All businesses will be interested in, and spend time looking at, how to cost out their products and/or services. There are many different methods and techniques which can be used to determine and analyse costs and provide management with information required to monitor and control them.
Different business types
The type of business will determine what costing methods will be used. For the purposes of cost accounting there are two different types of businesses – ‘specific order’ businesses and ‘continuous operation’ businesses.
Specific order businesses
A specific order business is where a definite order is placed before a job can commence. For these types of businesses, they may use job costing. Job costing is used for smaller jobs which will typically be completed in a relatively short time. The agreement could be verbal, and work is likely to commence after an estimate or quotation has been agreed. It is essential that the job can be separately identified so that all costs associated with the job can be charged correctly to it. The job itself is the cost unit and examples include:
- A set of accounts prepared for a client
- A patio laid by a landscape gardener
- A room decorated by a painter
- A car repair completed by a garage
Each job will have a job cost sheet on which all materials and labour can be listed. The price charged to the customer may be based on an estimate of direct costs, an amount to cover overheads plus an element of profit. Typically, the actual cost will not be known until the job has been completed, and the actual cost can be compared with the estimated costs to identify differences (called variances).
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Continuous operation businesses
A continuous operation business is where production or provision of a service takes place on a continuous basis without an order being placed initially – the product is available to anyone who wishes to purchase it. For these types of businesses, a common technique is process costing. Process costing is used in the production of most goods available for purchase where the manufacturing process is continuous, and the units of output are identical. It is the costs of the process over a specified period of time which are collected. The unit cost is determined by dividing the total costs for the period by the number of units completed. Used where there is a continuous production process, it sometimes makes it difficult to identify the cost per unit of output, or the cost per unit of closing stock. A common feature of continuous production is incomplete units at the end of the day. Manufacture takes place without a specific order being placed in the expectation that all items will be sold.