Costing system definition
/What is a Costing System?
A costing system is designed to monitor the costs incurred by a business. The system is comprised of a set of forms, processes, controls, and reports that are designed to aggregate and report to management about revenues, costs, and profitability. The areas reported upon can be any part of a company, including its customers, departments, facilities, processes, products and services, research and development, and sales regions.
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How a Costing System is Used
The information issued by a costing system is used by management for a variety of purposes, including:
Fine-tuning operations to generate higher profitability
Deciding where to cut costs in the event of a business downturn
Matching actual costs incurred against budgeted cost levels for control purposes
Creating strategic and tactical plans for future operations
How Costing Reports Are Used
The reports of a costing system are intended for internal use, and so are not subject to the reporting requirements of any of the accounting frameworks, such as GAAP or IFRS. Instead, management can decide what types of information it prefers to see, which information to ignore, and how the results are to be formatted and distributed for its consumption. Typical reports created by a costing system include:
Budget-versus-actual reports for costs incurred
Profitability reports for customers, sales regions, stores, products, and/or product lines
Expense trend reports that show expenses incurred by month for many consecutive months
These reports may be accompanied by additional information assembled by the accounting department, which provide details regarding how certain costs were incurred and who authorized them.
Types of Costing Systems
There are two main types of costing systems. A business can accumulate information based on either one, or adopt a hybrid approach that mixes and matches systems to best meet its needs. The primary costing systems are noted below.
Job Costing System
In a job costing system, direct materials, direct labor, and overhead costs are compiled for an individual unit or job. This approach works best for unique products, such as custom-designed machines or consulting projects. The cost accumulation process is highly detailed and labor-intensive.
Process Costing System
In a process costing system, direct materials, direct labor and overhead costs are compiled in aggregate for an entire production process, and are then allocated to individual production units. This approach works well for large production runs of identical items, such as a production run of 100,000 cell phones. The cost accumulation process is highly efficient and portions of it can possibly be automated.
Activity-Based Costing
Another costing system option is activity based costing (ABC). ABC was developed in response to concerns that overhead costs are rarely allocated in an appropriate manner, and involves a finer degree of differentiation in determining how overhead costs are assigned to different cost pools, and then how the costs in those pools are allocated to cost objects. An ABC system can be difficult to set up and operate, and so works best when designed for very specific cost allocation projects that have clearly defined boundaries.
In an ABC system, we identify individual activities within a process, determine the cost of each of these activities, and then assign costs to cost objects based on their use of the activities. An activity is a unit of work, task, or event that has a specific purpose, such as setting up a machine or operating a machine. A cost object is any item for which costs are being separately measured. The most common cost objects are the products or services that a company sells. Other cost objects include customer service calls, product rework activities, product design projects, suppliers, and customers.
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