Accountancy/Management Accounting/Costing

Costing is the process of determining cost of a product or service. According to Harold Wheldon,"Costing is the classifying, recording and appropriate allocation of expenditure for the determination of cost". Cost management requires costs to be determined, either by tracing the cost to a cost object , direct costing, or by allocating the cost based on a cost allocation base e.g. direct manufacturing hours , thus providing indirect costing. Direct costs can be traced to a cost object e.g. the amount of time a process worker puts in towards building his part of a complex product e.g. a car. Direct costs require source documents substantiating the direct costs attributed, like job time sheets and material acquisition records. These exist when the costing method is job costing ; in process costing, the units produced are very identical , or are measured in volumes, such as liquids, and then materials , machine and personnel labour time is averaged out according units of allocation called physical units and equivalence units, where equivalence units are the equivalent physical units estimated to have been produced if incomplete unit numbers were multiplied by an estimation of percentage completion: the estimation requiring professional judgement. Activity based costing is usually applied to job costing, and refers to indirect costs and not direct costs, because direct costs can have ideal accuracy by tracing to cost objects, but indirect costs are often simply totalled and divided by a chosen cost allocation base e.g. direct materials dollar cost ( as another example), which may not have a cause-and-effect relationship with the individual components of indirect costs. Some components of indirect costs may occur at a different level of cost hierarchy, instead of per output unit level , they may occur at a output unit batch level , and there may not be a constant number of output units per batch, but the total number of batches can be counted; product or service sustaining level costing may require costs be allocated on a per product type basis , and these costs grouped according to product groups for reporting; finally there are organisation or facility sustaining costs , which in some organisations may not be allocated to output units to give an overall unit cost, but may instead appear in the income statement as expenses for reporting reasons, and for summary profit calculations. Given the 4 levels of cost hierarchy, they give 4 levels of cost allocation bases which may differ : e.g. a product sustaining indirect costs often belong to different parts of the value chain, the value chain being research and development, product design, manufacturing and production, marketing, distribution, and customer service. Despite the apparent directness of activity based costing, the complexity of activity based costing is both social, requiring support from various levels of the organisation including top management, and training of on-floor production personnel, who may need to have the threat diffused of being monitored to establish activity levels and cost allocation bases; and numerical, where ABC is often seen as a large scale solution, requiring large scale information technology resources due to the proliferation of cost objects and cost allocation bases, and then the networking of cost objects by further cost allocations in order to come up with aggregate output unit costs.