Costing Methods Commonly Used in Accounting - Essay Example

Report On COSTING METHODS COMMONLY USED IN ACCOUNTING Outline Assessing different costing methods Introduction Costing Methods (a) Unit costing (b) Job costing (c) Contract costing (d) Process costing (e) Full costing (f) Service costing Rationale, Purpose and Conclusion Introduction Costing is a process and it entails a procedure where costs of resources or inputs in any production exercise are identified, allocated to their corresponding output activities or services. Managers under cost and management accounting generally design costing methods for use (Pinto 2010). They are distinguished for use to aid in decision-making; the decisions made are those that affect their firms’ operations. Since, there is no need for comparison with other external firms because the decisions made within are only meant to improve on the technical efficiency and effectiveness of the firm hence the creation of a competitive advantage through maintained secrecy (Horngren, Datar, Rajan 2012). The accountants who generate cost accounting information by employing costing methods provide valuable information to the managers which if employed on decision making would actually steer the organization through greater heights due to improved management and leadership style. The success of any organization depends on the better, effective, and efficient decisions made and this evident and reflected only through the performance of the organization regardless of the type of organization. The cost accounting system and costing methods is because of the decisions made by the managers of an organization and the organizational environment created in the process of operation (Pinto 2010). Costing Methods Costing as a method of identifying and allocating inputs to output is fundamental if we are to address costing methods. Costing methods are peculiar and different industries employ different methods in the ascertainment and fixing the costs of their products. The form that is likely to be adopted by any firm is highly dependent largely on the nature and type of the production as well as the type of output. The methods include:- Unit costing; Job costing; Contract costing; Batch costing; Process costing; Full costing; service costing; Operation costing ; Multiple costing (Porter 2011). The underlying fact behind any form of costing and the method employed all lies on the business of the operating firm whether it is product oriented or a service provider (Porter 2011). A careful choice has to be made for the value realization lest it be obsolete and irrelevant. This is the essence of the analysis of the various existing methods:- (a) Unit costing Unit costing is one major method of costing which has been in existent since time immemorial. This is based on the recognition that absolute costs can increase or be on the constant rise on year after year. The question, which remains, is the gain that is got from the value of the money and whether more services are supplied or not. Value can be defined when we link inputs to outputs so that we define effectiveness and efficiency. As result prudence comes in when costs are measured per unit produced, (unit cost) and hence definition for the value of money placed under investment. Effectiveness over time is arrived at by comparing the unit cost of the service over time while on the other hand efficiency is realized when the same unit cost is compared to the unit cost of another unit cost of a different organization operating in the same product or field (Hopper, Scapens 2007). The calculation of unit cost is arrived at by calculating the total cost of producing or providing the service and then dividing by the number of production units or the service units that are provided. The deal may sound so simple but it requires a great depth of understanding of the costs as well as their behavior to be meaningful in our application. The units have also to be identified in the right proportions and measure to aid in the performance of the services. To identify total costs both direct costs and indirect costs have to be looked at since it contains a major proportion of the costs to be summed up. Direct costs are costs such as those for labor and supplies and indirect costs in this case entail all the supportive costs (Hopper, Scapens 2007). Costs and cost behavior is a very important element that must be looked at keenly when one intends to arrive at a perfect unit cost. Cost behavior may be fixed or variable and semi variable, direct or indirect. Depending on the type of cost, there may be a realization in the change in output as a result in the change in inputs. It has to be noted that the more the services provided the more the costs will be accumulated. For example if the market is widened, it means production must go up and hence more man hours employed means more employee cost. This only applies to variable costs in nature since fixed costs are such that they do not vary with output in a direct way. However challenging it is t get cost of output since their separation is very hard; the cost accountant in the bid to work out unit cost is obliged to identify the cost. This seems to be the major challenge in unit costing method (Hopper, Scapens 2007). Unit costing computation is quiet hectic but after its calculation, they have several vital and unavoidable uses, which may entail the following. The uses also double up to form the merits of the method:- They measure the cost effectiveness which is a reflection of an organizations performance through unit; unit costing can also be used to set the targets of the