Target costing takes a different approach to costing. The advantages of employing a target-costing approach is self-evident. By trying to be proactive in product cost estimation, it stands to reason that these manufacturers have a better opportunity to achieve a desired profit margin.
Products within the product family the manufacturer produces and sells that do not, or cannot, meet a desired product level become candidates to be discontinued. The disadvantages of target costing are equally self-evident. As a result, job costing or direct costing may be a justifiable approach.
For manufacturers that have a wider array of products or mass produce similar products, being able to directly associate costs to a specific product can be very difficult, if not impossible at a minimum not worth the time and effort to attempt to achieve it. For these environments, standard costing or activity-based costing would likely be a better approach.
Regardless of which costing method works best, each has virtues that can help drive accurate pricing decisions. Experienced software companies should be offering a myriad of functionality that crosses traditional costing methodology lines.
First and foremost, they must support the predominant costing methodology required by the nature of the manufacturer. Secondly, they should also have incorporated functionality across other costing disciplines that help them to achieve accurate pricing decisions.
For example, manufacturers that predominantly benefit from job costing functionality can also benefit from features that would normally be associated with standard costing. Likewise, standard costing environments would benefit from functionality that might normally be associated with job costing environments. Manufacturers must choose a solution that supports their costing philosophy. The bottom line is to choose products that incorporate the necessary range of costing functionality to help you drive more informed pricing decisions.
Best Costing Methods for Manufacturers. The bottom line on how to drive more informed pricing decisions As a production manager, the challenge is always how to determine what product mix is optimal and how to price products to allow your company to achieve a desired profit margin — or better yet, maximize profit-making capabilities.
Short-term vs. The best costing method for facilitating pricing decisions The answer to this question is largely dependent on the type of products a business produces and the amount of effort that goes into determining how to analyze the costs associated with that business, along with the desired rate of return for those efforts.
Consider these two costing scenarios: I have a small shop where my use of one method of costing method-A results in a very accurate cost analysis to determine pricing, but it takes three people working 20 hours per week to establish those rates. In this method the costs are determined in terms of actual costs and not predetermined standard costs. Costs are determined only after it is incurred. Almost all organizations adopt this method of costing. It is also called the single output costing.
It is used in costing of products that are expressed in identical units and suitable for products that are manufactured by continuous activity. Under this method, costs are ascertained for each work order separately as each has its own specification and scope. Tailor made products also get covered by this type of costing. In this method costing is done for jobs that involve heavy expenditure and stretches over long period and across different sites.
It is also called as terminal costing. Through this method the costing is done for units that are produced in batches that are uniform in nature and design. It is used for the products which go through different processes.
Like in the process of manufacturing cloth, different processes are involved namely spinning, weaving and finished product. Each process gives an output that is a finished product in itself and can be sold. That is why; process costing is used to ascertain the cost of each stage of production. It is the method used for the costing of operating a service such as Public Bus, Railways, Nursing home. It is used to ascertain the cost of a particular service. When the output comprises different assembled parts like in televisions, cars or electronic gadgets, cost has to be ascertained for the component as well as the finished product.
Product costing methods are used to assign cost to a manufactured product. The main costing methods available are process costing, job costing and direct costing. Each of these methods apply to different production and decision environments. Job costing: This is the assignment of costs to a specific manufacturing job. The center of attention for cost accumulation can be individual customers, batches of products that may involve several customers, the products produced within individual segments during a period, or the products produced by the entire plant during a period.
The four accumulation methods that appear in Exhibit are discussed below. In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the work is done to the customer's specifications. As a result, each job tends to be different. For example, job order costing is used for construction projects, government contracts, shipbuilding, automobile repair, job printing, textbooks, toys, wood furniture, office machines, caskets, machine tools, and luggage.
Accumulating the cost of professional services e. Chapter 4 illustrates a cost accounting system that includes normal historical costing as the basic cost system, full absorption costing as the inventory valuation method and job order costing as the cost accumulation method.
In process costing, costs are accumulated by departments, operations, or processes. The work performed on each unit is standardized, or uniform where a continuous mass production or assembly operation is involved.
For example, process costing is used by companies that produce appliances, alcoholic beverages, tires, sugar, breakfast cereals, leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement, gasoline, steel, baby foods, flour, glass, men's suits, pharmaceuticals and automobiles.
Process costing is also used in meat packing and for public utility services such as water, gas and electricity. Chapter 5 illustrates a cost accounting system that includes normal historical costing as the basic cost system, full absorption costing as the inventory valuation method and process costing as the cost accumulation method.
Back flush costing is a simplified cost accumulation method that is sometimes used by companies that adopt just-in-time JIT production systems. However, JIT is not just a technique, or collection of techniques.
Just-in-time is a very broad philosophy, that emphasizes simplification and continuously reducing waste in all areas of business activity. JIT systems were developed in Japan and depend on the communitarian concepts of teamwork and continuous improvement.
In fact, many of the assumptions, attitudes and practices of communitarian capitalism are included in the JIT philosophy. One of the many goals of JIT systems is zero ending inventory. In a backflush cost system, manufacturing costs are accumulated in fewer inventory accounts than when using the job order or process cost methods. In fact, in extreme backflush systems, most of the accounting records are eliminated. The production facilities are also arranged in self contained manufacturing cells that are dedicated to the production of a single, or similar products.
In this way more of the manufacturing costs become direct product costs and fewer cost allocations are necessary. Thus, more accurate costing is obtained in spite of the fact that the cost accumulation method is simplified. The just-in-time philosophy and related accounting methods are discussed in Chapter 8. Hybrid or mixed systems are used in situations where more than one cost accumulation method is required. For example, in some cases process costing is used for direct materials and job order costing is used for conversion costs, i.
In other cases, job order costing might be used for direct materials, and process costing for conversion costs. The different departments or operations within a company might require different cost accumulation methods. For this reason, hybrid or mixed cost accumulation methods are sometime referred to as operational costing methods. A cost flow assumption refers to how costs flow through the inventory accounts, not the flow of work or products on a production line. This distinction is important because the flow of costs is not always the same as the flow of work.
The various types of cost flow assumptions include: specific identification e. Costs flow through the inventory accounts by the job in a job order cost system which represents an example of specific identification. The requirements of the various jobs determines the timing of the cost flows. Simple jobs tend to move through the system faster than more complex jobs.
Module 4: Process Costing and Production Costs. Search for:. Product costs are assigned to jobs. Unit Cost Information Similarities Unit cost information is needed by management for decision-making purposes.
Differences Process Costing Job Costing Unit cost information comes from the departmental production cost report. Unit cost information comes from the job cost sheet. Inventory Accounts Similarities Inventory accounts include raw materials inventory, work-in-process inventory, and finished goods inventory.
Differences Process Costing Job Costing Several different work-in-process inventory accounts are used—one for each department or process. One work-in-process inventory account is used—job cost sheets track costs assigned to each job. Business in Action 4. Key Takeaway A process costing system is used by companies that produce similar or identical units of product in batches employing a consistent process.
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