James Hope University

Business School

Managerial Accounting
EMBA 812/ACCT 821

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 TOPIC:

Costing Systems

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COSTING SYSTEM
Some costs are direct while others are
indirect, direct costs can be identified to
a specific products but indirect costs
which are not identifiable to specific
products, need to be allocated on some
objective and rational basis for product
costing and pricing which can be
justifiable to customers.

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 Costing systems are the systematic
allocation of cost to products. It can
be used for planning, decision
making and control purpose as well.

 Budgeted figures are used for

costing of products as actual prices
are not known at time when prices
are decided.
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TYPES OF COSTING
JOB COSTING
Job costing is a costing method used
to determine the cost of specific jobs,
which are performed according to the
customer’s specifications.

It is a basic costing method which is

applicable where work consists of
separate projects or contract jobs.
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 Types of businesses that use job
costing system
 Generally, the application of job
costing method is followed in
industries such as printing press,
automobile garage, repair
workshops, shipbuilding, foundry,
and other similar manufacturing
units, which manufactures
according to customer’s specific
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 Advantages of job costing
 Profitability for each job can be
individually determined
 It provides a detailed cost analysis
of materials, labour and overheads
for each job as and when required
 The efficiency of the plant can be
controlled by confining attention to
costs relating to individual jobs.
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 Helps in preparation of estimates
 Comparison of actual cost with
estimated cost and calculation of
variances.
 Helps in identifying unprofitable
jobs
 Helps in providing a precise
quotation for a product

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 Documents used in job costing
 Manufacturing or production order:
This document authorizes the
manufacturing or production
department to produce a specified
quantity of a product which
constitutes the job.
 Cost sheet: In job costing, a cost
sheet is often used to record costs
incurred in stages of production. 9
 The cost sheet and job order work
may also be combined, when costs
are recorded on the production
order document.

 Other documents: The other

documents such as material
requisition slips, tools and spares
order, time tickets, inspection order
etc., are used by the dispatching
department as a control mechanism 10
 PROCESS COSTING
 Process costing refers to a cost
accounting method that is used for
assigning production costs to mass-
produced goods.

 For instance, large manufacturing

companies that mass-produce
inventory might use process costing
to calculate the total amount of
direct and indirect costs associated
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 With process costing, companies
determine item cost by tracking the
cost of each stage in the production
process, instead of tracking costs
for each individual item.

 After adding up the cost of all the

steps in the process, they divide the
total cost by the number of items.
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 This is called the cost per unit. For
example, a paper company might
track the cost of each stage in the
process of turning wood pulp into
reams of paper, then divide the
total cost by the number of reams
to get the cost per ream.

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 Importance of Process Costing
 Process costing is particularly
important in the oil, chemical,
lumber, textile and food processing
industries.

 Getting a handle on production

costs enables these companies to set
the right prices for their products
and determine whether costs are
tracking in line with projections. 14
 Examples of Process Cost Accounting
 Process cost accounting is used in
circumstances where the units of
product are homogenous. Take a look
at a few examples of how it works in
these fictional companies. (The
companies are not real.)
 Bubblez’n’More is a seltzer bottling
company specializing in unique
flavors. The sodas pass through
several production departments. 15
 During the current month, the filling
department accumulates $25,000 of
direct material costs and $50,000 of
conversion costs (consisting of direct
labor and factory overhead). For that
period, the department processes
50,000 bottles.

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 The per unit cost for the filling
department in April is $.50 for direct
materials (direct material costs
divided by unit output for the month)
and $1.00 for conversion costs
(conversion costs divided by unit
output).

 The company performs similar

calculations for the labelling and
packaging departments and finds 17
 Types of process costing
 A company can use several different
methods of process costing to
determine the total costs incurred
before, during and after production,
as well as the total amount of units
produced.

 Standard cost
 Standard cost refers to calculating
costs for production units instead of
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 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

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 Weighted average
 This type of process costing groups
together all the costs associated
with production and assigns them
to the units the company produced.
This type of method may not take
into account the time period of
production and can be the simplest
type of process costing to calculate.

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 First-in, first-out
 This method of process costing focuses
on assigning costs to units in the order
that they are produced. Products that
are produced first are assigned a cost
first, and then, they are the first
products to ship or otherwise put out.
 Furthermore, first-in, first-out assigns
one set of costs to products started in
prior accounting periods but not
finished, and another set of costs for21
 Activity-based costing:
 Activity-based costing is a cost
accounting method, which
apportions specific overheads to
various products produced by the
company.
 It does this by first identifying all the
activities associated with production,
such as product design, setting up
and operating machinery, product 22
 It then computes the costs associated
with these activities and assigns them
to manufactured products.
 The main purpose of activity-based
costing is to allocate specific indirect
costs to products to gain detailed
insights into product costing and
profitability.
 It enables companies to improve their
cost management and pricing
strategies by singling out specific 23
 Activity-based costing: Process
 Activity-based costing involves the
following steps:
 Step 1: Determination of activities:
The first step is to identify all the
activities required for creating a
certain product, including research
and manufacturing facility set-up.

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 Step 2: Split activities into cost
pools/centres: Follow-up activity
identification by tracing costs
associated with each activity and
dividing them into corresponding
cost pools.
 Step 3: Ascribe cost drivers to the
cost centres: The cost driver is the
prime factor affecting an activity's
cost. It is usually in the form of the
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 Step 4: Compute the cost driver
rate: To calculate the cost driver
rate, divide the total activity
overheads by its corresponding total
cost drivers.

 Step 5: Assign costs: Finally, assign

indirect costs to your product. For
this, multiply the cost driver rate by
the number of hours/units/parts of
activities that are involved in making
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 Activity-based costing: Formula
 The formula for activity-based
costing (ABC) is as follows:

 ABC cost driver rate = Total cost

pool overheads / Total cost drivers.

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 Activity-based costing: Example
 ASD company desires to switch over
from absorption costing to ABC
costing and has identified two
distinct activity cost pools:
purchasing pool and assembling
pool.

 It estimates £175,000 overheads for

the ‘purchasing pool’ with the
number of purchase orders
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 Furthermore, the number of
assembly hours (currently at 500) is
the cost driver for the ‘assembling
pool’, with associated indirect costs
of £80,000. Here, ABC costing will
be as follows:

 ABC for purchasing pool =

N175,000/800 = N218.75 ABC for
assembly pool = N80,000/500 = N160
Total ABC for ASD company = 29
 Activity-based costing: Benefits
 There are numerous benefits to
using activity-based costing, which
are:

 Provides accurate and realistic costs:

By separating overheads into various
cost pools, activity-based costing
provides superior insights into cost
drivers and is a better reflection of
the actual costs involved in 30
 Identifies cost-saving areas: By
allocating costs to specific products,
the ABC method flags areas where
costs may be disproportionately high
due to process inefficiencies. Based
on these results, companies can
choose to improve their operations
or discontinue unprofitable
products.

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 Improves pricing decisions: Armed
with a more accurate picture of all
the costs involved in creating a
product, firms can optimise their
pricing methods, vastly improving
their profit margins over the long
term.

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 ACTIVITY BASED COSTING,
LESSONS FROM CHRYSLER.
https://thesystemsthinker.com/abc-
initiating-large-scale-change-at-
chrysler/

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