Types of costing

Types of costing

Different cost accounting techniques are used in different industries to analyze and present costs for the purposes of control and managerial decisions. The generally-used types of costing are as follows:

Marginal costing: Marginal costing entails the allocation of only variable costs, i.e. direct materials, direct labour and other direct expenses, and variable overheads to the production. It does not take into account the fixed cost of production. This type of costing emphasizes the distinction between fixed and variable costs.

Absorption costing: In absorption costing, the full costs (that is, both fixed and variable costs) are absorbed into production.

Standard costing: In standard costing, a cost is predicted in advance of production, based on predetermined standards under a given set of operating conditions. Standard costs are compared with actual costs periodically, and revised to avoid losses due to outdated costing.

Historical costing: Historical costing, unlike standard costing, uses actual costs, determined after they have been incurred. Almost all organizations use the historical costing system of accounting for costs.

Traditional costing

Basically, the traditional costing is used commonly by manufacturing companies to assign manufacturing overheads to the units they produce. Using this, only the products are assigned an overhead cost by the accountant. The downside of this method of costing is that it neglects to consider the non-manufacturing costs like administration expenses which are associated with production. Today, such method is considered outdated because a lot of the manufacturing companies already use computers and machines for their production. Also business accounting software is already being used widely. On the brighter side, the traditional costing is easy to use especially for those companies that have one product.

Activity-based costing

On the other hand, the activity-based costing (ABC) is a more logical method of assigning manufacturing overhead costs to products. Unlike traditional costing that simply assigns costs based on the machine work hours, the ABC assigns costs first to the activities and processes that cause the overhead. Then, these costs are assigned only to the products that require the activities. Simply saying, the ABC is typically used as a supplemental costing system for businesses.

Difference between Activity-based costing and Traditional Costing

The difference between ABC or Activity Based Costing and TCA or Traditional Cost Accounting is that ABC is complex whereas TCA is simple.

The ABC system began in 1981 whereas TCA methods were designed and developed between 1870 to 1920. In the TCA system, the cost objects and used up resources are required to evaluate the cost whereas in the ABC system the cost is dependent upon the activities used up by the cost objects.

Activity Based Costing is accurate and preferred over the TCA cost management system. The ABC method of cost management system is adopted when the overheads of the company are high and there are large numbers of miscellaneous products. Inaccuracy or errors are most unwanted and undesirable because of the competitive rates set by the competitors in the market. Due to this heavy and stiff competition, a highly reliable and accurate method is required for the cost management.

TCA or Traditional Cost Accounting uses a single overhead pool and is not able to calculate the true cost. The costs of the objects are allocated randomly based upon the labor or machine hours etc. ABC costing includes identifiable products parts or labor whereas TCA arbitrarily accumulates expenses, salaries, depreciations etc.

Smaller targeted costs that are built upon activities are calculated with the help of the ABC system. The ABC system is advantageous since it helps in simplifying the decision making process and it makes management concepts become clear and target -oriented. It also helps in evaluating performances and sets standards which can help the manager to use this information for comparison purposes.

In the Traditional Cost Accounting System, the company determines the cost of production after the products have been produced whereas in the target or Activity Based Accounting System, the value or cost of the product is determined on the basis of customer feedback and pocket range. The ABC system helps the company to determine whether to lower or raise the activities cost to grab the consumers. The ABC system also helps in keeping up with the competitors without sacrificing the quality and the quantity of the products.

Summary:

1.  Traditional cost accounting is obsolete whereas Activity Based Accounting is used more by various target-oriented companies.

2.  ABC methods help the company to identify the needs of keeping or eliminating certain activities to add value to the products.

3. TCA methods focus on the structure rather than on processes whereas ABC methods focus on the activities or processes rather than on the structure.

4. ABC provides accurate costs whereas TCA accumulates values arbitrarily.

5.    TCA is almost obsolete whereas  ABC methods are largely in use since 1981.