Question

You have decided to go into business with your peer and start a business. Which method of costing would be appropriate for the business? What factors would need to be considered for such a venture? How could the wrong costing method create inaccurate results?

Answer 1

Types of Costing

1. Marginal Costing : wherein only variable cost is allocated to production. Only direct material cost, direct labour cost and direct overhead expenses are included to compute Cost of Production.

2. Absorption Costing : in this type, variable and fixed cost are , I.e. Total cost is allocated towards production.

3. Standard Costing : Costing is done based on pre-determined sets of standards. Any variance in cost incurred can be easily detected.

4. Historical Costing: Costing is done based on actual incurred cost. This is easiest and almost all small scale business follows this method.

Methods of Costing

1. Unit Costing : Costing is based on cost allicatuon to a single unit, then applied to all production. This methos is suitable when production involves producing identical units.

2. Job Costing : when each work job has different specifications then job Costing is followed. Cost is ascertained for each job work differs under this method. When customization as per customer's specifications then this method is useful.

3. Batch Costing: when production is done on batch basis, wherein the character of goods produced are similar. Cost is ascertained and allocated to a batch as a whole.

4. Service or operation Costing : when business is involved in providing services then service Costing should be followed.

5. Contract Costing : contract based work which usually takes long gestation period required contract Costing wherein cost is allocated on the basis of percentage completion.

Factors to be considered while deciding Costing method:

1. Nature of the business : whether business is based on Production of good or providing services, influences the decision to greater extent.

2. Size of the business : mass production of identical units should follow unit Costing whereas tailor-made production should follow job costjng.

3. Nature or scope of inputs : Specifications such as value, volume, perishable nature is very important to considered while deciding on Costing method. Valuable or rare inputs require strict standard adherence manner of Costing.

4. Constraints : constraints such as time, resources are to be considered as post implementation, the decided method should enable the organization to efficiently ascertaine the same.

5. Organization's structure : the method should be suitable as per the organization's structure, industrial norms and vision, mission of the organization. Thorough understanding of process, structure is required.

CONSEQUENCES OF WRONG COSTING METHOD

1. Effect on pricing policy : unsuitable or inaccurate Costing may lead incorrect price decision, which may affect the profitability of the organization.

2. Standards settings or budgetary control : inaccurate standards or budget can be the results of wrong costing method.

3. Valuable inputs : allocation of inputs which are valuable in nature may get affected adversely due to inappropriate method of Costing.

4. Inventory valuation : inaccurate method may affect the inventory valuation.

5. Strategic decision : important decision based on Costing may go wrong and result in heavy loss.

6. Capacity allocation of machinery : under utilisation or non achievement of targets may be the caused of wrong costing method.