COSTING MASTERCLASS • EXAM NOTES
The sequel to: Cost Accounting basics • Financial vs Cost Accounting
Costing Methods, Types and Techniques: The Cost Is Not Found. It Is Chosen.
Twenty-one costing ideas, each with a plain description box and a worked example box, built around one fictional factory.
0METHODS
0TYPES
0TECHNIQUES
0WORKED EXAMPLES
One Factory. One Month. Two Profits.
Kalinga Steelcraft makes 500 almirahs and sells 400 at Rs. 2,600. Same sales, same cash in the bank. Ask two costing methods for the profit and you get two different answers.
ABSORPTION COSTING SAYS
Rs. 1,35,000
Profit for the month
MARGINAL COSTING SAYS
Rs. 1,05,000
Profit for the month
Which one is true? Both. Rs. 30,000 of fixed factory overhead sits in the 100 unsold almirahs under one method and is expensed immediately under the other. Nothing physical changed. Only the question you asked the books changed.
That is the whole subject in one paragraph: cost is not a fact you find, it is an answer you choose, and the choice depends on the question. In our last two posts we asked what cost accounting is and how it differs from financial accounting. This post answers the sharper question: how do we actually cost, and why does the "how" change the answer?
That is the whole subject in one paragraph: cost is not a fact you find, it is an answer you choose, and the choice depends on the question. In our last two posts we asked what cost accounting is and how it differs from financial accounting. This post answers the sharper question: how do we actually cost, and why does the "how" change the answer?
The Map: Three Layers, Three Questions
Students lose marks by mixing these up. Keep them in three separate boxes and most of the syllabus sorts itself.
LAYER 1 • METHODS (8)
How is the work organised?
Job, batch, contract, process, operation, unit, operating (service), multiple. Chosen by the nature of production.
LAYER 2 • TYPES (6)
On what basis, and when, is cost measured?
Historical, estimated, standard, absorption, marginal, uniform. Chosen by the purpose of the information.
LAYER 3 • TECHNIQUES (7)
Which decision or control are we serving?
Budgetary control, ABC, target, life-cycle, kaizen, throughput, differential. Chosen by the management problem.
MIX AND MATCH
A firm uses one method but several types and techniques at once
Kalinga runs batch costing (method) with standard costing (type) and uses budgetary control and ABC (techniques) on top. They are not rivals; they answer different questions on the same shop floor.
SYLLABUS ALERT
Books classify differently
Some syllabi, especially professional-course material, list historical, standard, marginal, absorption and uniform costing under "techniques". Many university texts call them "types". This post uses the types and techniques split most universities follow. In the exam, use the heading your own prescribed book uses; the definitions and examples stay the same.
Your Core Five at a Glance
These five methods carry most exam questions: job, contract, process, single (unit or output) and service (operating) costing. Here is each on one line before the full treatment below, where they appear as methods 1, 3, 4, 6 and 7.
| Method | Cost is collected for | Unit of cost | Typical business | Remember |
|---|---|---|---|---|
| Job costing | One customer order | Per job | Printing, furniture workshop | Cost-plus quotation, no averaging |
| Contract costing | One large site project | Per contract | Construction, shipbuilding | Profit taken in stages on work certified |
| Process costing | Each stage of continuous production | Average per unit | Sugar, steel, chemicals | Normal loss absorbed, abnormal loss written off |
| Single (unit or output) costing | One uniform product | Per tonne, litre or 1,000 units | Bricks, cement, coal | Cost sheet |
| Service (operating) costing | A service, not a product | Per passenger-km, tonne-km, room-day | Transport, hospitals, hotels | Composite unit; standing, maintenance and running charges |
Choose What to Study
Tap a button to focus on one layer, or show everything.
8 Methods of Costing
Methods answer one question: how is the work organised? Match the method to the way the product is made.
