Introduction to costing systems

Definition of costing system

A costing system is a system for collecting information about costs of an organization’s products or services.

Costing system is an integral part of cost and management accounting.  So, before discussing in detail what a costing system is, let’s recall the purpose of cost and management accounting i.e., assisting the management of a business in:

  • decision making,
  • planning business activities, and
  • controlling business activities.

Management needs different information to perform the above mentioned tasks, and in particular, it needs information related to costs. This is where the role of a costing system comes in.

Here are some examples where management needs information about the cost of its products or services:

  • Pricing decisions usually require information about the cost of the product, so that the price set covers the cost of the product and has some profit element.
  • Deciding on whether to produce a component in-house or buy it from the market, you need to know the cost your in-house component to compare it with the purchase price.
  • For planning and budgeting, product cost of previous period can be used to predict the budgeted costs and accordingly, finances can be arranged.
  • Monitoring of business activities can be done by comparing the actual costs of production with the budgeted costs.

Types of costing systems

A costing system is a system for collecting information about costs, designed to meet an organization’s information needs depending on how its products are manufactured or services are rendered. Every organization will have its own costing system customized according to its own information requirements and preferences, so you’ll not find identical costing systems in different organizations. However, as organizations operating in same industry usually have similar nature of business activities, so the costing systems of such organizations will also have some common features.

For instance, all companies operating in cement manufacturing industry will have similar costing systems. Similarly, all costing systems of professional accountancy firms will have some common features.

Depending on the suitability of a costing system to an organization’s nature of business activities and its goods or services, any of the following costing systems can be adopted:

All these costing systems are explained in detail along with examples in the coming articles. You can refer the above links in order to understand how these costing systems work.