company, the aim being the unit cost which should hence be maintained (Wheldon, Owler 1978). Unit costing also enhances the comparisons with the performance of other organizations hence efficiency, which helps in the realization of a competitive advantage. Unit costing is not generally applicable to the general industry, it is easily and understandable in the manufacturing scenario. This is because the field does not only produce quantitative but also qualitative output as well. The motivation of any manager is the ability that it can produce quality and satisfaction to its clients and quality can only be measured through productivity (Wheldon, Owler 1978). (b) Job costing This method is used in a systematic way to determine the costs of each job, after determination of such costs the quotes are the ones presented to the customers. It can be applied virtually in any industry to make sure that actual costs are adequately covered through effective pricing. The pricing method used in this way should even be in the position of making a provision for profit since this is one of the sole purposes of a contemporary private firm (Porter 2011). Job costing is a three-step process, which involves - determination of the customer requirements. Secondly, the costs and overheads related to the jobs are identified then categorized; this information is since used to get the actual cost and then make a quotation to the customer (Wheldon, Owler 1978). In job, costing costs are accumulated as either by job or batch where all the direct costs are traced at their actual and exact values. The tracking is done until the job is completed to finality (Wheldon, Owler 1978). If job costing is taken along with the modern software technology, several advantages are accrued such as improved cost control, risk reduction, and highly increased chances of profitability (Porter 2011). The advantages trail from the quality of the work delivered and clarity in its presentation. The speed of work delivery facilitated through current and modern technology is ensured. The major setback is that this method do not apply to other forms of work, it is quite specific and rigid (Wheldon, Owler 1978). (c) Contract costing A contract is simply an agreement to complete and therefore a commitment is shown that a piece of work that is likely to last for a longer duration will actually reach a completion. It is an assurance by a contractor to the client that they will complete the work within the prescribed and stipulated timeframe (Horngren, Datar, Rajan 2012). Contract costing method is a method in cost accounting that is used to collect, group and identify all the overheads relating to a particular contact. When a contract is entered into, every clause of the contract applies. Therefore, they have cost implications whether they have economic implications or not. Contract costing is relevant and even more of its importance is noted when a good share of the company’s total costs applies to labor costs. This means that labor cost takes a large proportion of the overheads, since then can contract costing as a method of cost accumulation in cost accounting, be applicable. Direct costs such as those for labor and employee benefits are very easy to measure, on the other hand, indirect costs relating to contracts have often proved difficult to identify and measure for ascertainment and accounting. The costs relating to contracts such as layoffs, arbitration charges and grievances are quite difficult to estimate so as t gauge their exactness (Horngren, Datar, Rajan 2012). Other contract costs that are complex in nature and therefore difficult to measure are the costs, which are geared towards showing the relationship that exists between variation in the cost of labor and employee attitude. Contract costing common costs and expenses include; material costs, labor costs, direct expenses, overheads allocated, sub-contract costs and cost of any extra work (Porter 2011). Contract costing method is important and relevant in costing for big jobs hence determination of such costs, without relevant contract costing knowledge job costing which is completely irrelevant on contract valuation and profit would not be calculated accurately. This is because relevant items such as value of work certified, contract price and notional profits are not handled under job costing (Horngren 1999). (d) Process costing Process costing method as opposed to the other methods does trace and collect together direct costs; also, they allocate the indirect costs of a manufacturing concern. It is applied in manufacturing firms majorly and its costs are linked to large batches at time batches, which go for even more than one month (Horngren 1982). As opposed to job costing, it assigns the costs to each unit that is the eventual allocation of each cost to the individual units of a product. Process costing intends to ascertain costs of a product at each stage or process of manufacture most so where the production takes the course or sequence of continuous and repetitive processes. Process costing as opposed to job order costing is applicable in manufacturing concerns where production involves manufacture of uniform or homogenous products such as paper or soda industries. Under process costing, one single product is produced continuously for a prolonged period and all the units of the product are identical. The costs incurred during the production are accumulated as per department and the relevant department computes the unit costs (Horngren 1982). Under process costing, the production report produced normally has three parts; A quantity schedule/timetable