Process of Product Costing

The process of product costing is an important procedure in the business operations of a company. Product costing involves not only determining the selling price of a product but also calculating production costs, operational costs, and other factors such as desired profit.

In this article, we will explore the process of product costing and the specific steps to carry it out. From identifying the components of production costs to applying rational pricing methods, we will delve deep into this process to understand and effectively implement it.

I. What is product costing?

Product costing is an important concept in managerial accounting, particularly for manufacturing companies. Product costing refers to the total amount of money that a company must invest to produce a specific product or service. It includes both direct and indirect costs related to the production process, such as raw materials, labor, machinery, electricity, rent, management, warranty, marketing, etc.

The formula for calculating the product cost is as follows:

• Product Cost = Beginning Work in Progress + Total Costs Incurred during the Period - Ending Work in Progress

Where:

• Beginning Work in Progress represents the cost of unfinished products carried over from the previous period.
• Total Costs Incurred during the Period refers to the total costs that the company incurred for production in the current period.
• Ending Work in Progress represents the cost of unfinished products carried over to the next period.

Example: Suppose a bakery has the following information:

• Beginning Work in Progress: 10 million VND
• Total Costs Incurred during the Period: 100 million VND
• Ending Work in Progress: 5 million VND
• Number of completed bread loaves in the period: 50,000 pieces

According to the above formula, the product cost of the bakery is:

• Product Cost = 10 + 100 - 5 = 105 million VND

The cost per bread loaf is:

• Cost per Bread Loaf = Product Cost / Number of completed bread loaves = 105 / 50,000 = 2,100 VND per loaf.

II. Methods of Product Costing

The methods of product costing are ways to determine the costs related to the production process of a product or service. Several different methods can be applied depending on the purpose and nature of the production activities. Here are some commonly used methods:

1. Direct Method (Simple Method)

This method calculates the product cost based on the total direct costs associated with the production of that product, such as direct materials, direct labor, and direct overhead costs. Indirect costs are not included in the product cost. This method is usually easy to implement and applicable to small-scale businesses or simple products.

2. By-Product Exclusion Method

This method is used to calculate the product cost for production activities that generate multiple different products from the same process, including some main products and some by-products. This method excludes the value of by-products from the total production costs to find the cost of the main product.

3. Step-Down Method

This method is used to calculate the product cost for production activities that involve multiple steps or stages. This method calculates the cost for each step or stage and adds them up to find the final product cost.

4. Job Order Method

This method calculates the product cost for production activities based on the specific requirements of customers, which are unique and specific. This method calculates the cost for each job order based on the actual costs incurred to complete that order.

5. Standard Costing Method (Ratio Method)

This method calculates the product cost based on predetermined standards and regulations for materials, labor, and other costs. This method calculates the product cost by multiplying the quantity of materials, labor, and other costs by the standard unit prices.

6. Factor Method

This method calculates the product cost based on a transformation factor determined by the ratio between indirect costs and direct costs. This method calculates the product cost by adding the direct costs to the indirect costs, which are calculated by multiplying the direct costs by the transformation factor.

Each method of product costing has its advantages and limitations. Businesses need to consider their scale, characteristics, and business objectives to choose the appropriate method for accurately and reasonably calculating the product cost.

III. Steps for Product Costing

This process involves the following steps:

• - Compilation of production costs:

This is the first step in the product costing process. These costs can be obtained from accounting documents such as purchase invoices, payroll records, expense receipts, cost sheets, etc.

• - Cost allocation:

After gathering the production costs, the next step is to allocate these costs to production units such as products, services, processes, or departments. The purpose of cost allocation is to determine the cost for each production unit reasonably and fairly. Cost allocation methods can be based on volume, activity, or value-added.

• - Selecting the method of product costing:

Depending on the type of production, the nature of the product, and the business objectives, different methods of product costing can be applied, such as job order costing, process costing, or activity-based costing. Each method has its advantages and disadvantages, so it is important to choose the most suitable method based on the conditions and requirements of the business.

• - Calculation of the quantity of completed and unfinished products:

To calculate the cost of completed products and unfinished products at the end of a period, it is necessary to determine their quantities. This can be done by adding the number of completed products at the beginning of the period to the number of products completed during the period and subtracting the number of products sold during the period. The quantity can also be verified through physical inventory counts.

• - Evaluation of the value of unfinished products:

Unfinished products are products that are not yet completed in the production process at the end of a period. To calculate their cost, it is necessary to evaluate the degree of completion for each cost element (direct materials, direct labor, and overhead costs). The degree of completion can be determined using technical indicators such as volume, time, or capacity.

• - Calculation of the value of completed products:

After determining the quantity and degree of completion of completed and unfinished products, the next step is to calculate their values. The value of a completed product is equal to the total cost of direct materials, direct labor, and allocated overhead costs for that product. The value of an unfinished product is equal to the total cost of direct materials, direct labor, and allocated overhead costs for that product multiplied by its degree of completion.

• - Calculation of the cost of each type of product:

Finally, to calculate the cost of each type of product, it is necessary to add the value of completed products at the beginning of the period to the value of completed products during the period and subtract the value of unfinished products at the end of the period. The result obtained is the cost of each type of product during the period. This is the final step in the product costing process, providing detailed information about the costs of each type of product to support business decisions.

IV. Conclusion

In summary, to accurately and effectively calculate the product cost, businesses need to identify costs related to production, distribution, and sales; choose an appropriate method of product costing for the type of product; and determine a reasonable selling price to maximize profitability and competitiveness.