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Cost Systems: Characteristics, Types

 The cost systems are the framework used by companies in order to estimate the cost of their products in order to calculate profitability analysis, inventory valuation and cost control.


Estimating the exact cost of products is critical to profitable operations. A business must know which products are profitable and which are not, and this can only be determined if the correct cost of the product has been calculated.


In addition, a product costing system helps estimate the closing value of materials inventory, work in process, and finished goods inventory, in order to prepare financial statements.


A typical costing system works by tracking raw materials as they go through different stages of production and slowly being converted into finished products in real time.


When raw materials are brought into production, the system immediately records the use of these materials by crediting the raw materials account and debiting the work-in-process account.


Since most products go through many stages before they can be called finished products, at the close of a period there are often several different work-in-process accounts.


In a manufacturing environment, various types of costs contribute to making the product. Accounting for these costs in financial and managerial reports improves understanding of the profitability of the manufacturing operation and enables decision making.


Characteristics

The real-time component of the cost system is its most valuable feature. Management can make decisions based on current data and does not have to wait for it to be added to reports at the end of the period. This important feature is not always easily achieved.


In a costing system, the allocation of costs is carried out on the basis of a traditional costing system or an activity-based costing system. The traditional costing system calculates a single expense rate and applies it to each job or department.


On the other hand, the activity-based costing involves the calculation of the activity rate and the application of overheads to the products based on the respective use of each activity.


Cost basics

Materials

Direct materials and indirect materials.


Workforce

Direct labor and indirect labor.


Variable overhead

- General production expenses, including manufacturing personnel.


- General administrative expenses, including office staff.


- General sales expenses, including the production and maintenance of catalogs, advertising, exhibitions, sales personnel, cost of money.


- General distribution expenses


- Maintenance and repair, both office equipment and factory machinery.


- Supplies


- Public services, which include gas, electricity, water and municipal assessments.


- Other variable expenses


Fixed overhead

- Salaries / payroll, including salaries, pensions and deductions.


- Occupancy (rent, mortgage, property taxes)


- Depreciation (durable goods, including office machinery and equipment)


- Other fixed expenses


These categories are flexible and sometimes overlap. For example, in some companies, machine cost is segregated from overhead and reported as a separate item entirely, and payroll costs are sometimes separated from other production costs.


Depending on whether or not fixed manufacturing overheads are charged to products, cost systems have two variants: direct or variable cost, and absorption cost.



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