Maximization of firm’s wealth is the utmost motive of any manager. In order to achieve this, calculation and control of cost of the product is necessary. Even, to survive in todays very competitive market cost controlling measures are very necessary. Cost of a product means the cost incurred on different elements such as material, labour and expenses. These elements may be related to the product either directly or indirectly. Based on utility, the classification of costs can be direct and indirect costs; controllable and uncontrollable costs; fixed, variable and semi-variable costs; differential incremental or decremental costs; opportunity costs etc. In the managerial decision making process, each classification has its own importance. Many costing techniques evolved in due course of time to ascertain the costs of above elements and to facilitate the control of the cost of the product. The main costing techniques that evolved include Absorption Cost Technique, Marginal Cost Technique and recently developed Activity Based Costing Technique.
The purpose of this paper is to analyse the Absorption Cost Technique and Activity Based Costing Technique and to highlight their basic differences. With the help of this the relative merits of each technique over the other can be critically examined so that, to conclude which technique is suitable for which circumstance.
Costing of a product:
Generally, the costing of product involves these following steps:
1. Identification of the cost object i.e. is anything that a manger want to know the cost of. That may be the cost of producting 1 No. product, or of a particular day’s production etc. 2. Identification of the direct costs which are directly related the cost object.Materials and labor that are directly related with the cost object are the direct cost for manufacturing companies. Thus, direct materials are those which become part and can be economically and comfortably identified with the specific units of the finished product. For a manufacturing company the raw material used for the output product is direct material. Also, the costs associated with labor that can be economically and comfortably identified with the specific units of the finished product. For a manufacturing company the labor directly involved in manufacturing the product is direct labor. 3. Identification of overhead costs which are very much related to the cost object, but cannot be identified economically and comfortably with the cost object i.e. they can’t be identified directly with specific products of production. 4. Selection of the cost allocation base to use in assigning overhead costs to the cost object. As the overhead costs can’t be directly identified with the product some suitable base has to be developed to assign that costs to the production. 5. Overhead rate to be developed for allocation of overheads to the cost object. This is the ratio of overhead costs to the total quantity of cost allocation base.
Costing Methods :
Different costing methods
As per the specific nature, the different businesses, manufacturing Industries follow different methods to ascertain the cost of the product. There are different procedures for ascertaining the costing. However, the basic procedures of costing remain the same. Some of the costing methods are as mentioned below:
Unit Costing: This is also known as 'Single output Costing'. This costing method is used where products are manufactured in identical quantitative units and in continuous manufacturing industries. Costs are evaluated for units of output. Examples: Oil Exploration, Cement Manufacturing, Soap Making etc.
Job Costing: Under this, the costs are ascertained for each work order separately as each job has its own specifications and scope. Examples: Painting, Car repair, Decoration, Repair of building etc.
Contract Costing: Under this method costing is done for big jobs which involves heavy...