Cost Accounting
Accounting & Bookkeeping

Cost Accounting – Types and Methods

8 Mins read

Cost accounting is one area of accounting with a speciality in the recording, analysis, and control of costs of products manufactured and services offered. This field is concerned with the systematic collection, classification, evaluation and analysis of cost data to allow management to make effective budgeting, cost control and pricing decisions. Although financial accounting gives a summary view of any company’s current financial status, cost accounting delves into the details of an organisation and provides more detailed cost information to enable efficient allocation of resources, thereby increasing operating efficiency.

Types of Cost Accounting

Cost accounting encompasses a variety of techniques and approaches to recording, classifying, evaluating and controlling costs. There are different sectors and business operations that require costing methods tailored to their specific processes and production characteristics. The variety of cost accounting techniques is designed to meet the unique cost analysis needs of different industries and organisational frameworks. Whether one uses Job Costing for custom orders, Process Costing for continuous production, or Activity Costing to distribute overhead accurately, each can be helpful in cost management, pricing strategies and profitability. The appropriate selection of a cost accounting system is what can enable an organisation to improve efficiency, control costs, and make intelligent financial decisions in order to drive sustainable growth and competitive advantage.

1. Job Costing

Job costing is the process of charging costs to specific jobs, projects or lots. It is relevant where the product or service is tailored or produced according to customer orders. Direct materials, labor and overheads of the job are some of the cost elements. Such industries use this method of cost allocation, which includes construction, printing, shipbuilding and custom manufacturing. For example, a printing company would determine the cost of producing a personalised brochure by adding up the cost of materials, labour hours and machine use specifically associated with that particular order.

2. Process Costing

Process costing is used when products go through multiple stages or processes one after the other. It pools the costs incurred at each stage over a specified period of time and then distributes those costs over all units produced. The major cost items are direct materials, labor and overhead that are related to the process. This method is typically used in industries such as chemicals, textiles, food processing and cement manufacturing. For example, in a paint-making plant, a cost is measured at every stage, which includes mixing and filling, and this is averaged against the number of litres.

3. Batch Costing

Batch costing is also similar to job costing but occurs when products are manufactured in lots rather than units. To establish the cost per unit, the total costs incurred with the batch need to be divided by the units produced. The cost elements involve materials, labour and overheads directly attributable to the batch. The method is most commonly used in industries that produce pharmaceuticals, textiles and electrical manufactured goods. A bakery, for instance, would bake 1,000 cupcakes in one batch and then total up the entire cost of the cupcakes and divide by 1,000 to determine the cost of a single cupcake.

4. Contract Costs

Contract costing is applied for long-term contracts, considering each contract as a separate cost centre. In this method, all the costs incurred for a particular contract are captured. This method is most commonly used in industries where project management is involved on a large scale. The cost elements involve materials, labour, equipment and overheads that are directly associated with the contract. It is most commonly used in the construction, infrastructure development and shipbuilding industries. For example, in building a bridge, a construction company will expense all the direct costs of its contract, like materials, labour and costs for subcontractors.

5. Operating Costs (Service Costing)

Service businesses use operating costing to identify costs related to the provision of services rather than physical products. Costs are evaluated per service unit, such as per kilometre, passenger, or room. All these costs consist of fixed as well as variable service-related cost components. This approach is widely used in industries like transport, hospitality, healthcare and utilities. For instance, the distance per kilometre cost for each passenger travelling by bus for a given transportation company is determined after absorbing fuel, wages of drivers and maintenance.

6. Activity Based Costing (ABC)

Activity Based Costing is a method that assigns overhead costs based on the activities that generate those costs. It moves away from the traditional volume-based methods. This method provides more accurate cost information because indirect costs are linked to specific items or services. The components of costs in this method include factors specific to each activity. ABC is particularly relevant in complex industrial sectors, information technology, and service industries. For example, a manufacturing company spreads the costs of machine maintenance over the products based on the actual machine hours used by each production line.

7. Marginal Costing

Marginal costing emphasises the variable expenses associated with production. Fixed costs are treated as period costs and are not assigned to individual units. This approach aids in making informed decisions regarding pricing, product assortment and cost management. The cost elements consist solely of variable costs, including direct materials, labour and overheads. Its application is prevalent in short-term decision-making within the manufacturing and service sectors. For example, a firm may decide to sell goods at a lower price during low seasons if the selling price is higher than the marginal cost, thereby helping recover fixed costs.

8. Standard Costing

Standard costing involves setting predetermined costs for products and services, which are then compared to actual costs to determine variances. This is useful for budgeting, cost management and performance evaluation. The cost components include the normal costs of products, labour and overheads. It is majorly applied in mass production sectors. In other words, for instance, when the actual cost of a chair produced is ₹1,100 instead of ₹1,000, then the company would trace the variance for its optimal operating efficiency.

9. Absorption Costing or Complete Costing

Cost of production and absorption of all costs, that is, both fixed and variable, are absorbed by the units produced. All manufacturing expenses are absorbed by the units produced, thus ensuring a comprehensive cost recovery. The cost components include direct costs as well as any fixed and variable overheads. It applies especially in the valuation of inventory within the manufacturing industries. A furniture manufacturer absorbs the costs of materials, labour, factory rent and depreciation into the total cost of each table produced.

10. Uniform Costing

Uniform cost considers the adoption of uniform costing in the various organisations in the industry. This gives an opportunity for thorough cost comparisons and benchmarking within the whole industry. The standardised cost factors used by a firm are applicable in this kind of costing method. It can be highly adopted in industries involving the same cost structures, say cement and textile industries.

