixed costs are written off against the profits for the period in which they arise. In the U.S., the term ‘direct costing’ or ‘variable costing’ is used for marginal costing.
6. Direct Costing:
In this, all direct costs, fixed as well as variable, identifiable with a product, service, job or activity are charged to the concern product, service, job or activity and all indirect costs are written off to the profit of the period in which they arise.
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7. Differential Costing:
A technique of costing which use differential costs/or differential revenues for ascertaining the acceptability of an alternative is called differential costing. The technique may be termed as incremental costing when the difference is increase in cost and decremental costing when the difference is decrease in cost.
Costing Techniques used for Cost Control and Decision Making
The following are the types and techniques of costing applied for cost control and decision making:
1. Historical Costing
It is the ascertainment of cost after they have been incurred. It aims at ascertaining the cost incurred on the work done in the past.”The ascertaining and recording of actual cost after they have been incurred is called historical costing”. – Batty J.
2. Standard Costing
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Standard Cost is a predetermined cost. Standard costing is “the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence” CIMA (London). It controls costs and improves performance.
3. Marginal Costing
Under this system of costing costs are classified into fixed costs and variable costs. Only the Variable costs are charged to products under marginal costing. This system of costing is very important for taking managerial decisions.
4. Direct Costing
It is a practice of charging all direct costs relating to operations, processes or products leaving all other costs to be written off against profits in which they arise.
5. Absorption Costing
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It is a practice of charging all costs both variable and fixed to operations, processes or products. It varies from marginal costing where variable costs only are charged to products.
6. Uniform Costing
It is not a different type of costing. This is the use of same costing principles or practices by several undertakings for common control or comparison of costs.
Costing Techniques Used for the Purpose of Ascertaining Costs
In addition to different methods of costing, the following techniques are used for the purpose of ascertaining costs:
(i) Historical Costing
In this, actual costs are ascertained after they have been incurred. This is a conventional method of cost ascertainment.
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(ii) Direct Costing
The ascertainment of direct costs in respect of department, product or process. This is the aggregate of marginal cost and a portion of fixed cost that are identifiable with the product or process. Direct costs are, therefore, traceable costs.
(iii) Absorption Costing
It is also known as total cost approach. Under this technique, all costs, both fixed and variable are charged to product, process or operations. It is useful in submitting tenders, preparing job estimates etc.
(iv) Uniform Costing
It is the use of some costing principles and methods by several concerns for common control or comparison of costs.
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(v) Marginal Costing
It classifies cost into fixed and variable and only variable costs are charged to product. This type of costing is useful in taking important decisions such as price decisions in time of competition make or buy decisions, selecting profitable product mix etc.
(vi) Standard Costing
Standard cost is predetermined cost. The costs are determined in advance of production. Standard performance is set in terms of costs. Actual costs are compared with the standards and variations are found. Then, reasons for variations are investigated and remedial actions are taken. This system enables control of costs and also measurement of efficiency of operations.
Everything you need to know about Costing Techniques
Costs may be allocated on actual basis or assigned on estimation or standard cost basis. Cost accounting implies a systematic arrangement of cost related details.
The following are the various techniques of costing:
(i) Historical Costing:
Ascertaining costs after they are actually incurred refers to ‘Historical Costing”. According to J. Batty, “Historical costing is ascertaining and recording of actual costs when, or after, they have been incurred, was one of the first stages in the growth of the cost accountant’s work”. It is known as traditional costing.
(ii) Standard Costing:
Standard cost is a predetermined cost. The standard costs are set in advance for different elements of cost. Actuals are ascertained and compared with standards. The differences, termed as “variances” are ascertained, causes are investigated and suitable action is initiated to correct unfavourable variances. Standard costing controls costs and improves performance.
(iii) Marginal Costing:
Under marginal costing costs are classified into fixed and variable. Variable costs are treated as product costs and fixed costs are treated as period costs. Marginal costing is helpful in managerial decision making.
(iv) Uniform Costing:
It is not a different type of costing. It is a policy of different industrial units to follow a specific type of costing, uniformly in all the units to facilitate comparison and assess the comparative performance of each firm to highlight any weak spots.
Remedial action taken on the basis of such assessment by the managements of the firms concerned results in overall improvement in performance throughout the industry. :
Costing Techniques: Standard Costing, Budgetary Costing, Uniform Costing, Marginal Costing and Absorption Costing
The various techniques of costing are as under:
1. Standard Costing
Standard Costing is used in cost control methods. Standard costs are predetermined costs in conformity with the efficient operation and use of resources.
2. Budgetary Costing
It is a technique which controls the total expenditure on materials, wages and overheads by comparing them with the actual performance. The budget is used for control and coordination of business activities.
3. Uniform Costing
It is defined as the use by several undertakings and it helps to compare the performance of one firm with that of another firm.
4. Marginal Costing
The marginal costing takes into account the variable cost of various products. The difference between sales and variable cost is called contribution. If fixed cost is deducted out of contribution profit is arrived. Marginal costing is a technique to ascertain the effect of profit.
The fixed costs are those which do not change on account of change in the quantum of production. The variable costs are those which change proportionately with the change in quantity of production.
5. Absorption Costing
It is a traditional technique, where both the fixed and variable costs are charged in the same manner.
