The decision to implement a new or change a current product costing system requires a lot of research and pre-planning. In order to determine the most effective product costing system management must decide which costs should be included in the product costs, at what level will direct costs be tracked, how indirect costs will be structured, and when to capture the indirect costs. Once all the costs have been identified and organized into fixed, variable, or overhead categories, management must then decide which product costing system would provide the output information necessary for important business decisions.
Comparison of the Product Costing Systems
Prior to the Industrial Revolution, businesses were able to set costs based on the market prices of the local goods necessary to produce the product. The inventions of the Industrial Revolution laid the groundwork for products to be fully integrated under one roof which created a need for managers and executives to develop a way to control costs and create financial reports that were able to assist in day-to-day operational decisions. As manufacturing companies grew managers were faced with new economic problems such as (1) Managers requiring records of raw material supplies in order to control inventory (2) A system of tracking payroll payments that would lower the risk of fraud (3) A way to track the useful life of equipment and a way to track replacement items (4) A way to track variable and fixed costs that would aid managers in setting prices and (5) A way to track product costs from different periods (Garner, 1947). Modern day cost management techniques were born out of the struggle of early managers and accountants to find the most effective way to find solutions to the economic problems they faced. This paper will identify and compare the product costing systems used by management to identify the cost per unit during each stage of the production process. The Basics of Product Costing
Before determining which type of costing system would be most beneficial for a company to use, the management must understand the basic concepts behind the information used to determine the price per unit. There are three major categories of costs: direct materials, direct labor, and overhead. Direct materials are items such as raw materials, parts, and assembly components used to complete a product. According to Hilton, Maher, and Selto (2012) the assembly components used to complete a product are only considered direct materials when “the costs of observing the use of the resource is less than the benefit of doing so” (p. 46). Direct labor is the cost of compensation for employees who are directly involved in the production process. As noted by Deo and Penkar (2010) direct labor costs “include the costs of conducting specific tasks, which include wages, related benefits, overtime, direct administrative, and vehicle-related costs” (p. 3). Overhead costs are all other costs necessary for production process but that do not directly contribute to the end product. Overhead costs normally include indirect material, indirect labor, and other costs not immediately associated with the production process. Indirect materials are those that are “(1) not a part of the finished product but are necessary to manufacture it or (2) are part of the finished product but are insignificant in cost” (Hilton et al., 2012, p. 46). Indirect labor includes the compensation for employees who do not work on the product but are nonetheless necessary for the production of the product. An example of indirect labor would be material-handlers and production supervisors. Other costs included in overhead costs are insurance expenses, utility costs, depreciation, and support services costs. Costing systems are based on classifying materials and labor into periodic costs based on if they are variable or fixed in nature. Variable costs vary with the output of the organization while remains unchanged...