productcosting

Product costing is the process of determining the total cost of producing a product or delivering a service. It consolidates all costs that can be linked to a cost object, including direct materials and direct labor, plus overhead. Overhead captures indirect expenses such as utilities, depreciation, and maintenance that support production. Costs are typically categorized as fixed or variable, and as direct or indirect relative to the cost object.

Traditional or absorption costing assigns all manufacturing overhead to products using a predetermined overhead rate based on a cost driver such as direct labor hours or machine hours. This method supports external financial reporting and inventory valuation under accounting standards like GAAP and IFRS. Variable costing, or marginal costing, allocates only variable manufacturing costs to the product and treats fixed overhead as a period expense; it is often favored for decision making and contribution margin analysis.

Activity-based costing (ABC) improves accuracy by assigning overhead according to activities that consume resources, using cost pools and activity measures. Standard costing employs predetermined costs for materials, labor, and overhead, with variances between actual and standard costs analyzed to monitor performance.

Target costing and life-cycle costing address market and long-term considerations. Target costing aims to achieve a desired price by constraining total costs, while life-cycle costing accounts for costs incurred throughout a product’s life, from development to disposal.

Key purposes of product costing include pricing decisions, budgeting, profitability analysis, product mix optimization, inventory valuation, and performance measurement. Limitations include data collection effort, complexity of allocation, and potential misallocation of overhead.