Costing Methods and the

Techniques of cost
Cost Analysis & Control

(Costing Methods, Costing Techniques)

This topic will teach you the what are the methods of cost, and what are the costing techniques

Learning Objectives

At the end of this topic, you will be able to:

Understand what are the methods of cost
Develop an understanding of the techniques of cost
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
Methods of Costing

The term ‘methods of costing’ can be used to refer to the different processes or procedures employed for the
determination and presentation of costs.

The principles in every type of costing are the same but the methods of analyzing and presenting the costs differ
with the nature of business. For example, the method of costing employed by a building contractor is different
from that of a transport company.

We can divided the methods of costing into two main heads:- 1. Methods Based on the Principles of Job Costing 2.
Methods Based on the Principles of Process Costing.

Some of the methods which are based on the principles of job costing are:- 1. Job Costing 2. Contract Costing 3.
Batch Costing.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
Some of the methods which are based on the principles of process costing are:- 1. Process Costing 2. Operation
Costing 3. Departmental Costing 4. Single or Unit or Output Costing 5. Operating or Operative or Working or
Service Costing 6. Multiple or Composite Costing.

Additionally, we can identify few other methods of costing:- 1. Uniform Costing 2. Multiple or Composite Costing 3.
Departmental Costing 4. Cost Plus Method 5. Target Costing Method 6. Farm Costing

Job costing and process costing are the two basic methods of costing. Job costing is suitable for industries which
are doing the work according to the specifications of the customers. Process costing is suitable to industries where
production is continuous and the units produced are also identical. All the other methods are simply combinations,
extensions or improvements of these basic methods.

Now, we will explain all of these in further details in the coming slides
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
1. Job Costing: This method is also specific order costing. When the production is not highly repetitive and there
are distinct jobs or lots so that the material and labor costs can be identified by job number, then we use the
system of job costing. There is no standard product and each job or work order is different from the others. The
jobs are done strictly according to the specifications given by the customer and normally the job takes only a
short time for completion. The purpose of job costing is to ascertain the cost of each job separately. In all these
cases, an account is opened for each job and all the expenditure applicable is charged to that account. This
method of costing is used by commercial foundries, printing presses, motor repair shops, etc.

2. Contract Costing: This method is also known as terminal costing. Concept-wise job costing & this method are
similar in nature, the difference being that contract costing is used for big contracts while job costing is for
smaller contracts. So, we can say that contract is a big job while a job is a small contract. This method is used
where the job is big and spread over a long period of time. The work is done according to the specifications of
the customers. This method is used by firms engaged in ship building, construction of buildings, bridges, dams
and roads.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
3. Cost plus Costing: In certain contracts, we add a markup on the cost of goods and services to arrive at a selling
price. Under this approach, we add together the direct material cost, direct labor cost, and overhead costs for a
product, and add to it a markup percentage in order to derive the price of the product. Cost plus pricing can
also be used within a customer contract, where the customer reimburses the seller for all costs incurred and
also pays a negotiated profit in addition to the costs incurred. This system is generally used in cases where
Government happens to be the contractor.

4. Batch Costing: Batch costing is an extension of job costing. A batch means a group of identical products. All the
units in a particular batch will be uniform in nature and size. Hence, each batch is treated as a cost unit and the
costing is done separately. The total cost of a batch is calculated and it is divided by the number of units in the
batch to determine the cost per unit. Main industries where batch costing is done are manufacturers of
biscuits, ready-made garments, spare parts, medicines etc.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
5. Process Costing: This is also called continuous costing. In certain industries, the raw material passes through
many different processes before the final product comes into existence. So, the finished product of one process
becomes the raw material for the subsequent process. Each process gives an output that is a finished product
in itself and can be sold. That is the reason that process costing is used to ascertain the cost of each stage of
production. Process costing is used in such industries.