Costing Techniques – Historical Costing, Standard Costing, Uniform Costing and Marginal Costing
Costing is the technique and process of ascertaining costs. The objective of cost accounting is the determination of all costs. The cost may be allocated on the basis of actual cost incurred or costs may be assigned on a standard cost basis.
A system of cost accounting implies that there is a planned and coordinated arrangement of all matters relating to costing; i.e., a systematic and planned procedure is to be followed.
The following are the systems generally in use:
1. Historical Costing:
Batty says, “Historical costing, the ascertaining and recording of actual costs when, or after, they have been incurred, was one of the first stages in the growth of the cost accountant’s work”. It refers to the ascertainment of costs after they have been incurred. It is also known as traditional costing.
2. Standard Costing:
Standard cost is predetermined cost. The costs are determined in advance of production. Standard performance is set in terms of costs and actual costs are compared with the standards.
The difference between the actual cost and the standard one is known as variations, which are recorded and causes thereof are investigated and remedial steps are taken. This system enables control of costs and also measuring the efficiency of operation.
3. Uniform Costing:
It is not a distinctive form of costing, but the cost system is designed by trade associations followed by several undertakings. This system enables inter- firm comparisons.
4. Marginal Costing:
This system of costing differentiates between fixed costs and variable costs. Under this system, fixed costs are not treated as product costs. The cost is thus the aggregate of direct material, direct wages, direct expenses and variable overhead.
This type of costing is useful in taking important policy decisions—price fixing during competition times, make or buy decisions, product mix etc. It is also known as variable for direct costing.
Costing Techniques Used for Job and Process Costing
Costing techniques represent the principles or bases which govern the cost computations. These are the mechanics for immediate tasks on hand of determining costs. Techniques are not tied down to the methods. The same set of techniques could be used for job and process costing.
The important techniques of costing are being discussed below:
Techniques # 1 Absorption Costing:
Absorption costing also known as ‘Full Costing’, ‘Total Costing’, or ‘Cost Attach’, is a technique of costing in which all items of costs, irrespective of whether they are fixed or variable, are absorbed or charged to units of production.
The Chartered Institute of Management Accountants, London, defines the term absorption costing as “the procedure which charges fixed as well as variable overheads to cost units”. Under this technique, fixed manufacturing overhead is unitised, i.e. averaged and assigned to products. The result is that not only the cost of goods sold but the ending inventory levels are also determined by this total cost.
Techniques # 2 Marginal Costing:
The Chartered Institute of Management Accountants, London, defines the term marginal costing as “the ascertainment of marginal costs by differentiating between fixed and variable costs and of the effect on profit of changes in volume or type of output.” It is a technique in which only variable costs are charged to products.
It is based on the fact that fixed costs are incurred on a time basis and should, therefore, be written off in the period in which they are incurred. In other words, fixed costs are regarded as period costs and charged against the revenue of the period in which they are incurred. Ending inventories of work in progress and finished goods are also valued on the basis of variable cost only. Marginal costing is a vital aid to management in decision-making.
Techniques # 3 Standard Costing:
Standard costing is the preparation and use of standard costs, their comparison with actual costs, and analysis of variances to their causes and points of incidence (fixing responsibility). Standard costs represent the predetermined costs for material, labour and overhead. Basically, these are estimates of what the costs should be under varying operating conditions.
Techniques # 4 Budgetary Control:
The establishment of budgets relating to the responsibility of executives and the continuous comparison of actual results against targets in budgets is important for effectiveness and efficiency.
Budgetary control is a system of controlling costs which consists in the preparation of various budgets, coordination of the activities of the departments and continuous comparison of actual performance with the budgeted performance.
Budgetary control is largely a matter of management action which is taken on the basis of information on variances. It could be described as ‘forward costing’—establishment of budgets and, then, their application with a view to monitoring and controlling the activities of a concern.
Techniques # 5 Uniform Costing:
The use by several undertakings of the same costing principles, methods and practices is known as uniform costing. Its great advantage is that it facilitates inter-firm comparison. Uniform costing may be adopted on the initiative of a trade association to undertake Joint action or prevent unhealthy competition in the interest of member concerns.
Costing Techniques – Absorption, Marginal, Standard, Uniform and Direct Costing
(a) Absorption costing
(b) Marginal costing
(c) Standard costing
(d) Uniform costing
(e) Direct costing
(a) Absorption Costing:
It is the technique or the practice of charging all of total costs (both variable and fixed costs) to operations, processes or products. This is a traditional technique. This technique is useful in submitting tenders or quotations and in preparing job estimates.
(b) Marginal Costing:
It is the technique of bifurcating the total cost of a product or operation into two classes Viz.-
i) variable costs and
ii) Fixed costs and charging only the variable costs to the product for the purpose of ascertaining its marginal or variable costs and the effect of the changes in volume or output on profit.
(c) Standard Costing:
It is a special technique under which costs are pre-determined on the basis of scientific standards for each element of cost. The actual costs are compared with the standard costs. The variance between the actuals & standards are analysed to find out the causes for deviation & to take corrective action for controlling the variance.
(d) Uniform Costing:
It refers to the adoption of the uniform or the same costing principles & procedures by all concerns engaged in the same line of activity in an industry.
Different Costing Techniques Used for Analyzing, Presenting, Controlling Cost and Making Managerial Decisions
There are different techniques of costing for analyzing, presenting controlling cost and making managerial decisions.
