Methods of Costing

As per the nature and peculiarities of the business, different Industries follow different methods
to find out the cost of their product. There are different principles and procedure for doing the
costing. However the basic principle and procedure of costing remain the same. Some of the
methods are mentioned below:
1.Unit Costing
2. Job Costing
3. Contract Costing
4. Batch Costing
5. Operating Costing
6. Process Costing.
7. Multiple Costing
8. Uniform Costing.
Different Methods of Costing
Unit Costing: This method also called 'Single output Costing'. This method of costing is used
for products which can be expressed in identical quantitative units and is suitable for products
which are manufactured by continuous manufacturing activity. Costs are ascertained for
convenient units of output. Examples: Brick making, mining, cement manufacturing, dairy, flour
mills etc.
Job Costing: Under this method costs are ascertained for each work order separately as each job
has its own specifications and scope. Examples: Painting, Car repair, Decoration, Repair of
building etc.
Contract Costing: Under this method costing is done for big jobs which involves heavy
expenditure and stretches over a long period and often it is undertaken at different sites. Each
contract is treated as a separate unit for costing. This is also known as Terminal Costing.
Construction of bridges, roads, buildings, etc. comes under contract costing.
Batch Costing: This methods of costing is used where the units produced in a batch are uniform
in nature and design. For the purpose of costing each batch is treated as a job or separate unit.
Industries like Bakery, Pharmaceuticals etc. usually use batch costing method.
Operating Costing or Service Costing: Where the cost of operating a service such as nursing
home, Bus, railway or chartered bus etc. this method of costing is used to ascertain the cost of
such particular service. Each particular service is treated as separate units in operating costing. In
the case of a Nursing Home, a unit is treated as the cost of a bed per day and for buses operating
cost for a kilometer is treated as a unit.
Process Costing: This kind of costing is used for the products which go through different

processes. For example, manufacturing cloths goes through different process. Fist process is
spinning. The out put of spinning is yarn. It is a finished product which can be sold in the market
to the weavers as well as use as a raw material for weaving in the same manufacturing unit. For
the purpose of finding out the cost of yarn, the cost of spinning process is to be ascertained. The
second step is the weaving process. The out put of weaving process is cloth which also can be
sold as a finished product in the market. In such case, the cost of cloth needs to be evaluated. The
third process is converting cloth in to finished product such as shirt or trouser etc. Each process
is to be evaluated separately as the out put of each process can be treated as a finished good as
well as consumed as a raw material for the next process. In such industries process costing is
used to ascertaining the cost at each stage of production.
Multiple Costing: When the output comprises many assembled parts or components such as in
television, motor Car or electronics gadgets, costs have to be ascertained or each component as
well as the finished product. Such costing may involve different methods of costing for different
components. Therefore this type of costing is known as composite costing or multiple costing.
Uniform Costing: This is not a separate method of costing. This is a system of using the same
method of costing by a number of firms in the same industry. It is treated as a common system of
using agreed principles and standard accounting practices in the identical firms or industry. This
helps in fixation of price of the product and inter-firm comparisons.

Types of Costing
There are different types or techniques of costings are used in cost accounting. Different types of
costing is used in different industries to analyze and presenting costs for the purposes of control
and managerial decisions. The generally used types of costing are as follows:
Marginal Costing: In Marginal Costing, it allocates only variable costs i.e. direct materials,
direct labour and other direct expenses and variable overheads to the production. It does not take
into account the fixed cost of production. This type of costing emphasizes the distinction
between fixed and variable costs.
Absorption Costing: The technique of absorbing fixed and variable costs to production is called
absorption costing. Under absorption costing full costs, i.e. fixed and variable costs are absorbed
to the production.
Standard Costing: When costs are determined in advance on certain predetermined standards
under a given set of operating conditions, it is called standard costing. Standard costing is to be
compared with the actual costs periodically to analyze the changes in the cost to revise the
standards to avoid any loss due to outdated costing.
Historical costing: When costs are determined in terms of actual costs and not in terms of
predetermined standards cost is called Historical costing. In this system of cost accounting, costs

