How to Calculate Product Costing

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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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