SOURCING & COSTING OF

APPAREL PRODUCTS
ASSIGNMENT 1

Submitted by
Sulogna Sikidar
(BFT/20/583)
COSTING
Costing is a type of accounting that works to assess an organization's total cost
of production by looking at both variable and fixed costs during each step of
production. This type of accounting data is calculated internally but is not
shared externally. Companies use costing information to make informed
business decisions and ensure each area of production is financially effective
and efficient. There are no set standards that cost accounting must meet, and it
has more flexibility in comparison to other types of accounting.

Types of Costing
VARIABLE COSTING
Variable costing or Direct costing is a costing method that includes only
variable manufacturing costs — direct materials, direct labour, and variable
manufacturing overhead in the cost of a unit of product. Variable costing is also
referred to as direct costing. Under variable costing, only those costs of
production that vary directly with output are treated as product costs. Fixed
manufacturing overhead is not treated as product cost under this method.
Formula
Cost of production = Direct Materials + Direct labour + Direct Expense +
Variable Factory Overhead

Advantages Disadvantages
Operations planning Inaccurate cost

Cost-volume-profit analysis Long term pricing

Product pricing Undervaluation of inventory

Management decisions External reporting and tax reporting

Management control

Cost control

Change in profit
Example
IFC is a manufacturer of phone cases. Below are excerpts from the company’s
income statement for its year-end (2018):
Labour $75,000.00
Materials $150,000.00
Insurance $50,000.00
Equipment $100,000.00
Building $123,000.00
Utilities (fixed) $20,000.00
Utilities (variable) $80,000.00

IFC does not report an opening inventory.  During 2018, the company
manufactured 1,000,000 phone cases and reported total manufacturing costs of
$598,000 (around $0.60 per phone case).

The manufacturer recently received a special order for 1,000,000 phone cases at
a total price of $400,000. Despite having ample capacity, the manager is
reluctant to accept this special order because it is below the cost of $598,000 to
manufacture the initial 1,000,000 phone cases as outlined in the company’s
income statement. The company’s cost accountant wants to determine whether
the company should accept this order.

First, it is important to know that $598,000 in manufacturing costs to produce

1,000,000 phone cases includes fixed costs such as insurance, equipment,
building, and utilities. Therefore, one should use variable costing when
determining whether to accept this special order.

Variable costing:

 Direct material of $150,000

 Direct labour of $75,000
 Variable manufacturing overhead of $80,000

Total = $305,000 / 1,000,000 units produced = $0.305 variable cost per case
Cost to produce special order of 1,000,000 phone cases = $0.305 x 1,000,000 =
$305,000. Therefore, there is a contribution margin of $400,000 – $305,000 =
$95,000.

Based on the variable costing method, the special order should be accepted. The
special order will add $95,000 of profits to the company.

ABSORPTION COSTING
Absorption costing is one approach that is used for the valuation of inventory or
calculation of the cost of the product in the company where all the expenses
incurred by the company are taken into consideration, i.e., it includes all the
direct and indirect expenses incurred by the company during the specific period.
It includes anything that is a direct cost in producing a good in its cost base.
Absorption costing also includes fixed overhead charges as part of the product
costs. Some of the costs associated with manufacturing a product include
wages for employees physically working on the product, the raw materials used
in producing the product, and all of the overhead costs (such as all utility costs)
used in production. In contrast to the variable costing method, every expense is
allocated to manufactured products, whether or not they are sold by the end of
the period. Absorption costing means that ending inventory on the balance
sheet is higher, while expenses on the income statement are lower.
Formula
Absorption cost formula = (Direct labour cost + Direct material cost + Variable
manufacturing overhead cost + Fixed manufacturing overhead) / No. of units
produced.
Advantages of absorption costing
 Provides a more complete picture of the total cost of a product by
including both direct and indirect costs.

 Helps in determining the total actual cost of goods sold and the cost of
inventory on the balance sheet.

 Allows a company to understand the full cost of each product or service

it provides.

Disadvantages of absorption costing

  May not accurately reflect the incremental costs associated with
producing an additional unit of a product, as it includes fixed overhead
costs that do not vary with production volume.

 Can lead to distorted cost data if there are significant changes in

production volume.

 May not provide as much information for management decision-making

as variable costing.

Example

Assume a company named JTP is known for creating widgets. It produced

10,000 widgets in January, of which 8,000 were sold by the end of the month,
leaving 2,000 in inventory. Suppose each widget requires $5 in labour and
materials directly related to the item. Furthermore, the production facility has
fixed overhead costs of $20,000 per month. In that case, JTP will add $2 to each
widget under the absorption costing method to cover fixed overhead costs
($20,000 total ÷ 10,000 widgets produced in the month).

Absorption costs will become $7 per unit ($5 for labour and materials plus $2
for fixed overhead costs). Due to the sale of 8,000 widgets, the total cost of
goods sold is $56,000 ($7 total cost per unit of 8,000 widgets sold). Thus, the
remaining inventory will be worth $14,000 in the form of widgets ($7 total cost
per unit for 2,000 widgets).

