You have finished producing a commodity. It would help if you introduced it to the audience. How much are you going to ask for it? The solution to that query is product costing.
You must know your production costs to calculate the profit margin. Product costing is the method of determining expenses.
These expenses are related to producing a specific product. Overall cost includes using raw materials, labor, and overhead expenses specific to one unit.
Product costing is crucial for accounting experts. They need to evaluate inventory and determine the cost of products sold. Managers start with product costing when determining
1) What to produce?
2) How much to charge for those?
You can use various pricing techniques to get the product’s excellent selling price. This takes place after computing the cost per unit.
The cost per unit is a manufacturing performance statistic. It aids in monitoring production costs.
Factors of Product Costing
Direct Materials
The process must incorporate the raw materials used to manufacture the product.
Hence, direct materials are essential to take into account.
For example, if a company is producing chairs as its niche. The wood used to produce those chairs will be a part of the direct material.
Direct Labor
Direct labor consists of expenses related to labor. These include salary, incentives, insurance, and other payments made to workers in the production process.
Manufacturing Overheads
These cover the costs related to the factory.
They are indirectly part of the costs incurred during product production, including machinery costs. It comprises indirect labor costs as well as the indirect cost of materials.
Here, the indirect material cost would include the expense incurred on materials. For example, glue, nails, etc. The indirect labor cost would consist of the cost of employing security to guard the factory.
Easy Guide to Product Costing
Pinpoint the Cost Object
If your business produces standard products, you can use a single product as the cost object.
You can do the following if you manufacture customized goods. You can use project costing to calculate the expenses of a whole order.
Pool the Direct Costs
Add up all direct labor and material expenditures to produce a specific item.
As mentioned above, these would include the expenditure on labor costs employed in making the chairs. In contrast, direct materials would mean the wood used to make the chair.
Add up the Overhead Costs
1) Indirect labor (planning and control, management, quality assurance, managers, shop floor janitors, etc.).
2) Indirect materials (greases, nails, and other items used in production but not tracked).
3) Manufacturing overhead are some examples (rent, utilities, insurance, depreciation, etc.).
Overhead Cost Allocation Base
Simply combine the indirect costs and distribute them equally across your products.
You should distribute the overhead under the following condition. ‘How resource-intensive a product is for improved clarity and decision-making.’
The products that require more time or resources to produce use more overhead, and those that need less use less. The base for allocating overhead costs is equipment or labor hours.
Compute the Overhead Allocation Rate
You can ignore this action if you use the same overhead for all products. Employ the following calculation. If you use machine or labor hours:
Overhead Allocation Rate = Total Overhead/Total Hours
The overhead allocation rate would be as follows. If the expected monthly overhead was $12,000 and production staff worked an overall total of 400 hours:
12,000/400 = $30/hr
Assign the Overhead Costs
You have manufactured 300 products and applied the same overhead to each one. The formula would be:
Overhead cost per product = Total overhead / Total products
The overhead per product using the figures from the preceding example would be:
12,000/300 = $40
But, to apply the overhead allocation rate, you would need to know how much time it took to produce certain goods.
Consider that you produce three different items: cupboards, chairs, and tables. A wardrobe requires 3.75 hours to create, a chair requires 1.25 hours, and a table requires 2.5 hours.
Therefore, the overhead allocation would be:
Cupboard: 3.75 x 30 = $112.5
Chair: 1.25 x 30 = $37.5
Table: 2.5 x 30 = $75
Calculate Total Cost
Add the product’s direct costs to the overhead designated for it.
Consider that the table comprises a $60 tabletop and four $40 per set table legs. The direct material costs would be $100.
A further $30/hour labor charge goes to the employees who assemble and complete the table, one person at a time. Given that it takes 2.5 hours to complete one table, the labor expense is:
$30 x 2.5 = $75
Let’s calculate the cost per unit by adding the direct costs and the applicable overhead for each table.
CPU = Direct labor + Direct materials + Overhead
75 + 100 + 75 = $250
One table’s construction entailed $250 in production expenses.
You can use the figures you’ve come up with for your items’ cost per unit as a starting point for determining their ideal selling pricing.
Features of Product Costing
Product costing has several advantages. It opens your eyes to how simply you can expand your firm.
Project Tracking
Project tracking is the process through which a business allocates expenditures to different project phases. It monitors product costs to see if costs are in line with objectives.
Without accurate costing, it can be challenging to examine cash flows and establish if a project has been successful or not.
Costing is an essential component of project tracking. For increased precision, costing also assists in dividing up broad costs. This is done among many groups and departments.
Project Development
Modern product development is known as project development. Product costing may be a beneficial tool for a business.
This is because preparing to develop a brand-new line of products is difficult. Even redesigning an existing product with new attributes will be tricky.
Costing enables the company to assign particular costs to goods. This includes their components, capabilities, and features. Hence, it enables exact projections of product costs.
Decision Making
A company manager makes a lot of decisions. One of them is the return on investment and the potential profit from a certain course of action. Making these choices can be supported by considering the costs of the products.
For instance, a manager is accustomed to absorption costing. Here, all production-related expenses are allocated to individual items. They would not see the advantages of specific price agreements that do not seem to increase profit.
However, by employing variable costing, the management may find the agreement beneficial. Also, the only expenses that change are the variable costs.
Conclusion
If the cost of production is higher than the selling price of a product, manufacturers may have other choices.
Lowering their production expenses may be the first action they take.
Whether this isn’t possible, they might need to reevaluate their pricing policy and marketing plan to see if they can justify raising the price or promoting the product to a different target market.
Producers may halt operations briefly or permanently if neither of these alternatives succeeds.
Hence, producers need to keep track of their product costs to succeed in their business.