We open a separate account is opened for each process to find out the total cost as well as cost per unit at the
end of each process. We apply process costing to continuous process industries such as chemicals, textiles,
paper, soap, lather etc.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Key Differences between Job & Process costing
Basis For Comparison Job Costing Process Costing
Meaning Job costing is the calculation of cost of a Process Costing is a costing method, in
special contract, work order where work which the costs which are charged to
has been performed as per client's or various processes and operations are
customer's instructions. ascertained.
Nature Customized production Standardized production
Assignment of cost Calculate cost of each job. First cost is determined for the process,
then spread over the produced units.
Cost Center Job Process
Scope of cost reduction Less High
Transfer of Cost No Transfer Cost is transferred from one process to
another
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Key Differences between Job & Process costing

Basis For Comparison Job Costing Process Costing
Identity Each job is different from another. Products are manufactured consecutively
and so they lose their identity.
Cost Ascertainment Completion of the job. End of the cost period.
Industry type Job costing is suitable for the industries Process costing is perfect for the industry
which manufactures products as per where mass production is done.
customer's order
Losses Losses are usually not segregated. Normal losses are carefully ascertained
and abnormal losses are bifurcated over
all processes.
Work-in-progress WIP may or may not exist at the beginning WIP will always be present in the
(WIP) or at the end of the financial year. beginning or at the end of the accounting
period.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
6. Unit Costing: This method is also called as single or output costing. It is more useful in industries where
production is continuous and the units are identical or two or three types of similar products with variation
only in size, shape or quality. By this method, we ascertain the total cost as well as the cost per unit. We
prepare a cost sheet by taking into account the cost of material, labour and overheads. Unit costing is used in
mines, oil drilling units, cement manufacturing units, and units manufacturing cycles, radios, washing machines
etc.

7. Operating Costing: This method is followed by service industries. Operating costing is adopted by airways,
railways, road transport companies, hotels, cinema halls, power houses etc. There is usually a compound unit
in such undertakings, e.g., tonne-kilometre (transport undertaking), kilowatt-hour (power supply) and patient
day (hospitals). For example a transport company is interested in knowing the cost of carrying one ton of goods
per kilometer.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
8. Operation Costing: This is a more refinement and more detailed application of process costing. It involves
costing by every operation instead of a process. This method is used where there is mass production of
repetitive nature involving a number of operations. The main purpose of this method is to get to know the cost
of each operation.

For instance, the manufacture of handles for bicycles involves a number of operations such as cutting steel
sheets into proper strips, moulding, machining and finally polishing. The cost of these operations can be found
out separately. Operation costing provides the management a minute analysis of costs to achieve accuracy and
it is applied in industries such as spare parts, toy making and engineering.

9. Multiple Costing (Composite Costing): This method refers to a combination of two or more of the above
methods of costing. In this method, the costs of different sections of production are combined after finding out
the cost of each and every part manufactured.

It is adopted in industries where several parts are produced separately and assembled to a single product. This
method is suitable for industries engaged in manufacturing and/or assembling of televisions, motor cars,
electronic gadgets, etc.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing

10. Departmental Costing: This system is applicable where the cost of a department or a cost centre is required to
be calculated. This method is similar to operating costing. This system is used where the factory is divided into
distinct departments and it is necessary to get the cost of production of each department rather than the cost
of each article produced.

Under this method, the cost of operating each department is found by allocating the total expenses incurred by
a concern to various departments, and the cost per unit of product produced in each department is
ascertained by dividing the total cost of the department by the number of units produced in that department.
This method is adopted by factories producing hosiery goods, cosmetics, footwear, etc.

11. Target Costing: In big businesses, the cost price of the work is ascertained by experts and other experienced
persons well in advance or even before the commencement of the work. At the time of production, the
organization always keeps in mind the ultimate goal. That is why this system is called ‘Target Costing Method’.
This system is mostly used in big contracts.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing

Target costing is not just a method of costing, but rather a management technique wherein prices are
determined by market conditions, taking into account several factors, such as homogeneous products, level of
competition, no/low switching costs for the end customer, etc. When these factors come into the picture,
management wants to control the costs, as they have little or no control over the selling price.

CIMA defines target cost as “a product cost estimate derived from a competitive market price.”

