Question

which costing methods are used by manufacturing companies and why? (please give reasons too)

Answer 1

Costing methods can be broadly divided into 2 categories

1. Inventory costing: The costing method used to determine the value of closing stock is known as inventory costing. Various ways in which inventory can be measured is:

(a) FIFO method: The first in first out (FIFO) method is the most commonly used method for inventory valuation. It is used if a company wants to include in its closing stock, the value of goods which were bought more recently.

(b) LIFO method: LIFO method determines the price of inventory by assuming that the last item of inventory purchased is the first one sold. In an inflanatory economy, companies may find it beneficial to use LIFO method.

(c) Weighted average method: Business where inventories cannot be differentiated easily use weighted average method.

2. Product costing: This is used to calculate the total cost which need to be assigned to the production of a particular product (material, labor and overhead)

(a) Job costing: This is used when the cost needs to be assigned to a particular "job", rather than a "process"

(b) Standard costing: Certained standards are set for the costs to be incurred during a given period. Actual and budgeted costs are compared to calculate variances and identify areas of improvement.

(c) Activity based costing: When multiple products are produced, involving same activities, this method can be really useful in a proper allocation of overhead activities, to get a better financial data of every product individually.

(d) Target costing: Setting a target cost by subtracting the desired profit margin from the sales price. This is used if the management is looking for a proactive cost planning strategy i.e. costs are planned early in the life cycle of product manufacturing.