STANDARD COST
Standard cost is an estimated cost determined by the company for the
production of the goods and services or operating under normal circumstances
and is derived by the company from the historical analysis of the data or from
the time and the motion studies. Such costs pre-determined by the company are
used as the target cost by the company for comparing it with actual costs, and
the difference will be the variance. The variance derived is then used by the
company’s management for knowing and correcting the cause, making a further
estimation for the coming years, and decision making related to business. It
almost always varies from the actual costs because the situation keeps changing,
involving different unpredictable factors. Therefore, it is also known as the
normal cost.

This method lets companies know the production cost for a certain number of
items. The main goal of standard costing is to simplify the process of assigning
costs and identify areas where more resources are needed. It also helps in
analysing the profitability of different product lines, and in some cases, the
management can use standard costing as a pricing tool.

Formula

Standard Cost = Material Cost + Direct Labour + Manufacturing Overhead 

Where,

Material Cost = Total Number of Units × Market Price Per Unit

Direct Labour = Employee Hourly Rate × Number of Hours Worked × Total

Number of Units

Manufacturing Overhead = Fixed Overhead (Variable Manufacturing Overhead

× Total Number of Units)

Advantages
Simplifies inventory costing
Makes it easy to fix the selling price
of the product
Efficient management of financial
records
Setting production benchmark
Disadvantages
Not applicable with cost plus
contracts
Can lead to incorrect measures
Not suitable for fast paced
environments with regular price
fluctuation
Offers slow feedback
Does not offer information on each
unit

Example

There is a company manufacturing watches. At the beginning of the year, the

company calculated the cost of the production of the watches by considering the
past trends and the expected future conditions of the market. In the coming year,
the company will likely produce 5,000 units of watches.

Also, it is expected that the standard direct material cost per unit will be $100,
the standard labour cost per hour will be $ 20, the standard variable overhead
cost is $15 per hour, and the standard fixed cost is $100,000. Therefore, the total
hours required for producing one unit is 10 hours. Find the standard cost of the
company.
  Expected No of Production: 5,000
 Standard Direct Material Cost Per Unit: $100
 Standard Labour Material Cost Per Unit: $20
 Standard Variable Overhead Cost: $15
 Expected Total hours per unit: 10

Standard Fixed Cost: $100,000

Total cost = direct material + direct labour+ variable overhead cost = $450

The total standard cost

The total standard cost = direct material + direct labour+ variable

overhead cost + fixed cost = $2,350,000

ACTIVITY BASED COSTING

Activity-based costing, also known as ABC, is a method to determine the total
costs associated with creating a product. ABC assigns costs to activities
associated with each step of the manufacturing process, such as employees
testing a product. Unlike other methods—such as the cost of goods sold
(COGS)—activity-based costing takes a comprehensive look at the cost of
manufacturing a product, including indirect expenses like overhead.
ABC helps managers make informed manufacturing and pricing strategies and
determine activities that cause production costs to increase. This cost provides
managers and teams with an accurate overview of the production cost
associated with a single item. It helps managers determine which items or
products they might want to keep producing. Using the ABC accounting
method, a company can perform an activity assessment to identify and
understand the cost drivers rather than assigning costs to generic
measurements. This provides an accurate idea of profitability and the actual
cost of production.
Formula
Activity-Based Costing Formula = Cost Pool in Total / Cost Driver

Advantages Disadvantages
Evaluates the efficiency of Requires lengthy installation time
productions
Gives accurate data for profit margins Requires more resources to gather
data
Provides insight into the distribution Provides less accuracy
cost
Gives details about facility costs Requires additional data
Helps in creating a budget Makes it challenging for smaller
companies to use
Helps in product pricing Collects data only once
Provides benefits in industries where
other methods do not work

Example
NewSerum Cosmetics is considering changing the cost of two products on the
market, their lip serum and their mascara, causing them to switch from their
current method of cost to a new system that allows their products to be sold at a
competitive market price. Their accounting team uses an ABC system, and
divide the actions associated with these changes into two primary costing
pools: purchasing and assembling. For each of these pools, they determine
unique cost drivers. For the purchasing cost pool, the cost driver is the amount
of purchase orders, which they predict to be 500 orders, and their estimated
overhead is $200,000. The ABC formula for the purchasing cost pool is:
Activity-based costing = 200,000 / 500
ABC = $400
Then, they identify that the cost driver for the assembling cost pool is the
number of assembly hours, which they predict to be a total of 100 hours and
they delegated this pool an overhead cost of $100,000. The ABC formula for
the assembling cost pool is:
Activity-based costing = 100,000 / 100
ABC = $1,000
This means that the total ABC for this new costing system is $1,400.

REFERENCES
 Variable Costing: Definition, Features, Advantages, Disadvantages
(iedunote.com)
 Variable Costing - Overview, Examples, and Accounting Formulas
(corporatefinanceinstitute.com)
 Absorption Costing Explained, With Pros and Cons and Example
(investopedia.com)
 Standard Cost (Definition, Examples) | What is Included?
(wallstreetmojo.com)
 Standard Costing in Accounting | Typer, Formula and Advantages
(khatabook.com)
 Activity Based Costing (Definition) | Formula & Examples
(wallstreetmojo.com)
 How to Calculate Activity-Based Costing (With Examples) | Indeed.com