Product costing is used by accountants and business owners
to determine both individual product costs and the total cost of goods sold.
When you keep track of costs in this manner, you have a better chance of
maximizing revenue and reducing expenses. Find out more about the advantages of
using a product costing system.
What Is Product Costing?
Product costing is used by accountants and business owners
to calculate both individual product costs and the total cost of goods sold.
When you keep track of costs in this manner, you have a better chance of
increasing revenue and reducing expenses. Learn more about the advantages of
using a product costing system.
Factors to Include in Product Costing
Product costing necessitates an in-depth examination of
various outgoing expenses. Here are the most important cost factors to
consider:
Labor expenses: To complete any type of activity-based
costing, you must first track how much labor you spend to create the goods.
Wages and other benefits provided to your own employees are considered direct
labor costs. In contrast, indirect labor costs are expenses incurred as a
result of tangentially related supervisors or outside contracts.
Manufacturing overhead costs: To ensure accurate product
costing, you'll need to keep track of all your manufacturing overheads. These
could include factory lease or insurance payments, for example. These are also
required elements to appear on GAAP financial statements (generally accepted
accounting principles).
Raw materials: Keep track of any direct or indirect
materials used in the manufacturing of a specific good. Direct materials are
the building blocks of a product, whereas indirect materials may include
screws, glue, and other small items required to realize the design.
How to Calculate Product Costing
Product costing necessitates a straightforward methodology.
To ensure that you price your products accurately, follow these steps:
Identify the new product. Before you begin, decide on
the product for which you will be running the numbers. The goal is to determine
the unit cost of a single product, so be as specific as possible. Once you've
determined the cost of one item, you can extrapolate that cost to a larger
scale. This is far more straightforward than looking at costs in aggregate and
attempting to break them down to a smaller scope.
Quantify overhead cost allocation. It is easier to quantify
a product's labor and material costs than it is to quantify its overhead
expenses. To determine overhead cost allocation, add up all indirect expenses
and divide them by the number of hours your company spends manufacturing this
specific product. Routing the overhead information into the rest of your
calculations will be simple if you use this standard cost formula.
Track individual cost components. At this point, consider
the cost of materials and direct labor. Examine each stage of the manufacturing
life cycle from start to finish. Multiply the number of hours your employees
spend making one of these products by the cost of their wages and benefits per
hour. Add up the costs of all the materials used in the manufacturing process.
Work on cost control. Using the data you've gathered,
estimate the total cost of an individual product as well as the total cost of
producing it. Now that you have this information, you can work on reducing
expenses to meet a lower target cost, allowing you to save money while
increasing profits.
Problems with Product Costing
Product costing may be useful, but it is not without flaws.
When using this type of management accounting, you may still encounter some
issues.
For one thing, when using this method, you must be extremely
precise in order to obtain the actual costs of goods. If even one small data
point is incorrect, the entire calculation will fail. If you intend to use this
information for financial reporting, it's even more important to get your
expenditure and income statements right the first time.
Furthermore, while product costing provides an in-depth look
at a product's variable costs, it does not allow you to compare it to the
prices of similar goods sold by your competitors. To compete in the market, aim
to price your product in a way that generates a profit in addition to recouping
the costs indicated by this method. Still, look at similar products on the
market so you don't overprice your own, as this may turn off customers.
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