11. Target Costs

Target cost is a cost-plus pricing approach that starts with the market price and subtracts the desired profit margin to obtain the acceptable cost of production. This method is used to create cost-effective products that meet market demand. The cost elements are determined based on market-based cost determination. This approach is often used in the electronics, automotive, and consumer goods industries.

12. Kaizen Costing

Kaizen costing emphasises incremental cost reduction on an ongoing basis throughout the entire lifecycle of a product. More specifically, its focus is the manufacturing stage of the product life cycle. This strategy encourages employee suggestions for reducing costs. The elements of costs revolve around production cost improvement through continuous enhancement. This approach applies to the following industries: automobile, electronics and lean manufacturing. For example, an automotive company could put into practice an employee suggestion regarding material waste elimination, and with time, that would gradually result in a decline in cost.

Methods of Cost Accounting

Cost accounting uses various methods to determine and control costs that are suitable for the organisation’s characteristics, the method of production used and the objectives of management. Each technique serves a different purpose and applies to many types of industries.

1. Job Costing

Job costing is used when the products or services are manufactured or delivered on specific customer orders. Every project or order is a separate cost center and expenses are separately tracked. The cost elements include direct materials, labor and overheads unique to the job. This technique is used widely in construction, printing, shipbuilding, interior design and custom manufacturing.

2. Process Costing

Process costing is used in businesses that have a continuous production system where products go through several stages or processes. Costs are aggregated for each stage over a given period and then distributed to all units produced. The cost elements are gathered at every stage of production. This method is prevalent in chemical manufacturing, textiles, food processing, cement and oil refining businesses.

3. Batch Costing

One variety of job costing is batch costing whereby products are always produced in large batches rather than as a singular unit. Using the total batch cost and number of units to determine the actual cost per unit, the cost is made up of both direct cost and indirect that are assigned toward the batch itself. This costing variant is utilised in sectors such as pharmaceuticals, textiles, electronics and toys.

4. Cost of Contract

Contract cost is used for big, long-range construction and engineering projects. For each contract, it treats all the expenses like a separate cost center and tracks all expenses on the life of the project. The costs include direct material, labor, sub-contract and special types of overhead costs. Such fields are construction, infrastructure, shipbuilding and engineering.

5. Cost of Operations (Cost of Service)

Operating costs are relevant for service-based organisations to determine the costs of delivering services. This method measures the cost per service unit, for example, kilometres covered, passengers carried, or accommodation offered. The cost elements involve fixed and variable costs. Examples of industries using this technique include transportation, hospitality, health care, and utilities.

6. Unit Costing (Single or Output-Based)

This technique of costing is utilised when identical units are mass-produced. In determining the cost per unit, production costs incurred overall are divided by the number of units produced altogether. Cost components include direct as well as indirect costs, and these costs should be spread homogeneously on each of the units produced. Common uses of this type of costing in industries include cement, brick, paper and steel productions.

7. Multi-Costing or Composite Costing

Multiple costing combines two or more costing techniques to determine the total cost of complex products that have several components and processes. The cost elements include task, process and batch pricing. Industries that commonly use this method include automobile manufacturing, aircraft production and electronics.

8. Marginal Costing

Under this approach, only the variable costs are considered, which are nothing but direct expenses incurred in product costing, whereas the fixed costs are considered period costs and are not charged to specific products. The approach is widely used for short-term decisions. The cost items include direct materials, direct labour and variable overheads. It is highly relevant for pricing strategy in both industries that manufacture and service sectors.

9. Absorption Costing (Complete Costing)

Absorption costing covers all production costs, direct and indirect; it is a procedure for determining cost prices. Since the entire amount of manufacturing expenses is absorbed by the manufactured units, the cost completely recovered. In the cost, direct cost elements are accompanied by fixed and variable overheads. It is indispensable for the evaluation of inventory costs in manufacturing organisations.

10. Activity-Based Costing (ABC)

Activity-Based Costing (ABC) assigns overhead costs based on the specific activities that incur those costs rather than merely on output volume. This method enhances product costing by linking indirect costs to particular items. The cost components include various activities and their corresponding cost drivers. ABC is applicable in industries such as complex manufacturing, information technology, healthcare and logistics.

11. Standard Costing

Predetermined costs for materials, labor, and overheads are established and compared with actual costs to determine variances. Budgeting and performance assessment are thus facilitated. The standard cost elements apply to all cost factors. It is commonly used in mass production and process-oriented industries.

12. Target Costing

Target Costing is a pricing strategy that starts with an established market price from which the desired profit margin is subtracted to form the allowable manufacturing cost. The degree of this strategy is to reduce costs during the product design stage. Cost components are based on market-driven cost estimates. Industries that commonly use this type include electronics, automotive, and consumer goods.

Conclusion

Different types and techniques of cost accounting provide companies with important tools for cost measurement, cost management and cost reduction. Organisations can effectively enhance their processes for decision-making, optimise the allocation of resources, fine-tune their pricing plans and increase efficiency and profit margin in such a competitive world through the effective selection of their appropriate strategy.

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I am a qualified Company Secretary with a Bachelors in Law as well as Commerce. With my 5 years of experience in Legal & Secretarial. Have a knack for reading, writing and telling stories. I am creative and I love cooking. Travel is my go-to for peace and happiness.
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