Concepts of costing

Concepts of costing

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Costing concepts is a way in which management plans to set objectives and control the set goals so as to achieve profitability with minimal costs. There are different costing concepts such as Activity based costing and standard costing which assist in making financial reports, preparing planning budgets and making decisions in organizations (Baker, 1998).

How they are applied is as elaborated below:

Activity based costing

This is a system that allows breaking down of each activity and assigning costs with resources that measure the element of work. It is a method that measures the cost and performance of activities, resources and objectives that enable generating of meaningful information for better decision making. Management of companies has implemented this system to justify investments in new technology to, increase competitiveness and profitability. It enables a business to decide what products, resources or services are contributing to losses or increasing their profits. It uses volume and non volume based cost drivers to allocate indirect costs to products. ABC allows business to collect data on their operating cost. The costs are allocated to particular activities like manufacturing, planning and engineering and they are related to different services or products. Managers use it to create budget and to gain understanding of expenses that keeps the company running.

A value-added cost are cost that affect products value to the customer when eliminated while non value added costs are costs that can be eliminated without affecting the products.

A diagram explaining how an Activity Based Costing works and how it differentiates from Traditional costing.


Standard costing

This system is based on determination of costs that are associated with manufacturing a product based on direct labor, direct material and manufacturing overheads. This assists management in identifying the variances as a result of difference between actual cost and standard cost. When actual cost is less than standard cost the variance is favorable but if it is greater it is unfavorable, meaning the profits will be less than planned. Standards are used everywhere for instants standard of cleaning and weight standard. Standards are used in management accounting where they relate to the quantity and cost of inputs used in producing services and manufacturing goods. Recently cost account of recording historical costs takes it further; by the way it allocates the company’s fixed costs for a given period of time to the items produced within that period, and records the result as the total cost of production.

Our business uses variances from its standard costing to target the problem areas for improvement. When the production variance exceeds 10% of sales, the manager responsible requires a variance to propose a plan of action to correct the detected problem. Traditionally variances were reported at every end month but modernly they are reported daily after the completion of work and the summary variance weekly.


Identify Questions → Receive Explanations → Take Corrective Actions

↑       ↓

Analyze Variances       Conduct Next Period’s Operations

↑ ↓

 ← ← Prepare Standard Cost Performance Report ← ←

  BEGIN Q1. What is the purpose of standard costing in budget creation?

Standard cost helps a company to create its annual budget. this assists to plan for the upcoming year by estimating and calculating the standard costs for labor and materials as well as presenting the information to the production managers. This gives a road map for future production expenditures with planned budgets for ideal lax and practical standards.

Q2. What are the limitations of activity based costing?

Several costs require allocations to products and departments based on random volume measures because getting the activity that brings about to the cost is impractical.

Services or Product costs recognized by an ABC system are most likely to be omitted for instance when costs are associated with the service or product.

Expense and time

An ABC system consumes time and it is expensive to develop and implement. The organization that is using traditional volume-based costing system and wish to install a new ABC system then it is likely to be very expensive, since it requires a longer time for successful development and implementation.


Activity based Costing and Standard costing main purpose is to reduce costs and promote efficiency. They both support strategic decision making in planning, monitoring and control.


Baker, J. J. (1998). Activity based costing and activity based management for health care. (pp. 2-

17). USA: Aspen Publishers.

Lucey, T. (2002). Costing. (6th ed., pp. 24-58). China: C&C Offset printingCo. Ltd.