These are listed below:
a) Marginal Costing
Marginal costing is a technique of costing which differentiate between fixed cost and variable cost. Fixed cost is charged to profit and loss of the period in which cost is incurred. The profitability of the product is expressed in term of contribution i.e., S-V (Selling Price – Variable Cost)
b) Absorption Costing
Absorption costing is a technique in which all cost, variable manufacturing cost and fixed cost are charged to product or process. Profit is ascertained by subtracting total cost from sales. This technique has a little scope as compared to marginal costing.
c) Uniform Costing
It means the practice of using the uniform costing principles and practical by different firms but same industry. Uniform costing makes possible the inter firm comparison, price fixation, cost control etc.
d) Standard Costing
In this techniques of costing standards are fixed for every element of cost. Then actual performance is compared with these standards and corrective actions are taken, in case there is any deviation. Moreover reasons of deviations are analyzed by the management.
e) Direct Costing
It means charging all direct costs to process or product and writing off all indirect cost against profit of same year in which they occur.
f) Activity Based Costing
It is a recent technique introduced in the costing. CIMA, London defines, “as a technique of Cost attribution to cost units on the basis of benefits received from indirect activities e.g. ordering, setting up quality, inspection, power consumed”. It is a technique basically used for apportionment of overheads costs in an organization producing different products.
g) Life Cycle Costing
It is a technique for evaluation of total cost of the product over its economic life. Thus it takes into consideration the entire useful life of the product from beginning to end. It considers both the pre and post production costs.
For example:
Preproduction Cost — Research and Development, Product Designing
Postproduction Cost — Marketing, Distribution, Sales Promotion, Publicity, etc.
h) Target Costing
Target costing is a technique to control the cost in competitive environment of a product. In this type of costing, a company focuses on what they will sell at which price and then it plans to produce the product. Thus, it is consumer oriented.
The target cost is determined as:
Target Cost = Target (Market Price) – Target (Desired Profit).
Costing Techniques Commonly used by Cost Accountants
The techniques are briefly explained below:
1. Standard Costing:
This is a very valuable technique to control the cost. In this technique, standard cost is predetermined as a target of performance and actual performance is measured against the standard. The difference between standard and actual costs is analyzed to know the reasons for the difference so that corrective actions may be taken.
2. Budgetary Control:
Closely allied to standard costing is the technique of budgetary control. A budget is an expression of a firm’s plan in financial form and budgetary control is a technique applied to the control of total expenditure on materials, wages and overhead by comparing actual performance with planned performance.
Thus, in addition to its use in planning, the budget is also used for-control and coordination of business operations.
3. Marginal Costing:
This is a technique of profit planning. In this technique, separation of costs into fixed and variable (marginal) is of special interest and importance. This is so because marginal costing regards only variable costs as the cost of the products.
Fixed cost is treated as period cost and no attempt is made to allocate or apportion this cost to individual cost centres or cost units. It is transferred to costing profit and loss account of the period. This technique is used to study the effect on profit of changes in volume or type of output.
4. Total Absorption Costing:
It is a traditional method of costing whereby total costs (fixed and variable) are charged to products. This is in complete contrast to marginal costing where only variable costs are charged to products. Although until recently this was the only technique employed by cost accountants, it is now-a-days considered to have only a limited application.
5. Uniform Costing:
This is not a separate technique or method of costing like standard costing or process costing. Uniform costing simply denotes a situation in which a number of firms adopt a uniform set of costing principles.
It has been defined by CIMA as the use by several undertakings of the same costing principles and/or practices. This helps to compare the performance of one firm with that of other firms and thus to derive the benefit of anyone’s better experience and performance.
Costing Techniques Used in Industries for Ascertaining the Cost of Products and Services
Costing is the technique consisting of principles and rules, which govern the procedure of ascertaining cost of products and services. Costing and cost accounting are two different terms. Costing refers to the principles and rules governing ascertainment of cost of products and services.
Cost accounting refers to the formal mechanism by means of which costs of products and services are ascertained. Costing can be carried out by means of memorandum record or by methods of integrated accounts, because it emphasises the principles and rules. On the other hand, cost accounting emphasises the formal procedure for cost ascertainment.
Following are the techniques of costing used in industries for ascertaining the cost of products and services:
1. Historical Costing
Historical costing i.e., ascertainment of costs after they have been incurred. This costing is based on recorded data and the costs arrived at are verifiable by past events.
2. Standard Costing
CIMA defines it as “a control technique which compares standard costs and revenues with actual results to obtain variances which are used to stimulate improved performance.”
3. Marginal Costing
Marginal costing is the accounting system in which variable costs are charged to cost units and fixed costs of the period are written-off in full against the aggregate contribution. Its Special value is in decision-making.
4. Direct Costing
Under direct costing, a unit cost is assigned only the direct cost. All indirect costs are charged to profit and loss account of the period in which they arise. Indirect costs are disregarded for inventory valuation as well. Basically, the terms direct costing and marginal costing are two different terms.
While direct costing is based on traceability of cost to cost objective, marginal costing is based on variability of cost. Unlike marginal cost, direct cost may include a part of fixed cost which is directly identifiable.
Direct costing is the term used in U.S.A. and marginal costing is the term used in U.K. The basic difference between the two terms is so insignificant that the two terms will be used synonymously in this text.
5. Absorption Costing
Absorption Costing is a technique that assigns all costs, i.e., both fixed cost and variable cost, to product cost or cost of service tendered.
