DEPARMENT OF APPLIED SCIENCES AND BUSINESS STUDIES

COSTING AND ESTIMATION FEBRUARY 2016
DEFINITION OF COSTING
Costing also known as cost accounting can be defined as the determination of an actual cost of a component after
adding different expenses incurred in various departments. It may also be defined as a system which systematically
records all the expenditures to determine the cost of manufactured products.

Costing is the process of calculating how much you have spent to produce a product or offer a service before you
can price that product or service at a profit. It is concerned with the ascertainment and control of costs so as to
provide detailed information for control, planning and decision making.
IMPROTANCE OF COSTING
Knowing your costs enable you to:
 Set your prices in such a way that you make a profit;
 Identify which items are most costly in the running of your business and if it is possible to reduce certain costs;
 Avoid over-pricing yourself out of competition i.e. charging prices which are well above the average market
prices; and
 Avoid underpricing yourself to bankruptcy i.e. charging prices which are well below the unit cost of
production.
To be of use, costing information must be appropriate, relevant, timely, well presented and sufficiently accurate
for the purposes intended.
USES OF COSTING INFORMATION
 Control- the costing system is the key financial control system and monitors the results of all activities and all
other control systems.
 Decision Making- as decision making is concerned with making a choice between alternatives, correctly
presented costing information can be of great value to management in decision making.
 Planning- management is not only concerned with analysis and recording of past costs and activities, but also
with future costs so that appropriate plans and decisions can be made in good time through budgeting.
 Estimating and Pricing- as pricing decisions are complex and many interacting factors need to be considered,
costing information based on past costs and expected future costs needs to be considered in pricing decisions.
METHODS OF COSTING
(a) Process costing.
(b) Job costing.
(c) Batch costing.

(a) Process costing
This method is employed when a standard product is being made which involves a number of distinct processes
performed in a definite sequence. In oil refining, chemical manufacture, paper making, flour milling, and cement
manufacturing etc., this method is used. This method indicates the cost of a product at different stages as it passes
through various processes.

Thus: Prime Cost = Direct materials + Direct labour + Direct expenses INDIRECT COSTS These are all material. labour and expense costs which cannot be identified as direct costs.  Indirect Labour. or attributable to.  Direct Materials. COSTS Cost may be defined as ‘The amount of expenditure (actual or notional) incurred on.  Direct expenses. Others include brand and loyalty expenses. indirect labour and indirect expenses. bought in parts and assemblies incorporated into the finished product. and  Indirect costs. DIRECT COSTS These are costs which can be directly identified with a job.e. maintenance wages.are the raw materials used in a product. Thus. Direct costs comprise direct material costs. etc. plant insurance.  Indirect Materials. ship building. Indirect costs are also known as Overheads. (c) Batch costing Batch costing is a form of job costing. Instead of costing each component separately. batch. consumable materials. bonus) paid to production workers for work directly related to production.’ (Lucey. each batch of components are taken together and treated as a job. depreciation of equipment and machinery. plant or tool hire charges for a particular job or batch. etc.  Indirect Expenses. say a reflector are to be manufactured.are expenses incurred specifically for a particular product. Thus: Cost= Quantity used x Price TYPES OF COST Costs are mainly classified as:  Direct costs. The unit price would be ascertained by dividing the cost by 100. The total of direct costs is known as Prime Cost.include rent and rates for factory/plant and land. batch or service. Indirect costs comprise indirect materials. direct wages or direct labour costs and direct expenses. Thus: Overheads = Indirect materials+ Indirect Labour + Indirect Expenses Therefore. product or service. etc. cost includes two components i. building contracts.includes factory supervision. etc.(b) Job costing or order costing Job costing is concerned with finding the cost of each individual job or contract. 2009) At the simplest level. storeman’s wages. These costs become part of the product or service. spare parts for machinery. if 100 units of a component. for example. maintenance materials. quantity used and price. job. Examples are to be found in general (job order) engineering industries. the framework of cost build-up is as follows: Total Manufacturing Cost = Prime Cost + Overheads .  Direct Wages or Direct Labour Cost.include lubricating oil.is the remuneration (salary. then the costing would be as far a single job. a specified thing or activity.