are determined only after they have been incurred. Almost all organizations use historical costing
system of accounting for costs.
6 types of costing used for ascertaining cost
For ascertaining cost, following types of costing 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, adopting common terminology for various items and processes 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 in the industry.
Under such a system it is also possible to determine the cost of production of goods which is true
for the industry as a whole. It is found useful when tax-relief or protection 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 effect of changes in volume or type of output on profit.
3. Standard Costing and variance analysis
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. This technique may be used in conjunction with any method of
costing. However, it is especially suitable where the manufacturing method involves production
of standardized goods of repetitive nature.
4. Historical Costing
It is the ascertainment of costs after they have been incurred. This type of costing has limited
utility.
5. Direct Costing
It is the practice of charging all direct costs to operations, processes or products leaving all
indirect costs to be written off against profits in which they arise.
6. Absorption Costing

It is the practice of charging all costs, both variable and fixed to operations, processes or
products. This differs from marginal costing where fixed costs are excluded.

TRADITIONAL COSTING APPROACH

Understanding Traditional Costing
Many manufacturing companies use the traditional costing system to assign manufacturing
overhead to units produced. Users of the traditional costing method make the assumption that the
volume metric is the underlying driver of manufacturing overhead cost. Under traditional
costing, accountants assign manufacturing costs only to products. Traditional accounting fails to
allocate nonmanufacturing costs that also are associated with the production of an item, such as
administrative expenses. Companies commonly use traditional accounting in external financial
reports because it provides a value for the cost of goods sold.
Pros and Cons of Traditional Costing
An advantage of using traditional-based costing is that it aligns with Generally Accepted
Accounting Principles, or GAAP. Easy implementation for companies that provide one product
also is a plus. However, traditional costing is an outdated costing system in many companies
because those manufacturing companies now use machines and computers for much of their
production. Computers and machines make the system outdated because it often uses direct labor
hours to calculate cost. Cost is not appropriately assigned because direct labor hours is not the
best cost driver to use. Traditional costing negates other cost drivers that may contribute to the
cost of an item. Another disadvantage of solely using the traditional costing system is that it can
lead to bad management decisions because it excludes certain nonmanufacturing costs.
Understanding Activity-Based Costing
Activity-based costing provides a more accurate view of product cost, but companies typically
use it as a supplemental costing system. The allocation bases used in activity-based costing differ
from those used in traditional costing. Activity-based costing determines every activity
associated with producing an item and allocates a cost to the activity. The cost assigned to the
activity is then assigned to products that require the activity for production.
Pros and Cons of Activity-Based Costing
Greater costing accuracy is the primary benefit of activity-based costing. Companies assign cost
only to the products that require the activity for production. This method eliminates allocating
irrelevant costs to a product. Other advantages of activity-based costing include an easy

interpretation of cost for internal management, the ability to enable benchmarking and a greater
understanding of overhead costs. Implementing an activity-based costing system within a
company requires substantial resources. This can prove a disadvantage for companies with
limited funds. Another disadvantage of using activity-based costing is that it is easily
misinterpreted by some users.

Activity-based costing (ABC) is a costing methodology that identifies activities in an

organization and assigns the cost of each activity with resources to all products and services
according to the actual consumption by each. This model assigns more indirect costs (overhead)
into direct costs compared to conventional costing.
Aims of model
With ABC, a company can soundly estimate the cost elements of entire products and services.
That may help inform a company's decision to either:

Identify and eliminate those products and services that are unprofitable and lower the
prices of those that are overpriced (product and service portfolio aim)

Or identify and eliminate production or service processes that are ineffective and allocate
processing concepts that lead to the very same product at a better yield (process reengineering aim).