6. Uniform Costing
CIMA defines it as “the use by several undertakings of the same costing system, i.e. the same basic costing methods, principles and techniques.”
Various Systems of Costing Techniques used for Ascertaining and Analysing Costs
Types of costing refer to various systems used for ascertaining and analysing costs.
The important techniques of costing are as follows:
1. Historical Costing:
The ascertainment and recording of costs after they have been incurred is known as historical costing. It provides the management with a record of what has happened and is thus a postmortem of the actual costs. Since, it is conventional in nature, it is known as ‘Conventional Costing’ or ‘Actual Costing’.
Actual costs can be ascertained in two ways:
(i) Post costing, and
(ii) Concurrent or continuous costing.
(i) Post Costing:
Under this system, cost is ascertained after production is completed, by analysing financial data in such a way as will disclose the cost of the units which have been produced. The main advantage of this procedure is that the figures analysed are the actuals and hence the cost arrived at is correct.
But the serious drawback of this procedure is that it is historical in nature since the information is obtained after the event has taken place. As such this procedure does not enable the manufacturer to take corrective action in time.
(ii) Continuous Costing:
Under this system, cost is ascertained by recording expenditure and allocating it to production as and when the same is incurred, with the result that cost is ascertained as soon the job is completed or even when the job is in progress. This necessarily involves the use of estimates, specially in respect of overhead.
Hence the figures of cost ascertained may not be exact. But since this method makes available the costing information promptly, it enables the management to take the necessary corrective action. But this system does not provide any standard for judging the efficiency of the current operations and does not disclose what the cost of the job ought to have been.
2. Standard Costing:
Under standard costing, costs are computed in advance on the basis of normal or probable expectation. The costs so computed are known as ‘standards’ or ‘standard costs’ and these are compared with actual costs, when incurred, so as to ascertain the variances or differences.
These variances or differences are later on analysed to their causes so as to enable the management to take corrective action where necessary.
3. Marginal Costing:
Marginal Costing (also known as Variable Costing) refers to “the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs”. Under marginal costing, all costs are segregated into fixed costs and variable costs.
Fixed costs refer to costs which tend to remain fixed or constant in total with changes in volume of output. Variable costs refer to costs which tend to vary or change in total directly in proportion to changes in the volume of output. The main object of marginal costing is to deal with the effects of changes in the volume or range of output on the costs or profit of a business concern.
4. Direct Costing:
According to the ‘Terminology of Cost Accountancy’ of the Institute of Cost and Management Accountants, ‘direct costing’ means “the practice of charging of all direct costs to operations, processes or products, leaving all indirect costs to be written off against profits in the period in which they arise”.
This differs from marginal costing in that some fixed costs could be considered to be direct costs in appropriate circumstances.
5. Absorption Costing:
It has been defined by the Institute of Cost and Management Accountants as “the practice of charging all costs, both variable and fixed, to operations, processes or products.”
Under absorption costing, no distinction is made between fixed costs and variable costs and all costs, whether fixed or variable, are taken into account for ascertaining the cost of production. Absorption costing is also known as ‘Full Costing’.
6. Uniform Costing:
It has been defined by the Institute of Cost and Management Accountants as “the use by several undertakings of the same costing principles and/or practices”.
Thus, when a number of undertakings, whether under the same management or otherwise, decide to adhere to one set of accepted costing principles particularly in matters where there can be two opinions, they are said to be following uniform costing.
It attempts to establish uniform costing methods so that comparison of performances in various undertakings can be made to the common advantage of all the participating undertakings.
Costing Techniques Used by Professional to Ascertain Costs
In addition to the different costing methods, various techniques are also used to ascertain costs.
These techniques may be grouped under the following heads:
1. Historical or Traditional Costing:
If the cost is ascertained with the help of actual expenses incurred, it is called historical costing. In this technique, the cost of the product, job or process is ascertained after the completion of production.
2. Standard Costing:
It is the name given to the technique whereby standard costs are pre-determined and subsequently compared with the recorded actual costs. It is, thus, a technique of cost ascertainment and Cost control. It may be used in conjunction with any method of costing. However, it is specially suitable where the manufacturing method involves production of standardised goods of repetitive nature.
3. Marginal Costing:
It refers to the ascertainment of costs by differentiating between fixed costs and variable costs. In this technique, only variable costs are considered as product costs and fixed costs are treated as period costs. The fixed costs are recovered from contribution (difference between sales and variable cost of sales). This technique is used to study the effect on profit, and of changes in volume or type of output.
4. Absorption Costing:
It is the practice of charging all costs, both variable and fixed, to operations, processes or products. It differs from marginal costing where fixed costs are excluded.
5. Uniform Costing:
If all the units of an industry adopt one method of costing, it is known as uniform costing. In fact, it is not a separate method of costing. It facilitates inter-firm comparisons.
7 Key Costing Techniques Used to Determine the Cost of Products and Services
Cost accounting is a process of ascertaining or estimating costs. Hence, it consists of a body of methods and techniques by which cost of products and services are determined and presented. These could be regarded as the tools of cost accountants.
Costing Techniques:
The technique consists of the principles and rules for determining the cost of products and services. The technique is, however, dynamic and changes with the change of time.
1. Absorption Costing:
Absorption costing also known as ‘Full Costing’, or ‘Total Costing’, is a technique of costing in which all items of costs, irrespective of whether they are fixed or variable, are absorbed or charged to units of production.
