Financial Accounting – Lesson 7.2 – Overview of the Different Types of Costing Methods
Categories of business expenses
Cost accounting examines a few distinct categories of expenses. These expenses include:
What is costing?
A system for calculating a company’s cost of production is called costing, or cost accounting. This method of accounting examines both variable and fixed expenses incurred during the course of production. Costing data is used by businesses to make wise business decisions and guarantee that every aspect of production is profitable and effective.
Contrary to other types of accounting, an organization’s internal management performs costing activities without being seen by clients or institutions from the outside. Cost accounting has more flexibility than other types of accounting because there are no predetermined standards it must adhere to.
Types of costing
The following cost accounting methods are typically employed by a company’s internal management or financial team:
1. Absorption costing
A company uses absorption costing, also known as full costing, to calculate all costs associated with producing a particular product. According to the level of activity within the organization, the total overhead of the business is absorbed by allocating all variable and fixed costs to cost units. Regardless of whether the product was sold during the period being evaluated, manufacturing overheads are allocated to specific products and included in the company’s stock valuation in this method of costing.
Common types of costs included in absorption costing are:
Businesses that employ absorption costing will have a higher ending inventory on their balance sheet. However, the expenses on their income statement will be lower.
2. Historical costing
The value of an asset is determined by its historical cost, which was the price at which the asset was purchased or acquired by the organization. Many businesses record the cost of long-term assets on their balance sheets using historical costing. Assets are recorded as historical costs even if their value has significantly increased since the asset was acquired. However, when using the historical costing method, asset depreciation is taken into account, and total accumulated depreciation is deducted from the historical cost on a balance sheet.
In the United States, this method of costing is frequently applied to fixed assets and is regarded as a generally accepted accounting principle (GAAP).
3. Marginal costing
A form of cost accounting known as marginal costing is used to determine how variable costs will affect overall output or production. This costing strategy adds a further unit to production to enable management to assess the effects of various levels of volume and costs on the overall operating profit of the company. Marginal costing is frequently employed to make short-term financial decisions and to evaluate the viability of new product development, marketing initiatives, and current product sales prices.
4. Standard costing
A costing methodology known as standard costing indicates standard costs for inventory and the cost of goods sold (COGS). (Standard costing costs are based on producing a good under typical operating conditions. Companies can then determine if there are any differences between the standard cost and actual cost or if they are comparable. Variance analysis measures the discrepancy between expected and actual costs.
When a business conducts a variable analysis and discovers that actual costs are higher than anticipated, the variance is deemed unfavorable. The variance is viewed favorably if the business discovers that the actual costs are equal to or lower than the standard costs. Whether a variance is favorable or unfavorable depends on two factors. These factors include the input’s price, also known as the rate variance, and its quantity or efficiency, also known as the volume variance.
5. Lean costing
Lean accounting, also known as lean costing, aids in improving an organization’s financial management procedures. Rather than using conventional or historical costing techniques, lean costing assigns value-based pricing to the costs of production. Based on lean performance measurements, this gives the company an idea of where waste can be reduced to maximize productivity in the production process.
6. Activity-based costing
A company uses activity-based costing, also known as ABC, when it allocates overhead expenses to particular products or services. This kind of cost accounting is dependent on a business’s operations, like a unit of work or product design. As they frequently incur the highest costs during the production process, these activities are known as cost drivers.
Instead of just allocating costs based on a general measurement, a company using the ABC accounting method conducts an activity assessment to identify the cost drivers. As a result, activity-based costing usually gives a more accurate picture of the total cost of production and the profitability of the company realized by that production.
What are different types of costing?
- Absorption costing. A company uses absorption costing, also known as full costing, to calculate all costs associated with producing a particular product.
- Historical costing. …
- Marginal costing. …
- Standard costing. …
- Lean costing. …
- Activity-based costing.
What are the 3 types of costing?
The types are: 1. Fixed Costs 2. Variable Costs 3. Semi-Variable Costs.
What are the 4 types of cost accounting?
Standard costing, activity-based costing, lean accounting, and marginal costing are examples of different types of cost accounting.
What are the two main types of costing?
Fixed and variable costs are the two main categories of expenses that businesses have. Variable costs change with output, whereas fixed costs do not. Fixed costs are sometimes called overhead costs.