1
Job Costing
METHODDESCRIPTION BOX
Cost is collected separately for each job, which is a single customer order made to specification. Every job gets a job number and a job cost sheet, and there is no averaging across jobs. The price is usually quoted as cost plus a profit margin.BEST FOR: Printing pressFurniture workshopRepair shopFoundry
EXAMPLE BOX
A hotel orders 10 customised almirahs. Kalinga opens Job No. 207.
| Direct material | 18,000 |
| Direct labour | 9,000 |
| Direct expenses | 1,500 |
| Prime cost | 28,500 |
| Factory overhead (100% of labour) | 9,000 |
| Office overhead (10% of factory cost of 37,500) | 3,750 |
| Total cost | 41,250 |
| Profit at 20% on cost | 8,250 |
| Quotation price (Rs. 4,950 per almirah) | 49,500 |
Exam hook: job number, job cost sheet, specific order, no averaging, cost-plus quotation.
2
Batch Costing
METHODDESCRIPTION BOX
A batch is a lot of identical units treated as one job. Cost is collected for the whole batch and divided by the units in it. Because each batch carries a one-time set-up cost, batch size becomes a decision, and the Economic Batch Quantity (EBQ) balances set-up cost against carrying cost.BEST FOR: GarmentsMedicine tabletsComponentsBakery
EXAMPLE BOX
Kalinga makes a batch of 200 locks.
| Material | 40,000 |
| Labour | 12,000 |
| Set-up cost (once per batch) | 8,000 |
| Batch cost (Rs. 300 per lock) | 60,000 |
Exam hook: batch = job of identical units; EBQ = square root of 2DS / C.
3
Contract Costing
METHODDESCRIPTION BOX
Used for large, long-duration work done at the customer's site, such as buildings, bridges and roads. Each contract has its own account, costs run across several years, and profit is recognised in stages as the architect or engineer certifies the work. Accounting standards follow the stage-of-completion idea; the traditional rule below is the exam staple.BEST FOR: ConstructionShipbuildingDams and roadsInfrastructure
EXAMPLE BOX
Kalinga builds a warehouse for a client. Contract price Rs. 50,00,000; cost to date Rs. 30,00,000; work certified Rs. 36,00,000; cash received is 80% of work certified (Rs. 28,80,000).
| Notional profit (36,00,000 less 30,00,000) | 6,00,000 |
| Work certified as % of contract price | 72% |
| Profit to P and L = 2/3 × 6,00,000 × 80% | 3,20,000 |
Exam hook: contract account, work certified, notional profit, cash received, retention, 25% and 50% rules.
4
Process Costing
METHODDESCRIPTION BOX
For continuous, mass production where the output of one process becomes the input of the next. Cost is collected process by process and averaged over the units produced. Normal loss is absorbed by good units, abnormal loss is charged to the Costing Profit and Loss Account, and joint products or by-products emerge at the split-off point.BEST FOR: SugarSteelChemicalsPaperCement
EXAMPLE BOX
Kalinga's rolling mill, Process 1: input 1,000 kg, total process cost Rs. 2,00,000, normal loss 10% (100 kg) sold as scrap at Rs. 20 per kg (Rs. 2,000).
| Net cost (2,00,000 less 2,000 scrap) | 1,98,000 |
| Expected good output (1,000 less 100 kg) | 900 kg |
| Cost per kg of good output | Rs. 220 |
Exam hook: normal loss absorbed, abnormal loss to Costing P and L, abnormal gain, equivalent units for work-in-progress.
5
Operation Costing
METHODDESCRIPTION BOX
Cost is worked out for each standard operation in the mass production of identical parts, then added up for the operations a product actually passes through. It refines process costing where parts take different routes through the same operations.BEST FOR: Auto partsHardwareElectronics assemblyBottling
EXAMPLE BOX
Kalinga's hinge line, cost per 1,000 hinges:
| Stamping | 8,000 |
| Drilling | 3,000 |
| Plating | 4,000 |
| Plated hinge: Rs. 15 each | 15,000 |
Exam hook: cost per operation, standard operations, combine only the operations used.