The Chartered Institute of Management Accountants, London, defines the term absorption costing as “the procedure which charges fixed as well as variable overheads to cost units”. Under this technique, the cost of a product includes direct materials and direct labour, and both variable and fixed manufacturing overheads.
2. Marginal Costing:
The Chartered Institute of Management Accountants, London, defines the term marginal costing as “the ascertainment of marginal costs by differentiating between fixed and variable costs and of the effect on profit of changes in volume or type of output.”
It is a technique in which only variable costs are charged to products. Here, a product cost includes direct materials and direct labour and only variable manufacturing costs.
In other words, fixed costs are regarded as period costs and charged against the revenue of the period in which they are incurred. Closing stocks of work in progress and finished goods are also valued on the basis of variable cost only. Marginal costing is a vital aid to management in short-term decision-making.
3. Direct Costing:
It is the practice of charging all direct costs to operations, processes or products, leaving all the indirect costs to be written off against profits in the period in which they arise. Here, the direct costs are the variable costs. This technique is similar to ‘Marginal Costing’ except that some fixed costs could be considered to be the direct costs in appropriate circumstances.
4. Standard Costing:
Standard costing is the preparation and use of standard costs, their comparison with actual costs, and analysis of variances to their causes and fixing responsibility. Standard costs represent the predetermined costs for material, labour and overhead. Basically, these are estimates of what the costs should be under varying operating conditions.
5. Budgetary Control:
The Chartered Institute of Management Accountants, London, defines budgetary control as “the establishment of budgets relating to the responsibilities of the executives to the requirements of a policy and the continuous comparison of actual with the budgeted results.
This is done either to secure by individual action the objectives of that policy or provide a basis for its revision”. Thus, budgetary control involves the preparation of budgets and continuous comparison of actual results with the budget estimates. Such a comparison may highlight variances and the need for management action.
6. Uniform Costing:
The use by several firms of the same costing principles, methods and practices is known as uniform costing. Its main advantage is that it facilitates inter-firm comparison. Uniform costing may be adopted on the initiative of a trade association to undertake joint action or prevent unhealthy competition in the interest of member concerns.
7. Activity-Based Costing:
Activity-Based Costing (ABC) has recently emerged as an important technique for processing cost data. ABC is essentially connected with the recovery of support overheads like set-up, planning, dispatch, purchasing.
It absorbs, charges, recovers overheads on the basis of cost drivers instead of production volume as measured by labour or machine hours. Cost drivers are the factors which cause the cost. ABC uses a number of cost drivers to relate overheads to the product or product lines.
Costing Techniques – Specific Order and Operation Costing
The main object of costing is to ascertain the cost per unit of production. To achieve this object, a suitable method of costing should be applied depending upon the nature of business.
Techniques of costing can be broadly divided into two:
i. Specific order costing, and
ii. Operation costing
i. Specific order costing is applied where the work consists of separate jobs, batches or contracts. Job, batch and contract costing are included in this category.
ii. Operation costing is applied where standardized goods or services result from a sequence of repetitive or more or less continuous operation to which costs are charged. Process, operating or service costing are included in this category.
The following are the various methods of costing:
1. Job Costing
It is applicable in industries where goods are made against individual orders from customers. This is suitable for industries where jobs are kept separate during manufacture. A separate account is maintained for each job to which all expenditure incurred there on are debited.
Sometimes a job card is prepared for each job for cost accumulation. This method is applicable to printing press, automobile workshops, film studios etc.
2. Contract Costing
When the job is big and spread over long period of time, the method of contract costing is used. This method is used by builders and civil engineering contractors.
3. Batch Costing
This is an extension of job costing. A batch may represent a number of small orders passed through the factory in a batch. Each batch is treated as a unit of cost and separately costed. The cost per unit is determined by dividing the cost of the batch by the number of units produced in a batch. This is suitable for cycle manufacturing units, toy manufacturing companies, bakeries etc.
4. Unit Costing
This method is used when production is uniform and consists of a single or two or three varieties of the same product. The cost per unit is obtained by dividing the total expenditure incurred during a period by the number of units produced during that period. It is suitable for industries like mines, quarries, tile works, brick works, etc.
5. Operating Costing
This method is used to ascertain the cost of services rendered. It is used in undertakings which provide services instead of manufacturing products. It is used by transport undertakings, hotels, hospitals etc.
6. Multiple Costing
It is the application of more than one method of cost ascertainment in respect of the same product. This is suitable for industries where a number of component parts are separately produced and subsequently assembled into a final product. This method is used in industries manufacturing engines, radios, televisions etc.
7. Process Costing
This method is used in mass production industries manufacturing standardised products in continuous process of manufacture. The raw material has to pass through a number of processes in a particular sequence to produce the finished product. The finished product of one process is the raw material of the next process, till finished product is obtained.
Top 5 Costing Techniques used to Control Cost
In addition to methods, the following costing techniques are also used to control cost. The basic difference between method and technique is costing methods are used to ascertain cost of process or job while costing technique are used to control the cost irrespective of the method employed by the company. Costing methods and techniques are used simultaneously to obtain better results.
(1) Marginal Costing:
Marginal costing lays emphasis on marginal (variable) cost. All the costs are divided into fixed and variable component. Only variable cost is considered as cost of production in marginal costing method. All fixed costs are treated as period costs and thus, are not included in the cost of production. All these costs are debited to the overhead account. This technique is used to calculate and control the costs at various levels of production.
