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Costing System

1. Illustrative Example: Government Hospital Tender

  • Context: You work for a government hospital inviting tenders for two widely used tablets.
  • Products:
    • Tablet A (Adult):
      • Contains a few chemicals with higher dosages.
    • Tablet B (Children):
      • Shares three chemicals with Tablet A, plus two different ones.
      • Dosages are smaller.
  • Observation:
    Two pharmaceutical firms submit substantially different price quotes.
  • Key Insight:
    Difference arises because each firm uses a different costing system—specifically, they allocate common costs differently in a multi‑product environment.

2. Designing a Costing System: Three‑Step Process

  1. Establish the Cost Object or Cost Center

    • A cost object (or cost head) is the lowest level at which cost data are collected.
      • Examples: Material, salary, repairs, freight, travel expenses, customers, dealers.
    • Cost objects are grouped into cost centers (e.g., Production Cost Center, Purchase Cost Center).

  2. Cost Accumulation

    • Create records to capture costs as they occur.
      • Material requisition slips: Track materials issued to jobs/processes.
      • Employee sheets / Machine log books: Log labor and machine usage per job.
    • Costs are recorded under their respective cost objects.

  3. Cost Assignment

    • Direct costs: Traced straight to the product or service (e.g., raw materials).
    • Common costs: Must be allocated across multiple products.
      • Examples: Depreciation of factory building, managers’ salaries.
      • Allocation bases include output quantity, material cost, labor hours, machine hours.
    • Choice of allocation base → different product costs → different tender quotes.

3. Common vs. Exclusive Costs

  • Common Costs:
    • Occur when several products share machines or resources.
    • Can represent 20 %–80 % of total costs.
    • Higher for high‑value‑added products on shared resources.
  • Exclusive Costs:
    • When each product has its dedicated production facility.
    • Result in fewer common costs to allocate.

4. Activity‑Based Costing (ABC)

  • Developed to address arbitrary allocation of common costs.
  • Key Features:
    • Identifies activities as cost objects.
    • Allocates overhead based on actual drivers (e.g., number of set‑ups, inspection hours).
  • Trend:
    • Increasing adoption as firms seek more accurate product costing.

5. Major Costing Systems

5.1 Job Costing

  • When to Use: Custom orders or services.
  • Examples:
    • IT projects (e.g., Infosys executes per client order).
    • Construction contracts (e.g., Gammon India).
    • Automobile service stations (each vehicle service → one “job”).
  • Process:
    1. Assign a unique job code.
    2. Capture all material, labor, and overhead under that code.
    3. Allocate common costs on job completion using a pre‑determined rate.

5.2 Process Costing

  • When to Use: Mass production of identical units.
  • Examples:
    • Manufacturing (sugar, cement, fertilizer).
    • Service providers with uniform services (banking, insurance, telecom).
  • Process:
    1. Divide production into sequential processes (each → cost center).
    2. Pool material, labor, and overhead costs by process.
    3. Allocate process costs equally to all units passing through.
    4. Allocate common costs across processes as needed.
    5. Prepare a cost sheet showing material cost + cost per process.

Flowchart

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