In a business organization, the ABC methodology assigns an organization's resource costs

through activities to the products and services provided to its customers. ABC is generally used
as a tool for understanding product and customer cost and profitability based on the production
or performing processes. As such, ABC has predominantly been used to support strategic
decisions such as pricing, outsourcing, identification and measurement of process improvement
initiatives.
FIXED COST
A periodic cost that remains more or less unchanged irrespective of the output level or sales
revenue, such as depreciation, insurance, interest, rent, salaries, and wages.
While in practice, all costs vary over time and no cost is a purely fixed cost, the concept of fixed
costs is necessary in short term cost accounting. Organizations with high fixed costs are
significantly different from those with high variable costs. This difference affects the financial
structure of the organization as well as its pricing and profits. The breakeven point in such
organizations (in comparison with high variable cost organizations) is typically at a much higher
level of output, and their marginal profit (rate of contribution) is also much higher.

In economics, fixed costs are business expenses that are not dependent on the level of goods or
services produced by the business. They tend to be time-related, such as salaries or rents being
paid per month, and are often referred to as overhead costs. This is in contrast to variable costs,
which are volume-related (and are paid per quantity produced).
In management accounting, fixed costs are defined as expenses that do not change as a function
of the activity of a business, within the relevant period. For example, a retailer must pay rent and
utility bills irrespective of sales.
In marketing, it is necessary to know how costs divide between variable and fixed. This
distinction is crucial in forecasting the earnings generated by various changes in unit sales and
thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior
marketing managers, 60 percent responded that they found the "variable and fixed costs" metric
very useful.
VARIABLE COST
Variable costs are expenses that change in proportion to the activity of a business. Variable cost
is the sum of marginal costs over all units produced. It can also be considered normal costs.
Fixed costs and variable costs make up the two components of total cost. Direct Costs, however,
are costs that can easily be associated with a particular cost object. However, not all variable
costs are direct costs. For example, variable manufacturing overhead costs are variable costs that
are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they
vary with the number of units produced.
Direct labor and overhead are often called conversion cost, while direct material and direct labor
are often referred to as prime cost.
In marketing, it is necessary to know how costs divide between variable and fixed. This
distinction is crucial in forecasting the earnings generated by various changes in unit sales and
thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior
marketing managers, 60 percent responded that they found the "variable and fixed costs" metric
very useful.
MARGINAL COST
In economics and finance, marginal cost is the change in the total cost that arises when the
quantity produced changes by one unit. That is, it is the cost of producing one more unit of a
good. In general terms, marginal cost at each level of production includes any additional costs
required to produce the next unit. For example, if producing additional vehicles requires building
a new factory, the marginal cost of the extra vehicles includes the cost of the new factory. In
practice, this analysis is segregated into short and long-run cases, so that over the longest run, all

costs become marginal. At each level of production and time period being considered, marginal
costs include all costs that vary with the level of production, whereas other costs that do not vary
with production are considered fixed.

PRICING PRACTICE
FULL COST PRICING
Selling price arrived at by adding overheads and profit margin to the direct cost per unit of a
product. In a manufacturer's overheads computation, less than full capacity utilization of the
plant is factored in to allow for fluctuations in the output. The profit margin is computed as a
fixed percentage of the average total cost of the product
Full cost pricing is a practice where the price of a product is calculated by a firm on the basis of
its direct costs per unit of output plus a markup to cover overhead costs and profits. The
overhead costs are generally calculated assuming less than full capacity operation of a plant in
order to allow for fluctuating levels of production and costs.
IMPLEMENTING FULL COST PRICING
This section focuses on the practical considerations of implementing full cost pricing.
The concepts of costing and pricing;
Components of a full cost price and how they are valued;
Treatment of community service obligations;
Structural reforms required; and
Reporting and compliance measures.
MARGINAL COST PRICING
marginal-cost pricing, in economics, the practice of setting the price of a product to equal the
extra cost of producing an extra unit of output. By this policy, a producer charges, for each
product unit sold, only the addition to total cost resulting from materials and direct labour.
Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an

item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item
might wish to lower the price to $1.10 if demand has waned. The business would choose this
approach because the incremental profit of 10 cents from the transaction is better than no sale at
all.
In the mid-20th century, proponents of the ideal of perfect competitiona scenario in which
firms produce nearly identical products and charge the same pricefavoured the efficiency
inherent in the concept of marginal-cost pricing. Economists such as Ronald Coase, however,
upheld the markets ability to determine prices. They supported the way in which market pricing
signals information about the goods being sold to buyers and sellers, and they observed that
sellers who were required to price at marginal cost would risk failing to cover their fixed costs.