Many companies that produce product in high volume. output or turnover. then no change over the next (and higher) volume range. COST ESTIMATION Cost estimation may be defined as the process of forecasting the expenses that must be incurred to manufacture a product. Procedure of estimating or method of estimating Estimating involves the following operations 1. then when activity increases still further. Standard costs are highly detailed scientifically determined costs of material labour and overhead chargeable to the product or service. Sunk costs are independent of any event that may occur in the future.e. Preparing abstract of estimate STANDARD COSTING Cost control is one of the important objectives of cost accounting.COSTS-TERMINOLOGY  Sunk cost.  Step cost. The most important reasons are shown below.  Semi-variable cost.  Estimate is also required to control the expenditure during the execution of work. because it has already happened. such as automotive companies.  Standard cost. This cannot be achieved without some standard against which actual can be compared. Temporary work standards are replaced with time studied work standards as rapidly as possible. 2.a cost which remains constant for a range of activity. or services produced in a period and can be determined on a number of bases. When stated on a graph. These expenses take into consideration all expenditures involved in design and manufacturing with all the related service facilities such as pattern making. with no change over a certain volume range. Cost estimates are the joint product of the engineer and the cost accountant. tool making as well as portion of the general administrative and selling costs. Calculating the rate of each unit of work 3.  Estimates as temporary work standards. then a sudden increase. will use estimates on the shop floor as temporary work standards. future costs that a business may face. the cost has to be increased by a significant amount. Estimate decides whether the proposed plan matches the funds available or not.a cost which varies with a measure or level of activity/production.  Fixed cost. step costs appear to be incurred in a stair step pattern.a cost incurred for an accounting period and which within certain output or turnover limits tend to be unaffected by fluctuations in the levels of activity i.  Should the product be produced? When a company designs a new product. REASONS FOR DOING ESTIMATES Cost estimates are developed for a variety of different reasons. A sunk cost differs from other. then another sudden increase. Preparing detailed Estimate. components. An example is rent of factory or plant.a cost that has already been incurred and thus cannot be recovered. such as stock costs or Research & Development expenses.  Variable cost. The same pattern applies in reverse when the volume of activity declines. Standard cost is also defined as a pre- . and so on.a cost containing both fixed and variable components and which is thus partly affected by a change in the level of activity. a detailed estimate of cost is developed to assist management in making an intelligent decision about producing the product.is a planned unit cost of products.

Material quantity standards-specify what kind. their comparison with actual costs and the analysis of variance to their causes and points of incidence. Advantages of Standard Costing: 1. d) Material Standards (Usage) I. 2.They are very much useful in management planning. 6. c) Basic Standards –It is a standard which is established for use for infinite period of time without alternation. Marketing and Accounting towards achieving a common goal.determined cost which is calculated from management’s standards of efficient operation and the relevant necessary expenditure. Labour Usage (efficiency) standards II. Material price standard-Pre-established measure in monetary terms of the price of the material e) Labour Standards I. Standard Costing is defined as the preparation and use of standard costs. . It is an economical means of costing and record keeping 5. II. Standards are predetermined and costs should be carefully predetermined. b) Normal Standards-The average standards. 2. which can be attained during a future period of time preferably one business cycle and standards are set on normal capacity basis. 3. Standard costs are more convenient than actual costs for budget preparations . Labour Cost ( or rate)Standards (price of labour) f) Overhead cost standard Limitations of Standard Costing 1. Establishment of standards co-ordinates all functions-Manufacturing-R & D. It helps for variance analysis and fixation of standardization of incentives Types of Standards a) Ideal (perfect) standards (costs) are the standards which can be attained under the most favorable conditions possible. Helps in formulating price and production policies. It is difficult to select the type of standards which can help in cost control. Helps in cost control and cost reduction 4. Standard cost expresses what costs should be under attainable good performance. what quantity of material should be used to make a product desirable.

The prices you charge are not pushing you out of competition. In pricing its products. iv) Affordability of Target Customers afford Customers will buy only the products they can afford. FACTORS AFFECTING PRICING Therefore. administration and distribution of the product. IMPORTANCE OF PRICING Pricing is important as it ensures that: 1. ii) Competitors’ prices An enterprise must consider competitors’ prices and if possible the competitor’s reaction to the enterprise’s own pricing moves. The prices you charge are able to give your enterprise a profit. The price of anything is its value measured in money. . It is important to note that prices chosen for an enterprise’s various products and services should give it some profit to ensure its sustainability and growth. If demand in declining. The enterprise will set a price that covers all its costs of production. PRICING DEFINITION OF PRICING This is the process of determining how much your products or services will be sold for after carefully calculating the cost of producing them. the enterprise may consider reducing its prices. the enterprise may maintain or increase its prices. iii) Premium can you charge above the competition Where the customer perceives your product as superior to competitors. PRICE A price is an amount (figure) arrived at after adding a profit margin to the unit production cost. 3. The prices you charge reflect the value and quality of your products/services. It is the value of a commodity (product) or service measured in terms of the standard monetary unit. v) Demand for the Product If demand is increasing. when developing a pricing strategy. a number of factors that need considering: i) The cost or break-even price Costs set the floor price that a company can charge. you may charge higher than the competitors by adding a premium to the price. 2. an enterprise must ensure the prices set are affordable to the target market.