Costing System

The costing system is the foundation of the internal financial information system for managers in any organization.

To plan and control all the activities of the organization and to make decisions about the future, management needs information which is provided by the costing system.

What is the COST?

The word cost can be used as a noun when it is referred to as the “cost of an item”. On the other hand, it can be used as a verb, when we say to attempt to “cost an activity”.

The word Cost has many different types, usefulness, and limitations in different circumstances.

COST Units

This is a unit of product or service relative to which cost is determined.

Sector – IndustryCOST Unit
EducationStudents’ Enrolment
Professional ServicesChargeable Hour
Power SupplyKilowatt per Hour
Component Making1000 Components
ActivityCOST Unit
SaleCustomer Call
Credit ControlAccount Maintained

COST Units Composite

Services are usually intangible, due to which, the cost of units are often composite cost units and made up of two parts.

BusinessCOST Unit
HospitalPer Day Per Patient-in
Traveling CompanyPer Passenger Per Mile
HotelPer Bed Per Day/Night

COST Centers

For which costs are accrued, either its function, service location, an item of equipment or production.

COST CenterExample
EquipmentPacking Machine
ActivityQuality Control
FunctionSales Representative
Service LocationStores, Canteen

COST Objects

Anything for which costs can be established is Cost objects. For example, a product, service, activity, center, etc.

Cost’s Classification

The cost can be classified in many different means. Cost’s grouping depends upon the purpose of the classification exercise.

In order to devise an effective system to gather and analyze the costs, it is essential to be able to categorize all costs to be able to organize them into logical groups,

Cost’s Classification According to Their Nature

Cost is grouped according to its nature whether it is material, labor or expense.

Material Cost: Includes obtaining the material and receiving within the organization, carriage inwards.

Labor Cost: Includes wages and salaries and related to the cost of employment.

Expense Cost: Includes all costs other than Material and Labor. For example, rent, power, postage, utility, etc.

These classifications can be further subdivided which may include the following:
  • Raw Material
  • Components
  • Consumables
  • Maintenance Material

This list may even be further subdivided according to their type.

Cost’s Classification According to Their Purpose

Cost is grouped according to its reason. The broader classification of this kind of cost is to divide the cost into Direct Cost and Indirect Cost.

Direct Cost: A direct cost that is directly identified with the object we are trying to cost. Usually, Direct cost is the combined cost of Direct Material Cost, Direct Labor Cost, and Direct Expenses.

Direct Material Cost: Any material, component, or raw material which is directly utilized to manufacture any unit of product or good is Direct Material. For example, suppose that a fixture maker is defining the cost of a wooden chair. The manufacture of the chair has involved the use of wood, bolts and metallic drawer handles.

Direct Labor Cost: Any wages paid to the machine operator, assembler or finisher who are directly involved to produce a unit of product or good for instance chair.

Direct Expenses: Direct expense would be the payment made to the designer of the chair who may be entitled to a royalty payment for each chair made.

Indirect Cost: All cost other than Direct Cost is classified as Indirect Cost. Although it is incurred in the production of the chair, it cannot be directly attributed to a particular cost unit. Examples are as follows:

COST IncurredCost Classification
Material related to Lubrication Oils and
Cleaning Material
Indirect Material Cost
Salaries of Floor SupervisorIndirect Labor Cost
Rent of Factory, PowerIndirect Expense

It is important to understand that a particular cost may sometimes be direct cost and sometimes an indirect cost depending on the cost object.

For example, the Salary of the Floor Supervisor is the Direct Cost of that Particular Department.

However, it is an indirect cost of each unit produced because it cannot be specifically identified with any particular cost unit.

Cost’s Elements

The elements of costs are the essential parts of cost which structure the total cost of a cost object.

Let’s See the framework of cost statement for a single cost unit demonstrations, how the total or full cost for a unit may be put up.

Direct Material
Direct Labor
Direct Expenses
Total Direct Cost or Prime Cost
Production Overhead:

Indirect Material3
Indirect Labor5
Indirect Expenses513
Total Production or Factory Cost
Other Cost:

Selling & Distribution Cost
Administration Cost
Total Cost
Selling Price

The Three Direct Costs are summed to derive the Total Direct Cost or Prime Cost.




    1. Thank Mr. Raza,
      We really appreciate your efforts to share knowledge with us. Keep visiting and share informative ideas for betterment of society.

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