GOING RATE PRICING

Setting a price for a product or service using the prevailing market price as a basis. Going rate
pricing is a common practice with homogeneous products with very little variation from one
producer to another, such as aluminum or steel.
BID PRICING
The price a buyer is willing to pay for a security. This is one part of the bid with the other being
the bid size, which details the amount of shares the investor is willing to purchase at the bid
price. The opposite of the bid is the ask price, which is the price a seller is looking to get for his
or her shares.
The use of bid and ask is a fundamental part of the market system, as it details the exact amount
that you could buy or sell at any point in time. Remember that the current price is not the price
for which you can purchase the security, but the price at which the shares last traded hands. If
you want to get an idea of the price for which you can buy a security, you need to look at the bid
and ask prices because they will often differ from the current price.
A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for a good. It is usually
referred to simply as the "bid."
In bid and ask, the bid price stands in contrast to the ask price or "offer", and the difference
between the two is called the bid/ask spread.
An unsolicited bid or purchase offer is when a person or company receives a bid even though
they are not looking to sell. A bidding war is said to occur when a large number of bids are
placed in rapid succession by two or more entities, especially when the price paid is much
greater than the ask price, or greater than the first bid in the case of unsolicited bidding.

In the context of stock trading on a stock exchange, the bid price is the highest price a buyer of a
stock is willing to pay for a share of that given stock. The bid price displayed in most quote
services is the highest bid price in the market. The ask or offer price on the other hand is the
lowest price a seller of a particular stock is willing to sell a share of that given stock. The ask or
offer price displayed is the lowest ask/offer price in the market (Stock market).

RATE OF RETURN PRICING

Rate of return pricing is practiced by businesses that set specific goals for the capital that they
spend and the revenue they wish to generate. A business can set prices to ensure that these goals
will be achieved. The concept of rate of return pricing is similar to the investment concept of
return on investment, except that the business owner can manipulate prices to help achieve this
goal. This method of pricing is most effectively achieved when a company has little or no
competition in the market, since the actions of competitors will likely affect the rate of return.
Just as investors wish to generate a certain amount of return on their investment, so to do
businesses have ideal goals in mind for their income on the sale of goods and services. Both
investors and businesses alike have to be concerned with the amount of risk involved with the
capital they spend. Since the similarities are so obvious, many business owners take an
investment-styled approach to how much their goods cost by practicing rate of return pricing.
PROJECT APPRAISAL
Project appraisal methodologies are methods used to access a proposed project's potential
success and viability. These methods check the appropriateness of a project considering things
such as available funds and the economic climate. A good project will service debt and maximize
shareholders' wealth.
Net Present Value
A project's net present value is determined by summing the net annual cash flow, discounted at
the project's cost of capital and deducting the initial outlay. Decision criteria is to accept a project
with a positive net present value. Advantages of this method are that it reflects the time value of

money and maximizes shareholder's wealth. Its weakness is that its rankings depend on the cost
of capital; present value will decline as the discount rate increases.
Payback Method
A company chooses the expected number of years required to recover an original investment.
Projects will only be selected if initial outlay can be recovered within a predetermined period.
This method is relatively easy since the cash flow doesn't need to be discounted. Its major
weakness is that it ignores the cash inflows after the payback period, and does not consider the
timing of cash flows.
Internal Rate of Return
This method equates the net present value of the project to zero. The project is evaluated by
comparing the calculated Internal rate of return to the predetermined required rate of return.
Projects with Internal rate of return that exceed the predetermined rate are accepted. The major
weakness is that when evaluating mutually exclusive projects, use of Internal rate of return may
lead to selecting a project that does not maximize the shareholders' wealth.
Profitability Index
This is the ratio of the present value of project cash inflow to the present value of initial cost.
Projects with a Profitability Index of greater than 1.0 are acceptable. The major disadvantage in
this method is that it requires cost of capital to calculate and it cannot be used when there are
unequal cash flows. The advantage of this method is that it considers all cash flows of the
project.
FEASIBILITY REPORTS

When to use a Feasibility Study?