6
Unit (Single or Output) Costing
METHODDESCRIPTION BOX
For a single, uniform product measured in natural units such as tonne, litre or 1,000 bricks. Total cost for the period is divided by units produced to get cost per unit, normally presented as a cost sheet.BEST FOR: BricksCementCoal miningQuarriesDairy
EXAMPLE BOX
A brick kiln in the Kalinga group fires 2,00,000 bricks in a season.
| Clay | 2,00,000 |
| Labour | 2,50,000 |
| Fuel | 1,00,000 |
| Overheads | 50,000 |
| Total cost: Rs. 3 per brick, Rs. 3,000 per 1,000 | 6,00,000 |
Exam hook: cost sheet, natural unit, cost per unit = total cost / units.
7
Operating (Service) Costing
METHODDESCRIPTION BOX
For businesses that sell a service, not a physical product. Cost is measured per unit of service, such as passenger-km, tonne-km, room-day, patient-day or kWh, and is split into standing (fixed), maintenance (semi-variable) and running (variable) charges.BEST FOR: TransportHospitalsHotelsPower supplySchools
EXAMPLE BOX
A Kalinga truck runs A to B (60 km, load 10 tonnes) and B to C (40 km, load 6 tonnes). Trip cost: Rs. 4,200.
| Measure | Working | Cost per tonne-km |
|---|---|---|
| Absolute tonne-km | (10 × 60) + (6 × 40) = 840 | Rs. 5.00 |
| Commercial tonne-km | Average load 8 × 100 km = 800 | Rs. 5.25 |
Exam hook: composite unit; absolute = sum of load × distance per leg; commercial = average load × total distance.
8
Multiple (Composite) Costing
METHODDESCRIPTION BOX
Used when one product is made from many separate components, each with its own production pattern. Each component is costed by the method that suits it, and the component costs are added to get the final product cost.BEST FOR: AutomobilesBicyclesTelevisionsMachinery
EXAMPLE BOX
One Kalinga almirah, costed in four ways:
| Steel panels (batch costing) | 1,350 |
| Locks (operation costing) | 120 |
| Paint coating (process costing) | 230 |
| Final assembly (job costing) | 500 |
| Cost per almirah | 2,200 |
Exam hook: composite costing; several methods under one roof; add component costs.
6 Types of Costing
Types answer a different question: on what basis, and when, is cost measured? The same factory can run several types together.
1
Historical Costing
TYPEDESCRIPTION BOX
Cost is ascertained after it has been incurred, from actual records. It is accurate about the past but arrives too late to control anything, which is why it is called post-mortem costing. It is still useful for setting the next period's prices and for cost-plus contracts.BEST FOR: Stable industriesCost-plus contractsRecord keeping
EXAMPLE BOX
Kalinga closes October's books on 5 November. Actual cost per almirah: Rs. 11,00,000 / 500 = Rs. 2,200. The extra steel was already bought and used weeks ago, so the report records the overspend but cannot prevent it.Exam hook: after the event, actual cost, post-mortem; it says what happened, not what should have happened.
2
Estimated Costing
TYPEDESCRIPTION BOX
Cost forecast before production begins, based on past records adjusted for expected price changes. It is an informed guess, not a rigorously engineered target, and it is the basis of quotations, tenders and price fixing.BEST FOR: TendersJob workQuotations
EXAMPLE BOX
A school invites a tender for 200 almirahs. Last cost: Rs. 2,200. Steel is expected to rise 5% (Rs. 1,200 becomes Rs. 1,260, an extra Rs. 60). Estimated cost = Rs. 2,260 per unit, or Rs. 4,52,000 for 200. Adding a 15% margin gives a quote of Rs. 5,19,800.Exam hook: forecast before production; based on past experience; used for quotations; less scientific than standard costing.
