COST SYSTEMS: CHARACTERISTICS, TYPES - DUDAS - 2025

The cost systems are the framework used by companies in order to estimate the cost of their products in order to calculate profitability analysis, inventory valuation and cost control.

Estimating the exact cost of products is critical to profitable operations. A company must know which products are profitable and which are not, and this can only be determined if the correct cost of the product has been calculated.

Additionally, a product costing system helps estimate the closing value of materials inventory, work in process, and finished goods inventory in order to prepare financial statements.

A typical costing system works by tracking raw materials as they go through different stages of production and slowly being converted into finished products in real time.

When raw materials are brought into production, the system immediately records the use of these materials by crediting the raw materials account and debiting the products in process account.

Since most products go through many stages before they can be called finished products, at the close of a period there are often several different work-in-process accounts.

In a manufacturing environment, various types of costs contribute to making the product. Accounting for these costs in financial and managerial reports improves understanding of the profitability of the manufacturing operation and enables decision making.

characteristics

The real-time component of the cost system is its most valuable feature. Management can make decisions based on current data and does not have to wait for it to be added to reports at the end of the period. This important feature is not always easily achieved.

In a cost system, the allocation of costs is carried out on the basis of a traditional cost system or an activity-based cost system. The traditional costing system calculates a single expense rate and applies it to each job or department.

On the other hand, activity-based costing involves the calculation of the activity rate and the application of overhead to products based on the respective use of each activity.

Cost basics

materials

Direct materials and indirect materials.

Workforce

Direct labor and indirect labor.

Variable overhead

- General production expenses, including manufacturing personnel.

- General administrative expenses, including office staff.

- General sales expenses, including the production and maintenance of catalogs, advertising, exhibitions, sales personnel, cost of money.

- General distribution expenses

- Maintenance and repair, both office equipment and factory machinery.

- Supplies

- Public services, which include gas, electricity, water and municipal assessments.

- Other variable expenses

Fixed overhead

- Salaries / payroll, including salaries, pensions and deductions.

- Occupancy (rent, mortgage, property taxes)

- Depreciation (durable goods, including office machinery and equipment)

- Other fixed expenses

These categories are flexible and sometimes overlap. For example, in some companies, machine cost is segregated from overhead and reported as a separate item entirely, and payroll costs are sometimes separated from other production costs.

Depending on whether or not fixed manufacturing overheads are charged to products, costing systems have two variants: direct or variable cost, and absorption cost.

Direct or variable cost

In direct or variable cost, only variable manufacturing costs are charged to inventory. Fixed manufacturing costs are charged as expenses in the period in which they are incurred.

This method has some advantages and some disadvantages for internal reporting. However, it does not provide an adequate allocation of cost, because the current fixed costs associated with the production of inventory are charged to expenses, regardless of whether or not the production is sold during the period. For this reason, direct costs are generally not acceptable for external reporting.

Cost per absorption

Cost per absorption, also called total cost, is a traditional method where all manufacturing costs, variable and fixed, are charged to inventory and converted to assets.

This means that these costs do not become expenses until the inventory is sold. In this way, the assignment is closer to reality.

However, all selling and administrative costs are charged to expenses. Technically, an absorption cost is required for external reporting. The absorption method is also frequently used for internal reporting.

Activity-based cost

It is a relatively new type of procedure that can be used as an inventory valuation method. The technique was developed to provide more accurate product costs. This increased accuracy is achieved by tracking product costs across activities.

Costs are assigned to activities (activity costs) and then, in a second stage, they are assigned to outputs that use those activities. That is, activities consume money and products consume activities.

Basically, it seeks to treat all costs as variables, recognizing that all costs vary with something, either with the volume of production or with some phenomenon not related to the volume of production.

Manufacturing costs as well as selling and administrative costs are allocated to products.

Difference with traditional cost systems

In traditional absorption cost and direct cost systems, manufacturing overhead costs are assigned to products based on a measurement related to production volume, such as direct labor hours used.

Therefore, the fundamental differences between traditional systems and activity-based systems are:

- How indirect costs are allocated. Activity-based cost uses both production volume and non-production-volume bases.

- What costs are assigned to the products. Activity-based costing attempts to allocate all costs to products, including marketing, distribution, and administration costs.

Types

Calculation of costs by work order

Work order costing is a costing system that accumulates manufacturing costs separately for each job. It is appropriate for companies that are dedicated to the production of unique products and special orders.

Costs accrue for 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, the calculation of cost per work order is used for construction projects, government contracts, shipbuilding, auto repair, job printing, textbooks, toys, wooden furniture, office machines, caskets, tools and luggage.

The accumulation of the cost of professional services (eg, lawyers, doctors) also falls into this category.

Calculation of costs per process

The cost calculation per process is defined as the costing method applicable when products or services result from a sequence of operations or continuous or repetitive processes. The costs are averaged over the units produced during the period.

It is a cost system that tracks and accumulates manufacturing costs separately, for each process. Determine the cost of a product in each process or manufacturing stage.

It is appropriate for products whose production is a process that involves different departments and costs flow from one department to another. For industries that produce large quantities of homogeneous products and where production is a continuous flow.

The process costing accumulates the direct costs and allocates the indirect costs of a manufacturing process. Costs are allocated to products, usually in a large batch, which can include an entire month's production. Finally, costs must be assigned to individual units of the product.

For example, it is the cost system used by oil refineries, chemical or cement producers, etc.

Hybrid or mixed cost calculation

There are situations in which a company uses a combination of the cost per job and cost per process features in what is called a hybrid costing system.

Hybrid or mixed systems are used in situations where more than one cost accumulation method is required.

For example, in some cases you use process costing for direct materials and you use cost per job calculation for conversion costs (that is, direct labor and factory overhead).

In other cases, the work order cost calculation can be used for direct materials, and the cost per process for conversion costs. Different departments or operations within a company may require different methods of cost accumulation.

For this reason, hybrid or mixed cost accrual methods are sometimes referred to as operating cost methods.

References

1. Jan Obaidullah (2013). Cost Accounting Systems. Accounting Explained. Taken from: accountingexplained.com.
2. Wikipedia, the free encyclopedia (2018). Process costing. Taken from: en.wikipedia.org.
3. James R. Martin (2018). What is a Cost Accounting System? Management And Accounting Web. Taken from: maaw.info.
4. My Accounting Course (2018). What is a Cost Accounting System? Taken from: myaccountingcourse.com.
5. Patricia Woodside (2018). What Are the Two Types of Cost Accounting Systems for Manufacturing Operations? Bizfluent. Taken from: bizfluent.com.
6. Wikipedia, the free encyclopedia (2018). Cost accounting. Taken from: en.wikipedia.org.