How To Select Types of Costing Systems

In business, costing is sacred! Every business, no matter how big or small is interested in minimizing costs and maximizing profits. Funnily enough, there can be as many types of costing systems as there are costs, and quite often, many are left confused as to which method is actually the right one for them and in the process, end up spending a significant amount of money in choosing a costing system! If you’re one of those confused souls, groping in the dark about the types of costing systems, here’s some information which should provide you with some relief!

Some of the more well-known and popular costing systems which are in use today are as follows:

  • Activity-based costing or ABC
  • Lifecycle costing
  • Process costing
  • Job-order costing
  • Operation costing
  • Back-flush costing

These 6 types of costing systems are discussed in brief detail further in this article.

Activity-based costing or ABC

This is one of the most widely used types of costing systems. As the term itself suggests, costs are allocated based on activity and the resources required to complete such activities. The ABC method of costing is most useful for businesses that are complex and multi-tiered, and where there is a clear cause-and-effect connection

Lifecycle costing

Lifestyle costing looks at the costs incurred during a product’s entire life cycle – from conception to demise – of the product. The advantage of using this type of costing system is that all costs can be allocated upfront, and cost control can be applied at any time of the product cycle, including after the product is sold.

Process costing

This type of costing is useful in businesses where the product line is similar. If the process or method used to produce a particular set of products, then costs can be similarly applied at each stage of the process, from conception to the actual production. The average costs of all work-in-progress processes over a specified period of time are calculated in this type of costing.

Job-order costing

Costs are calculated based on individual job orders rather than the product cycle or activities. This type of costing system is useful for companies or businesses which work on a job-order basis. For example, clothing manufacturers or merchandise that is produced on consignment.

Operation costing

This is an extension of two types of costing systems previously discussed – process costing and job-order costing. The mixed system is used primarily in industries such as textile manufacturing, electronics, etc. Direct costs are applied using the job-order system, whereas indirect costs are applied using the process costing system.

Back-flush costing

This is a costing system which is not typically used by most businesses. In this type of costing, all costs are not applied as and when necessary in the business cycle. Instead, some costs are held back from application, with the result that inventories may often be underestimated. This type of costing is not considered to be in line with standard and approved systems of accounting.

Now that you have a fair idea about different types of costing systems, you can look for more in-depth information by consulting your CPA or cost accountant, not to mention the huge amounts of information available online! With this, you should be able to make a fairly knowledgeable decision on selecting the right type of costing system for your business needs!


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