3
Standard Costing
TYPEDESCRIPTION BOX
Standards for each cost element are set scientifically, using time and motion studies, engineering specifications and price quotes. Actual cost is then compared with standard, the variances are analysed, and managers act only on the exceptions. It works best in repetitive manufacturing.BEST FOR: Repetitive manufacturingFMCGAutomobiles
EXAMPLE BOX
Standard: 24 kg of steel at Rs. 50 = Rs. 1,200 per almirah. For 500 almirahs the standard quantity is 12,000 kg. Actual: 13,000 kg bought and used at Rs. 52.
| Usage variance = (12,000 less 13,000) × 50 | 50,000 Adverse |
| Price variance = (50 less 52) × 13,000 | 26,000 Adverse |
| Material cost variance (standard 6,00,000 vs actual 6,76,000) | 76,000 Adverse |
Exam hook: standard vs actual, variance, management by exception. Standard = scientific; estimate = past-based.
4
Absorption (Full) Costing
TYPEDESCRIPTION BOX
All manufacturing costs, both variable and fixed, are absorbed into the product. Stock is valued at full production cost, so part of the fixed overhead sits in closing stock and moves into the next period. External financial reporting follows this approach.BEST FOR: External reportingStock valuationLong-run pricing
EXAMPLE BOX
Facts for this and the next point: produced 500, sold 400 at Rs. 2,600; variable cost Rs. 1,650 per unit; fixed factory overhead Rs. 1,50,000 (Rs. 300 per unit); office and selling costs Rs. 1,25,000 treated as fixed period costs.
| Sales (400 × 2,600) | 10,40,000 |
| Cost of goods sold (400 × 1,950) | 7,80,000 |
| Gross profit | 2,60,000 |
| Less office and selling costs | 1,25,000 |
| Profit | 1,35,000 |
Exam hook: full cost, fixed overhead carried in stock, profit rises when stock rises.
5
Marginal (Variable) Costing
TYPEDESCRIPTION BOX
Only variable costs are charged to the product. Fixed costs are written off in full in the period as period costs, and stock is valued at variable cost. Profit moves with sales instead of production, and contribution (sales less variable cost) drives break-even and decision analysis.BEST FOR: Short-term decisionsBreak-even analysisInternal reporting
EXAMPLE BOX
Same facts as the previous point.
| Sales | 10,40,000 |
| Variable cost (400 × 1,650) | 6,60,000 |
| Contribution (Rs. 950 per unit) | 3,80,000 |
| Less fixed costs (1,50,000 + 1,25,000) | 2,75,000 |
| Profit | 1,05,000 |
Exam hook: contribution, period cost, stock at variable cost; profit difference = change in stock × fixed overhead per unit.
6
Uniform Costing
TYPEDESCRIPTION BOX
Not a new way of calculating cost, but a common set of principles, formats and definitions adopted by several firms in one industry, or by the units of one group. It makes cost figures comparable, usually through a trade association.BEST FOR: Trade associationsGroup companiesRegulated industries
EXAMPLE BOX
Steel-furniture makers (a fictional association) report in one format. Kalinga compares itself with the industry benchmark per almirah:
| Element | Kalinga | Industry | Gap |
|---|---|---|---|
| Material | 1,200 | 1,140 | +60 |
| Labour | 400 | 410 | -10 |
| Direct expenses | 50 | 50 | 0 |
| Overheads | 550 | 500 | +50 |
| Total | 2,200 | 2,100 | +100 |
Exam hook: common principles, inter-firm comparison; needs willingness to share data.
7 Techniques of Costing
Techniques answer the manager's question: which decision or control problem are we solving? Each is a tool you can lay on top of any method.
1
Budgetary Control
TECHNIQUEDESCRIPTION BOX
Budgets, which are financial plans for a future period, are set for every department. Actual results are compared with budget regularly, variances are investigated, and corrective action is taken. Flexible budgets adjust the plan to the actual level of activity.BEST FOR: PlanningCoordinationDepartment accountability
EXAMPLE BOX
Budget: 500 almirahs at Rs. 2,600 = Rs. 13,00,000. Actual: 460 at Rs. 2,600 = Rs. 11,96,000. Sales variance: Rs. 1,04,000 Adverse, entirely from a volume shortfall of 40 units × 2,600. The sales team investigates the lost orders, and production for next month is trimmed to avoid piling up stock.Exam hook: plan, compare, investigate, correct. A budget is a total for the department; a standard is a rate per unit.