(2) Standard Costing:
It is also called variance costing. This is very important technique to control the cost. In this technique, actual cost of production is compared with predetermined cost (generally called standard cost) to calculate any variation in the two costs. The differences in these two costs are called variance. The efforts are made to know the reasons for variances and effective measures are adapted to control and minimize these variances in the future.
(3) Absorption Costing:
It is also called total costing or full costing. In this costing technique, all costs both variable and fixed are charged to the production. According to ICWA, absorption costing is a method of costing by which all direct costs and applicable overheads are charged in product for finding out total cost of production.
(4) Uniform Costing:
Uniform costing means where standardized methods and techniques of cost accounting are employed by many companies. It helps in inter firm comparison of costing data. It is defined by CIMA as – “the use by several undertakings of the same costing principles/practices”.
(5) Activity Based Costing:
It is a recent technique of allocating overhead cost to the product. In this technique, overhead cost (indirect costs) of the organization is allocated to the product with reference to the activities involved in its production. Therefore, activity based costing may be defined as a technique which involves identification of each cost driving activity and making it as the basis for absorption of costs over different products or jobs.
Costing Techniques – Total Absorption Costing, Marginal Costing, Standard Costing, Direct Costing, Budgetary Control and Uniform Costing
The techniques of costing are as discussed below:
1. Total Absorption Costing:
It is a traditional method of costing. Under this method, total costs (fixed and variable) are charged to products. This is, in contrast, to marginal costing where only variable costs are charged to products. Until recently, this was the only technique employed by cost accountants, however, nowadays it is considered to have only a limited application.
2. Marginal Costing:
In the marginal costing technique, separation of costs into fixed and variable (marginal) is of special interest and importance. The reason is marginal costing regards only variable costs as the cost of the products.
Fixed cost is treated as period cost and no attempt is made to allocate or apportion this cost to individual cost centers or cost units. It is transferred to costing profit and loss account of the period. The use of this technique is made to study the effect on profit of changes in volume or type of output.
3. Standard Costing:
In this technique, standard cost is pre-determined as target of performance and actual performance is measured against the standard. Analysis is done to measure differences between standard and actual costs with a view to know the reasons for the difference so that corrective actions may be taken. Hence, it is a very valuable technique of controlling cost.
4. Direct Costing:
It is a practice of charging all direct cost into, variable and fixed cost relating to operations process or products leaving all other cost to be written off against profit in which they arise.
5. Budgetary Control:
The technique of budgetary control is closely allied to standard costing. A budget is an expression of a firm’s business plan in financial form and budgetary control is a technique applied to the control of total expenditure that is to be incurred on materials, wages and overheads by comparing actual performance with planned performance.
As such besides its use in planning, the budget is used for control and coordination of business operations as well.
6. Uniform Costing:
This method denotes a situation wherein a number of firms adopt a uniform set of costing principles. CIMA, London defines it as, “the use by several undertakings of the same costing principles and/or practices”.
This helps in making comparison between the performance of one firm and that of other firms with a view to derive the benefit of anyone’s better experience and performance.
The Choice of a Particular Methods of Costing Depends on the Nature of Business
The choice of a particular method of costing depends on the nature of business of the concern.
There are two basic techniques of costing namely:
(a) Specific or Job Order Costing
Job costing is the basic costing method applicable to those industries where the work consist of separate contracts, jobs or batches each of which is authorized by a specific order or contract.
(i) Contract Costing
Contract costing is a variant of job costing system applicable particularly in the case of organizations doing construction work. It is also known as Terminal costing. Each contract, short term or long-term, is treated as a job.
It is understood that construction work involves massive investment and labour employment. So it may take much time to complete the work and may extend more than year period.
(ii) Batch Costing
Batch Costing is defined as that form of specific order costing which applies where similar articles are manufactured in batches either for sale or for use within the undertaking. Batch Costing is used where articles are produced in batches and held in stock for assembly of components to produce finished products or for sale to customers.
Costs are collected against each batch. When the batch is completed cost per unit is computed by dividing total cost by the number of units in each batch.
(b) Process Costing
Process costing method is applicable where goods result from a sequence of continuous or repetitive operations or processes and products are identical and cannot be segregated. For example, Chemical Manufacturing Industries.
(c) Service or Operating Costing
The cost of operating a service is known as the operating cost and the method of ascertaining the operating cost is known as “Operating Costing”.
(d) Unit and Output Costing
In this method, cost per unit of output or production is ascertained and the amount of each element constituting such cost is determined. In case where the products can be expressed in identical quantitative units and where manufacture is continuous,this type of costing is applied.
Cost statements or cost sheets are prepared in which various items of expense are classified and the total expenditure is divided by the total quantity produced in order to arrive at per unit cost of production. The method is suitable in industries like brick making, collieries, flour mills, paper mills,cement manufacturing etc.
(e) Multiple Costing
Under this system, the costs of different sections of production are combined after finding out the cost of each and every part manufactured. The system of ascertaining cost in this way is applicable where a product comprises many assailable parts, e.g., motor cars, engines or machine tools, typewriter, radios, cycles etc.
Costing Techniques Specifically Designed to Suit the Needs of Different Industries
The methods or types of costing refer to the methods employed in the ascertainment of costs. Several methods have been designed to suit the needs of different industries.
