Welcome to my blog, good friends. It has been awesome making this last post for the week. I hope to share value as required. Let's get started!
Whenever the term cost is mentioned, it is not necessarily viewed as an expense but rather as an investment associated with the product. Therefore, costing methods are simply those strategies used in achieving the right cost associated with producing a product and services rendered. Costing methods are an important part when the profitability of a product is considered, as well as its financial management. Appropriate determination of product pricing can only be efficiently done with the use of costing methods.
It brings our attention to the price of raw materials used for the overall production while determining if they're unnecessarily on the high side or affordable. It also tries to ascertain the overall production line by identifying where and at what stage to optimize the process. This helps to give a clearer view of how best to arrive at the minimum product pricing by optimizing all stages of production. We have different costing methods that fit into our own goals or service purposes as required. Let's check them out...
1.Absorption Costing Method: is a type of costing method that allocates all costs of producing a product to it. If the cost of producing a product x is $5, which means the price of the product x placed in the public domain, less $5, is the profit. Costing methods like this have to be well managed to avoid profitability distortions. Note that both fixed and variable costs are factored into product pricing.
2.Variable Costing Method: As the name implies, variable costs are allocated to the product pricing. It does not consider fixed costs while determining the cost of a product as it believes fixed costs should be treated as periodic expenses. The cost of purchasing machinery is a one-off cost that isn't purchased in every product processing line.
3.Job Order Costing Method: also known as customized costing. The orders received on a customer prescription are used in determining the product costing. We have seen situations where the same product from a company has different qualities. This is a common situation found in developing countries where they tell the manufacturers to produce according to their citizen's purchasing power and not quality-driven.
4.Activity Based Costing Method: There are direct and indirect activities associated with our product manufacturing, which all should be considered while making its final pricing. This is one method that gives the real product costing.
5.Process Costing Method: This is for commercial type of costing where larger units of products are rolled out using automated process subsequently. This mass production makes it easier to determine product pricing by volume.
The importance of costing methods can not be overemphasized, we need them more than they need us. Let's get to know some. Of.the importance of costing method.
Decision making:
Collection of the different product pricing, raw materials used for production, and other variables are base points for adequate decision-making tailored towards profitability.
Product Pricing:
This is an adequate platform that helps in the accurate determination of product pricing. In doing this, profit margins are assured.
Financial accounting:
Good way of staying in line with accounting standards. Cost of all fixed and variable, are generated and well used for profitability performance.
Profitability and Performance Driven:
This is one way we can drive the performance and profitability of a company without having to run down the capital used.
| Parameter | Job Order Costing | Process Costing |
|---|---|---|
| Production type | product production based on customized orders | mass production of products mostly identical in a sequential manner |
| Tracking Cost | Costs are determined on an individual basis | Costs are determined on a process averaging |
| Product Costing | Cost determined by job order received at a time | Cost determined by average cost per unit product |
| Industry Line | Printing press, manufacturing, construction, etc | Chemicals, food processing plants, bottling companies |
As I mentioned above, there are direct and indirect activities associated with our product manufacturing, which all should be considered while making its final product pricing. This is one method that gives the real product costing, unlike the traditional way of aligning product cost to direct labor used.
The truth is that, aside from the direct labor usage we know, other untouched activities contributed to the production process of the product in view. This is where the Activity Based Costing method comes in while determining the product price. This is simple, all we have to do is to pay attention to details to those other activities we may seem are unnecessary and little during the production process. Identifying this product is one phase, and assigning cost to it follows up immediately.
This method of costing seems to come with relatively advanced costing precision levels. In using this method we should be sure of the following;
Gives a more precise product costing. There is a cost tag on all activities consumed during the manufacturing of product items. If all cost indicators are identified and considered, a more realistic pricing is achieved.
True knowledge of product pricing is one sure way of giving sound decision-making on product lines by quickly optimizing all parameters needed for performance growth.
Performance. And a Profitability-driven approach. Since we already know all activities required to make. With a product and the prerequisites of product lines, we can optimize all process stages and make out the best from profit margins.
Adequate resource allocation to all production lines is required for improved performance and profiteering.
Cost control measures. Issues of wastage would be a thing of the past. All activities are identified and optimized by knowing what is required for a per-unit product. The entire production process is efficient.
Like the term, variable costs are allocated to the product pricing. It does not consider fixed costs while determining the cost of a product as it believes fixed costs should be treated as periodic expenses. The cost of purchasing machinery is a one-off cost that isn't purchased in every product processing line.
It is believed the direct use of raw materials and labor are the major determinants of product pricing. This is why it could be called marginal or direct costing methods. This could be effectively done by separating fixed costs from variable costs. This should be well implemented while making the income statement to have a clearer view of the different contributing factors to profit margins.
However, we cannot remove the fact that variable costing methods also have some intriguing benefits;
Brings simplicity in cost control since we already know what cost line to implement. We are dealing with variables, and this is our consideration for profitability.
Help improve decision-making as we already know the pricing regime to follow. Having variables at the back of mind, we should be able to make provision for depreciation/wear and tear for improved performance.
Regulation in production to avoid over or under-production. Fewer incentives come in, so there is low moderate production and fewer storage windows.
It is also a good method to guide internal reporting, budgeting, and performance growth. Direct costs should be seen to be lower than product costs for profitability.
This would help us have an overview of all indices that are required in carrying out cake production while bearing in mind better pricing and profiteering.
Before we can delve into this, I have always told us that we need to identify the different cost lines. In this case, we need to know what kind of cake we are producing: a wedding, anniversary, or birthday cake. This comes with different order types that would tilt the cost. The size is also a determining factor.
The second stage is determining the costs for all activities consumed during this process. For direct raw materials, we have; flour, sugar, butter, eggs, and decorators. For direct labor, we have the wages of bakers. Variable overheads include the packaging, and delivery cost.
I will be making my identifying views for a wedding cake.
| Materials | Unit Cost | Amount Used | Total Cost ($) |
|---|---|---|---|
| Direct Raw Materials | |||
| Flour | 5.5 | 8 lbs (3.63kg) | 44 |
| Eggs | 0.11 | 15 pcs | 1.65 |
| Sugar | 0.55 | 7 lb (3.18kg) | 3.85 |
| Butter | 1.2 | 4 lb (1.81kg) | 4.4 |
| Decorations | 20 | 1 section | 20 |
| Total Direct Raw Materials | $73.9 | ||
| Total Direct Labour | $30/ hr | 4 hr | $120 |
| Overhead Costs (variable) | |||
| Packaging | $5 | 1 batch | 5 |
| Delivery | $10 | 1 batch | 10 |
| Total Overhead Cost (Variables) | $15 | ||
| Total Cost of Wedding Cake | $208.9 |
Tentatively, this figure for producing a wedding cake should be more given the size, unlike what we usually see when producing birthday cakes. However, this should vary along with different sizes chosen for the design.
I am inviting @@@rosselena, @stef1, and @chilaw.