2
Activity-Based Costing (ABC)
TECHNIQUEDESCRIPTION BOX
Overhead is first traced to activities such as set-ups and inspections using cost drivers, then charged to products according to the activities each one uses. This replaces a single blanket basis like labour hours and exposes the products that quietly consume more overhead.BEST FOR: Many productsHigh overheadsComplex operations
EXAMPLE BOX
Overhead pool Rs. 1,00,000: set-ups Rs. 60,000 (30 set-ups = Rs. 2,000 each) and inspections Rs. 40,000 (200 inspections = Rs. 200 each).
| Model | Units | Set-ups | Inspections | Overhead | Per unit |
|---|---|---|---|---|---|
| Standard | 300 | 10 | 80 | 36,000 | 120 |
| Premium | 200 | 20 | 120 | 64,000 | 320 |
Exam hook: activities, cost drivers, cost pools, cross-subsidisation.
3
Target Costing
TECHNIQUEDESCRIPTION BOX
Start with the price the market will pay, subtract the profit you need, and what remains is the maximum cost allowed. If the product's estimated cost is higher, the gap must be engineered out through redesign and value engineering before launch. It flips cost-plus pricing into price-minus costing.BEST FOR: New productsCompetitive marketsDesign stage
EXAMPLE BOX
The market will pay Rs. 2,400 for an economy almirah. Kalinga needs a 20% margin on price.
| Market price | 2,400 |
| Required profit (20% of price) | 480 |
| Target cost | 1,920 |
| Current estimated cost | 2,050 |
| Gap to engineer out | 130 |
Exam hook: price less profit = target cost; works at the design stage; value engineering.
4
Life-Cycle Costing
TECHNIQUEDESCRIPTION BOX
Tracks every cost of a product or asset across its life: research, design, purchase, installation, running, maintenance and disposal. Because most lifetime cost is locked in at the design and purchase stage, it stops managers from choosing the option that is cheap now and costly later.BEST FOR: Machinery purchaseInfrastructureLong-life products
EXAMPLE BOX
Kalinga compares two powder-coating machines over 5 years (ignoring time value of money, for simplicity).
| Cost item | Machine A | Machine B |
|---|---|---|
| Purchase | 12,00,000 | 9,00,000 |
| Installation | 1,00,000 | 1,00,000 |
| Running and maintenance (5 years) | 7,50,000 | 12,00,000 |
| Resale value | (1,00,000) | 0 |
| Lifetime cost | 19,50,000 | 22,00,000 |
Exam hook: cradle to grave, total cost of ownership, design stage locks in cost.
5
Kaizen Costing
TECHNIQUEDESCRIPTION BOX
A Japanese-origin technique of continuous, small cost reductions during the manufacturing stage, after the product has launched. A reduction target is set each period against the last period's actual cost, and workers contribute improvement ideas. It complements target costing, which works before launch.BEST FOR: Mature productsLean factoriesShop-floor culture
EXAMPLE BOX
Kalinga sets a kaizen target of Rs. 6 less conversion cost per almirah every month. After 6 months the saving is Rs. 36 per unit, which on 500 units is Rs. 18,000 a month, the same amount once lost to scrap. No big project, just small steps that compound.Exam hook: continuous improvement, after launch, small cumulative steps. Target costing = before launch; kaizen = after.
6
Throughput Costing
TECHNIQUEDESCRIPTION BOX
Built on the Theory of Constraints. Only direct material is treated as a truly variable product cost; labour and overheads are operating expenses of the period. Throughput is sales less direct material, and the goal is to maximise it by managing the bottleneck.BEST FOR: Bottleneck operationsShort-term profit decisions
EXAMPLE BOX
Kalinga's month:
| Sales | 13,00,000 |
| Less direct material | 6,00,000 |
| Throughput (Rs. 1,400 per almirah) | 7,00,000 |
| Operating expenses (labour, direct expenses, all overheads) | 5,00,000 |
| Profit | 2,00,000 |
Exam hook: throughput = sales less direct material; bottleneck; Theory of Constraints.