These techniques of costing are as follows:
1. Job Order Costing:
This method applies where work is undertaken to customers’ special requirements. Cost unit in job order costing is a job or work order for which costs are separately collected and accumulated.
A job, big or small, comprises a specific quantity of a product to be manufactured as per customer’s specifications. The industries where this method is used include printing press, repair shops interior decorators, painters, etc.
2. Contract Costing or Terminal Costing:
This is a variation of job costing and, therefore, principles of job costing apply to this method. The difference between job and contract is that job is small and contract is big. It is well said that a contract is a big job and a job is a small contract.
The cost unit here is a ‘contract’ which is of a long duration and may continue over more than one financial year. Contract costing is most suited to construction of buildings, dams, bridges and roads, ship-building, etc.
3. Batch Costing:
Like contract costing, this is also a variation of job costing. In this method, the cost of a batch or group of identical products is ascertained and therefore each batch of products is a cost unit for which costs are ascertained. This method is used in companies engaged in the production of readymade garments, toys, shoes, tyres and tubes, component parts, etc.
4. Process Costing:
As distinct from job costing, this method is used in mass production industries manufacturing standardised products in continuous processes of manufacturing. Costs are accumulated for each process or department. Here raw material has to pass through a number of processes in a particular sequence to completion stage.
In order to arrive at the unit cost, the total cost of a process is divided by the number of units produced. The finished product of one process is passed on to the next process as raw material. Textile mills, chemical works, sugar mills, refineries, soap manufacturing, etc., may be cited as examples of industries which employ this method.
5. Operation Costing:
This is nothing but a refinement and a more detailed application of process costing. A process may consist of a number of operations and operation costing involves cost ascertainment for each operation instead of a process.
6. Single, Output or Unit Costing:
This method of cost ascertainment is used when production is uniform and consists of a single or two or three varieties of the same product. Where the product is produced in different grades, costs are ascertained grade-wise.
As the units of output are identical, the cost per unit is found by dividing the total cost by the number of units produced. This method is applied in mines, quarries, brick-kilns, steel production, flour mills, etc.
7. Operating or Service Costing:
This method should not be confused with operation costing. Operating costing is used in undertakings which provide services instead of manufacturing products. For example, transport undertakings (road transport, railways, and airways, shipping companies), electricity companies, hotels, hospitals, cinema, etc., use this method.
The cost units are passenger-kilometer or tone – kilometer, kilowatts hour, a room per day in a hotel, a seat per show in cinema, etc. This method is a variation of process costing.
8. Multiple or Composite Costing:
It is an application of more than one method of cost ascertainment in respect of the same product. This method is used in industries where a number of components are separately manufactured and then assembled into a final product.
For example, in a television company, manufacture of different component parts may require different production methods and thus different methods of costing may have to be used.
Assembly of these components into final product still requires another method of costing. Other examples of industries which make use of this method are air-conditioners refrigerators, scooters, cars, locomotive works, etc.
The Method of Costing Depend Upon the Nature of Manufacturing Activities, Processes or Products of the Company
There are two important methods of costing viz., job costing and operation costing. These two methods are further divided to suit the requirements of different organizations. Some organizations are engaged in producing only one product while others may be manufacturing variety of products.
Some may be producing homogeneous products passing through various stages while other may be producing joint or multiple products. Therefore, the method of costing will depend upon the nature of manufacturing activities, processes or products of the company.
Following are the important techniques of costing:
1. Job Costing:
Job costing method is used where a particular work is undertaken on the requirements of the customer. Separate accounts are opened for each job undertaken by the firm. All material, labour and corresponding overhead cost is charged to the job cost sheet. Some industries where job costing is applied are repair & maintenance, printing work, equipment manufacturing etc.
2. Contract Costing:
Contract costing is similar to the job costing with the difference that contrast is a big job. The cost unit here is contract instead of a job. So this method is used by those businesses which are engaged in undertaking big projects (called contracts) like building dam, roads, residential projects, flyovers etc.
3. Batch Costing:
This method is used where large number of parts are produced in batches. It is not advisable to ascertain the cost of a single unit. Instead a batch (consisting of identical units) is taken as cost unit to ascertain the cost of production.
However the costing records or accounts will be prepared in same way as in job costing. Industries where batch costing method is used are component parts, brick making, shoes, toys, pencils etc.
4. Single or Output or Unit Costing:
This method is used in industries where only a single (standardized and uniform) product or few varieties of products are manufactured. As the unit produced is identical, cost per unit is obtained by dividing total cost by the number of units produced. No separate books of account are required for each unit. Cost related to entire production is presented in a statement called ‘Cost sheet’.
5. Process Costing:
When a product passes through different, distinct and well defined processes, the process costing method is used. Process costing helps in ascertaining cost of each process. The system is suitable for the industries like chemical manufacturing, oil refineries, sugar mills, textile mills etc.
6. Operation Costing:
Operation costing is refinement of process costing. There is no big difference between operation and process costing. The method of costing is similar to the process costing except that cost unit for which cost is ascertained is an operation instead of process.
7. Operating Costing (Service Costing):
Operating costing is generally used to ascertain the cost of a service provided such as -transport, hospitals, electricity, hotels etc. The cost unit here may be very simple like cost per bed (hospitals), cost per km (transport), and cost per kilowatt (electricity).
