Costing methods and their types

The purpose of costing methods is to determine the cost of a so-called cost object. This is most often cost unit, i.e. usually a single piece of product. In particular, the costing is used to value inventory, for example for the purpose of their proper accounting, product valuation, management of inventory and even of the entire enterprise.

The process of manufacturing or providing services can be very diverse, and the products (services) may differ from unique products (services) to identical products produced in large-scale or mass production. For this reason, different methods of costing may be appropriate in different situations.

POSSIBLE COSTING METHODS

Depending the production method and the cost object (mainly type of product) to which costs are ascertained:

• Operation costing - used where production process is repetitive and manufactured products are indistinguishable. It includes:
  • Unit costing
  • Process costing

• Specific costing – used where each production activity is specific and unique. It includes:
  • Job costing
  • Contract costing
  • Batch costing

Costing methods according to the costs included to the value of the product:

• Full costing methods or full production costing methods
  • Activity Based Costing (ABC)
  • Absorption costing
• Marginal (variable) costing
• Throughput costing (Direct material costing)

Costing methods that assign direct costs and indirect costs allocate, for example:

• Costing by simple division
• Costing method by division using relative numbers
• Costing by using an allocation base – for example Absorption costing method

Specific costing methods are used during joint (common) production during which joint or main/by products are manufactured. In case of joint products, an allocation base is used to divide the common costs. In case of main/by-product, the selling price of by-product is deducted from the common costs and the difference is used to value the main product.

A form of costing method can also be STANDARD COSTS. They are estimated and normalized unit costs and quantities set in advance to the production. The differences between actual unit costs and quantities are then analyzed and standard costs possibly updated. 

Alternative approaches have these costing methods:

• Target costing
• Life cycle costing

It is possible to combine various costing methods.  The combinations can be called as hybrid costing methods. They are sometimes used in specific industries or branches which usually have own uniform and specific costing practices.

Nevertheless, not all costing methods are acceptable in financial accounting.  The reason is mainly in the fact that inventory is in most accounting systems valued by direct costs and allocated part of production overheads. 

However, in management accounting it is up to the company decision.