In industries such as FMCG (Fast Moving Consumer Goods), construction, healthcare, and energy, competition
is so intense that prices are determined by supply and demand in the market. Producers can’t effectively
control selling prices. They can only control, to some extent, their costs, so management’s focus is on
influencing every component of product, service, or operational costs.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing

12. Farm Costing: In this method of costing, we calculate the total cost and per unit cost of various activities
covered under farming. Farming activities cover agriculture, horticulture, animal husbandry, poultry farming,
dairy farming, etc.

Farm costing helps in improving the farming practices to reduce the cost of production, it helps ascertain the
profit for each line of farming activity which helps for better control by management and to obtain loans from
banks and other financial institutions as they give loans on the basis of proper cost accounting records.

The individual farmers also use this information for making decision on crop or other enterprises for planning
and budgeting of the farm as a whole. On the basis of cost and the probable returns they decide whether to
continue with or drop that particular enterprise or increase the acreage under the same.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
Techniques of Costing

Apart from the above methods of costing, there are also many costing techniques which the management uses to
control costs and making important managerial decisions. These are not independent methods of cost finding like
job or process costing but are costing techniques which can be used with advantage with any of the methods
discussed in the previous slides

1. Marginal Costing: Marginal Costing (also known as Variable Costing) is “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”. All costs are segregated into fixed costs and variable costs.

Fixed costs are the costs which tend to remain fixed or constant in total with changes in the volume of output.
Examples of fixed costs are rental payments, salaries, insurance, interest expenses, etc.

Variable costs refer to costs which tend to vary or change in total directly in proportion to changes in the
volume of output. Examples of Variable costs are the cost of raw material, labor wages, etc.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
Characteristics of Marginal Costing

Classification
into fixed
cost and
variable cost

Determination
of price Characteristics of Valuation
marginal costing of stock

Profitability
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
• Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of variability into fixed cost
and variable costs. In the same way, we separate semi variable cost.

• Valuation of Stock: While valuing the finished goods and work in progress, we take only variable cost into
account. However, for valuing the inventory, the variable selling and distribution overheads are not
included.

• Determination of Price: The prices are determined on the basis of marginal cost and marginal contribution.

• Profitability: The ascertainment of departmental and product’s profitability is based on the contribution
margin.

In addition to the above characteristics, marginal costing system brings together the techniques of cost
recording and reporting.

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.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
2. 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 is
different from marginal costing as some fixed costs could be considered to be direct costs in some
circumstances. The direct costing concept is extremely useful for short-term decisions, but can lead to harmful
results if it is used for long-term decision making, as it does not include all costs that may apply to a longer-
term decision. In brief, direct costing is simply put the analysis of incremental costs. Few examples of the usage
of this method are:

(i) Automation investments. A common scenario is for a company to invest in automated production equipment
in order to reduce the direct labor costs. Under direct costing, we will collect the incremental labor cost of any
employees who will be terminated, and the new period costs which will be incurred as part of the equipment
purchase, such as depreciation on the equipment and maintenance costs.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Methods and Techniques of Costing
(ii) Customer profitability. An organization might have few customers that require a great deal of support, but
they place large orders that a company will earn a considerable profit from the relationship. If there are such
resource-intensive situations, then the organization should occasionally calculate how much money the
company really earns from each customer. If this analysis is done, then the company might get to know that it
would be better off eliminating some of its customers, even if this results in a noticeable revenue decline.

(iii) Outsourcing. The organization can decide whether to manufacture an item in-house or maintain a
capability in-house, or whether to outsource it. If the decision involves whether to manufacture in-house or
elsewhere, it becomes crucial to determine how many staff and which machines will actually be eliminated; in
many cases, these resources will be simply shifted elsewhere within the company, so there is no net profit
improvement by shifting production to a supplier. However, it can also be that by shifting these employees, the
efficiency of some other department/process is improved, so the organization will gain by outsourcing.

Direct costing is an excellent analysis tool. It is almost always used to create a model to answer a question
about what actions the management should take. But, it is not a costing methodology for constructing financial
statements – in fact, accounting standards specifically exclude direct costing from financial statement
reporting.
Cost Analysis & Control

(Costing Methods, Costing Techniques)

Summary

In this topic, you learnt:

Understood what are the methods of cost

Developed an understanding of the techniques of cost