which shows the flow of units through the sections and this is where the equivalent units are computed. Secondly, costs per equivalent unit will be calculated at this stage and finally, reconciliation will be conducted of all costs inflow and outflows of the department. (e) Full costing Full costing is a method of cost accounting that explains and adequately describes how products and services should be priced to reflect their true costs. It integrates the long time ignored environmental and social costs into production and its general hence relates to any form of accounting system(Bhimani, Horngren, Datar, Foster 2008). This method of costing is so diverse and it therefore includes all forms of manufacturing costs. The argument behind the inclusion of all these costs is that all the production costs are required in the creation of the products. In the process, it is also highly depicted that the costs involved posses’ future economic benefits. In its analysis of costs, the method integrates both the fixed and variable costs as a unit in its total costs. Regardless of the sales made full costing method has a great challenge since it is highly prone to manipulation by the managers to their gain. The manager’s acts may be with intent to defer costs to the following financial period so that the current income and profits remain higher so that they can get the favors for promotion or even high dividends for the shareholders (Bhimani, Horngren, Datar, Foster 2008). Absorption costing depending on how it is computed has consequences on the value of profits in the following ways: - when the value of both the opening and closing inventory are equal, then variable costing profits equal absorption costing profits. If the inventory levels are run down over the period, then variable profits automatically becomes higher than the absorption costing. Lastly, absorption costing becomes higher than the variable costing profits if the inventory levels are raised considerably. (f) Service costing This is one component of operation costing and it is employed by virtually all organizations that are engaged in service provision instead of manufacturing of goods and services. Companies that render services may be transport companies, schools, hospitals, gas generation and distribution companies (Bhimani, Horngren, Datar, Foster 2008). In the calculation of the costs all expenses are collected that relate to the service then a cost sheet to show all the costs is prepared based on time aspect i.e. cost of service provision is ascertained, then unit cost is got by dividing total cost by the total number of units provided for cnsumption. This method of costing is used to find the unit cost of services or operations, services may be visible or invisible depending on the nature of its provision. Rationale, Purpose and Conclusion Costing is part of any organization and a suitable costing method ought to be employed to satisfy the achievement of the goals of any form of organization. Without an effective form or method of costing, wastage of the organizations, resources both financial and time would be realized and this leads to a cut on the profitability and growth of the organization (Bhimani, Horngren, Datar, Foster 2008). To ascertain costs using the costing methods various costing techniques have to be employed such as; marginal costing, absorption costing, standard, as well as uniform cost technique. Consistency in the use of a costing method is a matter of emphasis to realize its efficiency and effectiveness. Cost methods are used for different cost reasons, which range from the determination of market valuations and the management of reporting systems. The study and analysis of methods of cost and their critique is of much importance under project cost management. This is solely because it enables the officers understand the various cost components that a project posses and allow in their optimal estimation for cost effectiveness (Practice standard for project estimating 2011). In the process, cost effective innovative measures may be introduced in the process such as the employment of the modern technology in handling projects and project costs. Costing methods are of fundamental importance since a better method put in place supports in the estimation of project costs that is the basic component towards the generation of cost budgets. Cost budgets are important for planning as a function of any formal organization. References Bhimani, A., Horngren, C. T., Datar, S. M., & Foster, G. (2008). Management and cost accounting (4th ed.). Harlow [etc.: Financial Times Prentice Hall. Emblemsvåg, J. (2003). Life-cycle costing: using activity-based costing and Monte Carlo methods to manage future costs and risks. Hoboken, N.J.: Wiley. Horngren, C. T. (1982). Cost accounting: a managerial emphasis (5th ed.). Englewood Cliffs, N.J.: Prentice-Hall. Horngren, C. T., Datar, S. M., & Rajan, M. V. (2012). Cost accounting: a managerial emphasis (14th ed.). Upper Saddle River, N.J.: Pearson/Prentice Hall. Pinto, J. K. (2010). Project management: achieving competitive advantage (2nd ed.). Upper Saddle River, N.J.: Prentice Hall. Practice standard for project estimating. (2011). Newtown Square, Pa.: Project Management Institute, Inc. Wheldon, H. J., & Owler, L. W. (1978). Wheldons Cost accounting and costing methods (14th ed.). Estover: Macdonald and Evans. Top of Form Bottom of Form Porter, E. R. (2011). Quantitative methods for management accounting. Milton Keynes: Open University. Hopper, T., & Scapens, R. W. (2007). Issues in management accounting (3rd ed.). Harlow: Financial Times Prentice Hall. Read More