2.1 Costing Methods

Hello. Welcome back to Career Readiness sponsored by UCI Extension. This is the course in Finance for Non-Financial Professionals, and in this module we’re gonna be looking a bit at costing. Interesting to have an entire module dedicated to costing. But costing is, it’s a very confusing area of, of accounting and of finance because there’s a lot of subjectivity to it. There’s a lot of different ways that we can determine a cost. And even though, like I said, there’s a lot of subjectivity to it, in the end costs are costs, and costs need to be accounted for. So we’re gonna look at the three main costing methods known as process costing, standard costing and job order costing. Three different methods of costing. What it is your business does that we can then add this on to our line of cost equal fixed plus variable, right? So process costing. Now process costing is used to cost a situation where everything manufactured or everything produced is basically the same, right? So you’re, you’re producing a lot of the same thing. So what you’re gonna do is you’re gonna take the number of units you produce, and again, these can be widgets. You can produce 100,000 widgets at a factory. Or you can be a consulting firm that bills, you know, 10,000 hours a month or, or whatever it is, okay? But what it is you’re producing is this, is usually the same time after time after time. So you look at the number of units produced. Again, widgets are hours. You’ll look at the direct costs that, that unit incurred. So what you had to pay for what you produced, whether paying the consultant for his time, or paying for the material for, for the thing produced. And then you take the overhead costs of that particular department and you subtr, or you divide those overhead costs by the number of units produced. And you get a price. Okay, that, that particular department you get a cost. I mean that, that particular department incurred in producing each unit. You put that cost onto the unit, you send it to the next department and they do they same thing, and they do the same thing, and they do the same thing. And when it comes out of the system whether it went through one department or multiple departments, it’s got a cost attached to it. And that’s process costing, okay? Then there’s standard costing. So standard costing says rather then apply the cost of the direct material, the direct labor, the direct costs that are incurred, what we’re gonna do is we’re going to use pretty much an average cost. And in fact this is done a lot in the pizza industry. I’m not sure if you’ve ever realized but when you order a pizza, most expensive thing on there is the cheese. And the cheese market is like the stock market. What you pay for mozzarella or what you pay for parmigiano reggiano, it changes all the time, right? So some days it’s a little bit more expensive, some days it’s a little bit cheaper, right? Well this would be a nightmare to, to always have to account on how much did I pay for mozzarella today. So a pizzeria is going to use the average cost of mozzarella, right? And that’s the cost we’re going to put into each pizza. Now some days it’s gonna be a little bit higher, some days it’s gonna be a little bit lower. And they’ll have an account called a variance account to track that. But that’s standard costing. We’re gonna use an average standard cost for simplicity’s sake. Then there’s job order costing. And job order costing is a lot like process costing, except job order costing is used when a factory or a service organization produces different things that are going to incur different costs. You see, a consultant who goes and cons, does a consulting job at one company, he gets an hourly rate. He goes and does another consulting job at another consulting company, or an, I’m sorry, another company, he’s getting the same hourly rate, okay? So you could just use a process costing there. But if somebody is making custom furniture for you, well if you have them make a chair well there, there’s a cost involved in that. You have them make a table, there can be completely different costs involved, right? And if you have him make just a standard square table maybe you’re, you’re paying for or using a cheaper laborer. Because there’s not a lot of design in it, whereas if the table is going to be embellished with beveling and artwork and everything, you have to pay a very skilled laborer, and that’s gonna incur more costs. So in this case we can’t use process costing because you’re making things either individually or in small batches and then you’re changing it and making something else that has a whole different costing profile. So we do what’s called job order costing, and basically we do process costing, okay? We’re gonna apply direct cost. We’re gonna apply overhead cost. But we’re gonna do it for individual units or small batches, okay? And in, in, in, in a general sense that’s all job order costing is, okay? Making sure that we’re costing the actual unit that’s being used every time that, or that’s being manufactured or, being performed every time that unit eh, changes.