7
Differential (Incremental) Costing
TECHNIQUEDESCRIPTION BOX
Compares the extra revenue and extra cost of one alternative against another. Only costs that change between the alternatives are relevant; sunk costs and unchanged fixed costs are ignored. It is the workhorse for make-or-buy, special orders, shut-down and product-mix decisions.BEST FOR: Special ordersMake or buyShut-down decisions
EXAMPLE BOX
A dealer offers Rs. 1,900 each for 100 almirahs, below the full cost of Rs. 2,200. Kalinga has spare capacity and the order will not disturb regular prices.
| Incremental revenue (100 × 1,900) | 1,90,000 |
| Incremental cost (100 × 1,650 variable) | 1,65,000 |
| Incremental profit: accept | 25,000 |
Exam hook: relevant cost, sunk cost, incremental revenue less incremental cost.
Method Picker: Test Yourself on 8 Businesses
Tap a business and see which costing method fits, and why. Try guessing before you tap.
Tap any business above. The best-fit method and the reason will appear here.
Quick Self-Test
Answer in your head first, then tap to reveal.
Q1.A shipyard builds one vessel over three years at the buyer's own yard. Which method applies?
Contract costing. It is large, long-duration, site-based work with stage-wise certification and profit recognition.
Q2.Kalinga produces 500 and sells 400. Which type shows the higher profit, and why?
Absorption costing (Rs. 1,35,000 vs Rs. 1,05,000). Rs. 30,000 of fixed factory overhead is carried forward in the 100 unsold units instead of being expensed.
Q3.Which technique begins from the market price and works backwards to the allowed cost?
Target costing. Price less required profit equals target cost; the gap to current cost is engineered out before launch.
Q4.Cost per tonne-km is the unit of which method?
Operating (service) costing. It uses a composite unit because a transport business sells movement, not a physical product.
Q5.Why can a special order priced below full cost still be worth accepting?
Differential costing. With spare capacity, only incremental cost matters. At Rs. 1,900 against Rs. 1,650 variable cost, each unit adds Rs. 250 of profit, provided regular prices are not disturbed.
Last-Minute Revision
Methods (8): job, batch, contract, process, operation, unit, operating (service), multiple.
Types (6): historical, estimated, standard, absorption, marginal, uniform.
Techniques (7): budgetary control, ABC, target, life-cycle, kaizen, throughput, differential.
One-line rule: method organises, type measures, technique decides.
Formulae: EBQ = square root of 2DS / C • Contract profit = 2/3 × notional profit × cash / certified • Target cost = price less profit • Throughput = sales less direct material.
Key reconciliation: absorption profit less marginal profit = change in stock units × fixed overhead per unit.
The Last Word
The cost is not found. It is chosen.
Go back to the opening numbers. Rs. 1,35,000 or Rs. 1,05,000. The money in Kalinga's bank account is identical under both. Only the story the books tell has changed, and both stories are honest, because each answers a different question.
Every method in this post is a lens. Job costing asks which customer? Process costing asks which stage? Standard costing asks what should it have cost? Target costing asks what is it allowed to cost? ABC asks who is really consuming the overhead? Pick the wrong lens and the numbers will be tidy, precise and wrong.
Here is a sentence worth carrying into any exam hall: method organises, type measures, technique decides. And here is a question worth leaving with any classroom: if profit moves by Rs. 30,000 while nothing physical happens, what exactly is profit? A fact, or a report?
So the next time someone asks, "What does it cost?", answer like a costing professional: "For which decision?"
Taxloom Academy • Finance, taxation, capital markets and CA/CMA/CS exam preparation. The Kalinga Steelcraft factory, its group units, the trade association and all figures are fictional and used for teaching only.