The purpose of a Feasibility Study is to identify the likelihood of one or more solutions meeting
the stated business requirements. In other words, if you are unsure whether your solution will
deliver the outcome you want, then a Project Feasibility Study will help gain that clarity. During
the Feasibility Study, a variety of 'assessment' methods are undertaken. The outcome of the
Feasibility Study is a confirmed solution for implementation
A Project Feasibility Study is an exercise that involves documenting each of the potential
solutions to a particular business problem or opportunity. Feasibility Studies can be undertaken
by any type of business, project or team and they are a critical part of the Project Life Cycle.
At this stage the clients business needs are analyzed, information about project participants is

collected, and the requirements for the system are gathered and analyzed. The clients
expectations for system implementation are studied and the proposed solution is offered. During
the Feasibility Study stage, the projects goals, parameters and restraints are agreed upon with
the client including:

Project budget and rules for its adjustment;

Project time frame;

Conceptual problem solution.

The following tasks are performed at this stage:

The project feasibility is estimated and the project scope is defined;

Risks and benefits are identified;

The project structure is elaborated;

The project is roughly planned;

The next project stage is planned precisely;

Cost of the next phase is evaluated precisely and cost of the other phases
approximately;

Functionality development priorities are defined;

System creation risks are estimated.

At the end of this phase the following documents are available:

Feasibility Report description of the proposed solution and list of high-level

functional requirements;

Project Structure> description of the project organization;

Project Plan project schedule;

Risks List list of potential project risks and possibilities of their elimination.

Feasibility studies address things like location, raw material availability, connectivity,
availability of natural resources, like water etc. They provide in-depth details about the business

to determine if and how it can succeed, and serve as a valuable tool for developing a winning
business plan.
The information we gather and present in your feasibility study will help you:

List in detail all the things you need to make the business work;

Identify logistical and other business-related problems and solutions;

Serve as a solid foundation for developing your business plan.

Feasibility study will help to find a cost-effective way to set up the plant. This is especially
important when operating cost plays the dominant role for survival.
The Components of a Feasibility Study:

Description of the Business: The product or services to be offered and how they will be
delivered.

Market Feasibility: Includes a description of the industry, current market, anticipated

future market potential, competition, sales projections, potential buyers, etc.

Technical Feasibility: Technology selection, Raw material availability, Grid

connectivity, Water availability, Road and rail connectivity etc.

Financial Feasibility: Projects how much start-up capital is needed, sources of capital,
returns on investment, etc.

Market Feasibility
The client's business needs are analyzed, information about project participants is collected, and
the requirements for the system are gathered and analyzed. The client's expectations for system
implementation are studied and the proposed solution is offered. During the Feasibility Study
stage, the project's goals, parameters and restraints are agreed upon with the client including:

Project budget and rules for its adjustment;

Project time frame;

Conceptual problem solution.

The following tasks are performed at this stage:

The project feasibility is estimated and the project scope is defined;

Risks and benefits are identified;
The project structure is elaborated;
The project is roughly planned;
The next project stage is planned precisely;
Cost of the next phase is evaluated precisely and cost of the other phases approximately;
Functionality development priorities are defined;
System creation risks are estimated.

Technical Feasibility
Technology selection, Raw material availability, Grid connectivity, Water availability, Road and
rail connectivity etc.
Feasibility studies address things like location, raw material availability, connectivity,
availability of natural resources, like water etc. They provide in-depth details about the business
to determine if and how it can succeed, and serve as a valuable tool for developing a winning
business plan. Feasibility study will help to find a cost-effective way to set up the plant. This is
especially important when operating cost plays the dominant role for survival.
The information we gather and present in your feasibility study will help you:

List in detail all the things you need to make the business work;
Identify logistical and other business-related problems and solutions;
Serve as a solid foundation for developing your business plan.