What are different methods of cost accounting? Explain their adaptability in different industries.(2019)
Different Methods of Cost Accounting and Their Adaptability in Various Industries
Cost accounting methods are designed to allocate and control costs, providing management with valuable information for decision-making. Differential methods of cost accounting are employed based on the nature of the business, the complexity of operations of business and the specific needs of the industry. method of costing
Here’s an overview of the major methods of cost accounting, along with their adaptability in different industries:
1. Job Order Costing
Meaning:
In the Job Order Costing method, costs are assigned to specific jobs or orders during the business. This method is used when products or services are customized or produced in distinct batches, and each job or order is different from the others order.
- Manufacturing Industry (Custom Production): Industries like shipbuilding, construction, aerospace, and furniture manufacturing where each job or project has unique specifications and costs. Method of costing
- Printing Industry: Printing businesses often produce jobs with different designs and specifications, making job order costing suitable.
Why Suitable?
- This method is ideal for industries that produce products or services that are unique and identifiable not part of a continuous production process involved in this business.
- This method provides detailed cost information for each specific job as well as order, enabling accurate cost control and pricing for the orders and job.
2. Process Costing
Meaning:
In this Process Costing, costs are accumulated for each process for job or department order and then averaged over the units produced. This method is used for industries where the production is continuous and the products are homogeneous but in the unique form. Method of costing
Industries Adaptability:
- Chemical Industry: In industries like petrochemicals or pharmaceuticals, where products are produced in continuous processes (e.g., the production of chemicals or drugs).
- Oil Refining and Steel Manufacturing: These industries typically have large-scale, continuous production, making process costing ideal.
- Food and Beverage Industry: For mass production of standardized food items like canned goods or beverages (e.g., Coca-Cola or Nestle), process costing works well because production is continuous and the products are identical. Method of costing
Why Suitable?
- Process costing is suitable when products go through a series of similar operations or processes. It helps in distributing costs evenly across large quantities of similar products, making it easy to calculate the cost per unit.
3. Unit Costing
Meaning:
Unit Costing is a method of costing where the cost per unit is calculated by dividing the total cost by the number of units produced. This is typically used when products are standardized and produced in large quantities.
Industries Adaptability:
- Textile Industry: In the textile industry, where standardized garments are produced in large volumes, unit costing helps in determining the cost per item. Method of costing
- Electronics and Appliances Manufacturing: Companies like Samsung or LG use unit costing for mass-produced items like televisions, refrigerators, etc.
- Automobile Industry: In car manufacturing, unit costing can be used to calculate the cost of producing each vehicle model based on the total costs. Method of costing
Why Suitable?
- Unit costing is best suited for industries that produce homogeneous products in large quantities. It simplifies cost allocation and provides a clear understanding of the cost of each unit produced.
4. Activity-Based Costing (ABC)
Meaning:
Activity-Based Costing (ABC) allocates overhead costs based on activities that drive costs. It provides more accurate cost information by tracing costs to the specific activities that cause them, rather than just spreading them across products or services.
Industries Adaptability:
- Service Industry: Companies like consulting firms, IT companies, or law firms use ABC to allocate indirect costs like office supplies, administrative costs, and other overheads based on the actual activities performed. Method of costing
- Manufacturing Industry (High Overheads): In industries with significant overhead costs, like automobile manufacturing or electronics assembly, ABC can be used to better allocate costs related to machine hours, inspection, and other activities.
- Healthcare Industry: ABC can be used in hospitals or healthcare centers to allocate costs based on the services provided to patients, such as diagnostic procedures, surgeries, and treatments. Method of costing
Why Suitable?
- ABC is suitable for industries with complex processes and multiple products or services that require detailed and accurate cost allocations. It provides a clearer picture of the cost drivers, helping to improve cost control and pricing strategies.
5. Standard Costing
Meaning:
Standard Costing involves setting a predetermined or “standard” cost for each product or service. These standard costs are then compared with actual costs to determine variances, which can be analyzed for cost control and performance evaluation.
Industries Adaptability:
- Manufacturing Industry: Used widely in industries like automobile production, electronics, and food processing, where repetitive production occurs and setting standards for materials, labor, and overhead is possible.
- Retail Industry: Retailers use standard costing to predict costs related to inventory, procurement, and sales operations.
- Construction Industry: Standard costs are used to estimate and control costs on various projects, helping in budgeting and cost tracking.
Why Suitable?
- Standard costing is effective for industries with repetitive manufacturing processes or where historical data can be used to set realistic benchmarks. It aids in identifying variances and taking corrective actions for efficiency improvements. Method of costing
6. Marginal Costing
Meaning:
Marginal Costing involves calculating the cost of producing one additional unit of a product. It separates fixed costs from variable costs and focuses on the behavior of costs at different levels of production.
Industries Adaptability:
- Retail and Wholesale Industries: In industries where prices are often determined by the need to cover variable costs (such as supermarkets or clothing retail), marginal costing helps determine the minimum price.
- Manufacturing Industry: For companies involved in bulk production with significant fixed costs, marginal costing helps in deciding whether to accept additional orders or price products competitively.
Why Suitable?
- Marginal costing is beneficial when businesses need to make quick decisions related to pricing, break-even analysis, or special orders. It helps in analyzing profitability at different levels of production and understanding the impact of fixed and variable costs. Method of costing
7. Direct Costing
Meaning:
Under this Direct Costing method only direct costs (like direct materials, direct labor) are considered and charged to products. Indirect costs are not included under the direct Costing method. but these costs are considered as period expenses.
Industries Adaptability:
- Contract Manufacturing and Custom Goods Production: Industries where products are made-to-order, such as construction or bespoke furniture manufacturing, typically use direct costing to focus on the costs directly attributable to each job or order. Method of costing
- Project-Based Industries: Companies that focus on project-based work (e.g., construction or event management) use direct costing to allocate costs directly to specific projects.
Why Suitable?
- Direct costing is useful in industries with distinct projects or contracts, allowing for clear allocation of costs that are directly tied to the production of goods or services.
Conclusion:
Each costing method has its strengths and is suited to particular types of industries based on their operations, production processes, and cost structures. For example:
- Job order costing is perfect for industries with unique or custom jobs.
- Process costing fits industries with continuous production and standardized products. Method of costing
- Activity-based costing helps industries with complex, overhead-heavy operations, such as service and healthcare industries.
Choosing the appropriate cost accounting method is crucial for effective cost management, budgeting, pricing, and decision-making, allowing businesses to stay competitive and efficient in their respective industries. You can find the syllabus of cost Accounting on the official website of Gndu.
Essential questions of Cost Accounting