Sometimes composite cost unit can also be used like cost per bed per day or cost per bed per patient in hospital industry. The cost per unit is obtained by dividing the total expenses of providing services by number of units served.
8. Departmental Costing:
This method is used to ascertain the cost of each department separately. The method is suitable where a factory is divided into well-defined departments like sales, production, office, research, maintenance etc.
9. Multiple Costing:
Multiple costing means a combination of two or more methods to calculate cost. The method is followed where the final product consist of number of separately manufactured components like radio, television, car, refrigerators etc.
For example manufacturing a car may require manufacturing different parts of car using different costing methods.
List of all Commonly Used Costing Techniques
The Techniques of costing are as follows:
1. Historical Costing:
‘The ascertainment of costs after they have been incurred’ is called Historical costing. Such costs are, therefore, ‘post mortem’ costs as under this method all the expenses incurred on the production are first incurred and then the costs are ascertained.
2. Standard Costing:
‘The preparation and use of standard costs, their comparison with actual costs and the analysis of variance to their causes and points of incidence’ is called standard costing. Here, the standards are first set and then they are compared with actual performances.
The difference between the standard and the actual is known as the variance. The variances are analysed to find out their causes and also the points or locations at which they occur.
3. Marginal Costing:
Marginal Costing involves the ascertainment of marginal costs and of the effects on profit of changes in volumes or type of output by differentiating between fixed costs and variable costs. The fixed costs are those which do not change but remain the same, with the increase or decrease in the quantum of production.
The variable costs are those which do change proportionately with the change in quantum of production. The marginal costing takes into account only the variable costs to find out ‘marginal costs’. The difference between Sales and Marginal costs is known as ‘Contribution’ and contribution is an aggregate of Fixed costs and Profit/Loss. So, the fixed costs are deducted from the contribution to find out the profits.
Marginal costing is a technique to ascertain the effect on profits. Marginal costing is a technique to ascertain the effect on profit by the change in the volume of output or by the change in the type of output.
4. Absorption Costing:
It is the practice of charging all costs, both variables and fixed, to operations, processes or products. This is the traditional technique as opposed to Marginal or Direct costing techniques. Here, both the fixed and variable cost are charged in the same manner.
5. Job Costing:
The job costing methods are applicable where the unit of manufacture is one and complete in itself. They include printers, job foundries, tool manufactures, and contractors, etc.
The following methods are included in Job Costing:
(a) Contract Costing:
This method if applied in undertaking erecting buildings or carrying out constructional works, e.g., house buildings, ship building, civil engineering contracts etc. Here, the cost unit is one and completed in itself. The cost unit is a contract which may continue for over more than a year. It is also known as the Terminal Costing, since the works are to be completed within a specified period as per terms of contract or agreement executed by the contractor and contractee.
(b) Batch Costing:
In this method, a batch of similar or identical products is treated as a job. Here, the unit of cost is a batch of group of products, costs are collected and analysed according to batch numbers and the costs are ascertained batch wise.
This method is applied in pharmaceutical industries where medicines or injections are manufactured batch wise or in general engineering factories producing components in convenient batches.
(c) Process Costing:
Process costing method is applicable to those industries manufacturing an number of units of output requiring processing. Here, an article has to undergo two or more processes for reaching the stage of finished goods and succeeding process till completion.
(d) Unit Costing:
This method is also known as single or output costing. The objective of this method is to ascertain the total cost as well as the cost per unit. A cost sheet is prepared taking into account the cost of material, labour and overheads.
Unit costing is applicable in the case of mines, oil drilling units, cement works, brick works and units manufacturing cycles, radios, washing machines, etc.
(e) Operating Costing:
This method is followed by industries which render services. To ascertain the cost of such services, composite units like passenger kilometers and tone kilometers are used for ascertaining costs. For example, in the case of a bus company, operating costing indicates the cost of carrying a passenger per kilometer.
6 Main Costing Techniques Used for Ascertaining the Costs
For ascertaining the cost, the following techniques of costing systems are usually used:
1. Uniform Costing:
When a number of firms in an industry agree among themselves to follow the same system of costing in detail by adapting common terminology and calculation methods for various items of expenses, they are said to follow a system of uniform costing. In such a case, a comparison of the performance of each of the firms can be made with that of another, or with the average performance of the industry.
In such a system, it is also possible to determine the average cost of production of goods for an industry as a whole. It is found to be useful when tax relief, subsidy, or production quota is sought from the Government.
2. Marginal Costing:
It is defined as the ascertainment of marginal cost by differentiating between fixed and variable costs. It is used to ascertain the effects of changes in volume or level of output on profit.
3. Standard Costing:
It is the name given to the technique where standard costs are predetermined and subsequently compared with recorded actual costs. Therefore, it is a technique which can be used with any method of costing.
However, it is specifically suitable where manufacturing methods involve production of standardized goods of repetitive nature. Standard costs can also be used for cost control or as a basis for fixing selling price.
4. Historical Costing:
It is the ascertainment of costs after they have been incurred. This type of costing has limited utility in real life.
5. Direct Costing:
It is the practice of charging all direct costs to operations, processes, or products; and leaving all indirect costs to be written off against resultant profits.
6. Absorption Costing:
It is the practice of charging all costs, both variable and fixed, to operations, processes, or products. Unlike marginal costing where fixed costs are excluded, absorption costing takes both variable and fixed costs into consideration.