Costing is the accumulation, classification, and assignment of direct materials and direct labor, and factory overhead costs to products. The development of a costing system to fit different organizations involves choosing one of the three characteristics related to costing. The cost accumulation method consists of process costing, joint costing and job costing while the cost measurement method is made up of the actual, normal, or standard costing (Blonder et al., 2009). Another characteristic is the overhead assignment method that is made up of volume-based or activity-based costing. The costing method settled on by most firms is based on the type of industry, the service, or the product offered.
Activity-Based Costing
Activity-based costing allows companies to monitor the activity costs during the production of a product or service. It allocates factory overhead costs to products through the cost and effect method by employing several cost drivers. Cost drivers are used for accurate allocation of factory overhead costs to products based on the resources they use during various factory activities (Blonder et al., 2009). The costing system is based on the fact that a firm’s products or services resulting from activities that incur costs. According to Blonder et al. (2009), activity-based costing has three procedures as follows:
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Identify resource costs and activities
An activity analysis is carried out to point out the resource consumption and activities of an organization. The unit-level activity, which is normally volume-based, is carried out for every unit of the firm's product or service. Examples of the primary activities are direct materials, direct labor costs, insertion of components, and inspection (Weygandt, 2017). Batch-level activity is for batches or groups of units of products or services. They include machine set-up, production scheduling, expediting production, placing purchasing orders, and materials handling. Product-level activity supports product-level activities such as designing products, product purchase, and engineering modifications for different products. Facility level activity supports the general operations of the company such as security that do not stem from products or customer service needs.
Assigning resource costs to activities
Activities influence the costs related to production. Therefore, resource consumption cost drivers should be established on the relationship between cause and effect. Labor hours, employees involved in payroll-related activities, batch-related activities set-ups, and the physical space used for general maintenance and cleaning activities are the typical resource consumption costs (Weygandt, 2017). The assignment of the resource costs can be done by direct tracing or by estimation.
Allocation of activity to cost objects
Costs related to activities are allocated to cost objects depending on the suitable cost drivers.
Job Costing
Job costing amasses costs and allocates them to predetermined jobs, projects, customers or contracts. The job costing method is majorly defined by the job cost sheet in electronic form that has a summary of manufacturing costs. It will accompany the fan through the production process as the materials and labor costs are noted down. The overhead is included after production, mostly based on a set amount per hour of labor. In the job costing method, the direct and indirect material costs are accounted for using a materials requisition document which indicates the materials the production department needs to complete a product (Weygandt, 2017). The direct labor costs are noted on the job sheet using a time ticket filled for every employee daily. Indirect labor costs such as salaries and wages for rework labor are under the overhead costs. The overhead costs are calculated against standing order numbers and cost centers (Blonder et al., 2009). The surplus, excess, or incorrect materials are returned to the sellers on material return notes. Scrap and waster that arise during manufacture are taken back similarly. This costing method is appropriate for service industries whose costs can be traced to a specific product, the batch of product, project, customer order, or contract. Job costing is suitable for companies such as construction, printing, and custom furniture industries.
Process Costing
Process costing is appropriate for mass production of homogenous items and manufacturing industries that involve one or more processes. The product system accumulates the costs corresponding to specific processes or departments and allocates them to many nearly identical products (Kelly, n.d.). In this costing system, the cost report is used to track each department's production proportion and cost associated with it. The unit product cost is derived from the division of process costs for every department by the amount of equivalent units produced within a time interval. According to Blonder et al. (2009), process costing has the following procedures:
Analysis of production units’ physical flow
This procedure establishes the number of units available in the beginning, during work in progress and the end of production.
Calculation of manufacturing cost elements equivalent units
This process measures the amount of work employed during production during a particular accounting period.
Determination of manufacturing cost element total costs
The costs are derived from material requisitions, labor time cards, and factory overhead allocation sheets.
Compute manufacturing cost element cost per equivalent unit
Manufacturing costs are computed per equivalent production unit to determine the appropriate costs of products and income expected for an accounting period, including complete and incomplete units.
Assigning units completed total manufacturing costs and ending work in progress
The total costs for each manufacturing element should be equal to the total costs in this step.
Costing Method for Cool Air Inc.
Cool Air Inc. is a manufacturing company that does mass production of fans. The production of fans involves several departments that ensure quality output. The fans are of different models but have almost similar production. I would recommend the use of the process-based costing method in the mass assembly of fans. Using this system, the production system of the fans will have clearly defined cost centers that account for all the material, labor, and overhead costs as the products are transferred from one department to the other. To achieve the production of fans, the output results from the sequence of repetitive operations are identical. The transfer of the products to different departments makes process costing a better alternative as the costs of each stage of manufacture will be ascertained (Kelly, n.d.). Another major feature of process costing that makes it suitable for this project is that the output from one department is the input for another process. In this case, the output from research and development is the input for product design, whose output becomes the input for production scheduling (Kelly, n.d.). The process goes on till the last stage of the final product inspection. The job costing method is not appropriate since the fans cannot be allocated to specific customers or contracts as they are sold in retail. While activity-based costing is used to determine accurate costs, it would be difficult to assign costs to all the activities in the eight departments.
By using product costing, the accounting department will be able to predetermine the overhead costs, ensuring that the costing can be carried out every week. The average cost of production can also be determined by standardization of the production process and price quotations submitted more quickly. The accounting and managerial departments will also have better control of the company’s finances due to the availability of cost reports.
References
Blocher, E., Stout, D., & Cokins, G. (2009). Cost management: A strategic emphasis (5th ed.). McGraw-Hill/Irwin.
Kelly, R. (n.d.). Process Costing [PDF document]. CPA Ireland. https://www.cpaireland.ie/CPAIreland/media/Education-Training/Study%20Support%20Resources/F2%20Management%20Accounting/Relevant%20Articles/f2-mgmt-acc-process-costing-article.pdf
Weygandt, J. J. (2017). Managerial accounting: Tools for business decision-making, 5th Canadian edition Epub Reg card .
