Cost formula or cost volume formula

The cost formula also known as cost volume formula is an important formula of cost accounting. Cost accounting is a reporting system that describes about the organization to its management so that they may be able to make better decisions regarding the costs of the operations of the organization for a good present and a sustainable future. There are many different types of costs like direct costs, indirect costs, fixed costs, variable costs, marginal costs, differential costs, opportunity cost, relevant cost, replacement cost, shutdown cost and capacity cost. Of all these above mentioned types of costs, there are four basic types of costs that an accountant needs to know about, these are direct costs, indirect costs, fixed costs and variable costs. The direct costs are associated to the products like the material and labor costs whereas the indirect costs are related to the product’s activity like overhead costs. On the other hand, the fixed costs are those which do not change with the production level like the lease whereas the variable costs change with the production level like cost of the material used.

The cost volume formula is used to obtain the total cost incurred on a certain volume of production. It is a simple calculation formula which is very useful to derive the total costs for the purpose of budgeting. It is also very beneficial to get the knowledge of the profit and loss levels that are likely to be obtained at a certain sales volume level. The cost volume formula is as under:

•    Y=A+BX
•    Y= Total cost
•    A= Total fixed cost
•    B= Variable cost per unit
•    X= Number of units

The total fixed cost is the sum of pure fixed cost as the rent of the property and of the fixed components of mixed costs as fixed cost on the carried out delivery. The variable cost is sum of pure variable cost incurred per unit as the material cost and variable components of the mixed cost as variable cost of delivery that is fuel expenses. A cost volume formula can be used in its linear equation form or the quadratic form and other related complex forms that give an exact result and so they are more useful to use practically.

The cost volume formula works only at a limited relevant range of given number of units and outside that range the components of cost like the fixed cost and the variable cost are more likely to alter. This may happen because a high volume may result to purchase in bulk that eventually reduces the variable cost per unit. Similarly, it may require an increase in the fixed cost expenses in order to improve on the production line capacity. It is therefore very important to carefully analyze the relevant range while applying the cost volume formula. This formula is very simple in its use and application but a wide range of mixed costs, cost drivers and a wide range of products instead of a single product type may make it a complex matter to deal with. Due to such possible complexities, the cost volume formula needs to be appropriately applied by doing the necessary adjustments. This will help in showing a proper business costing environment.         

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Methods of Costing formula

Methods of Costing:

As per the nature and peculiarities of the business, different Industries follow different methods to find out the cost of their product. There are different principles and procedure for doing the costing. However the basic principle and procedure of costing remain the same. Some of the methods are mentioned below:

Methods of Costing

Unit Costing: This method also called 'Single output costing'. This method of costing is used for products which can be expressed in identical quantitative units and is suitable for products which are manufactured by continuous manufacturing activity. Costs are ascertained for convenient units of output.  Examples: Brick making, mining, cement manufacturing, dairy, flour mills etc.

Job Costing:  Under this method costs are ascertained for each work order separately as each job has its own specifications and scope. Examples: Painting, Car repair, Decoration, Repair of building etc.

Contract Costing:
Under this method costing is done for big jobs which involves heavy expenditure and stretches over a long period and often it is undertaken at different sites. Each contract is treated as a separate unit for costing. This is also known as Terminal Costing. Construction of bridges, roads, buildings, etc. comes under contract costing.

Batch Costing:
This method of costing is used where the units produced in a batch are uniform in nature and design. For the purpose of costing each batch is treated as a job or separate unit. Industries like Bakery, Pharmaceuticals etc. usually use batch costing method.

Operating Costing or Service Costing:
Where the cost of operating a service such as nursing home, Bus, railway or chartered bus etc. this method of costing is used to ascertain the cost of such particular service. Each particular service is treated as separate units in operating costing. In the case of a Nursing Home, a unit is treated as the cost of a bed per day and for buses operating cost for a kilometer is treated as a unit.

Process Costing:
This kind of costing is used for the products which go through different processes. For example, manufacturing cloths goes through different process. Fist process is spinning. The out put of spinning is yarn. It is a finished product which can be sold in the market to the weavers as well as use as a raw material for weaving in the same manufacturing unit. For the purpose of finding out the cost of yarn, the cost of spinning process is to be ascertained. The second step is the weaving process. The out put of weaving process is cloth which also can be sold as a finished product in the market. In such case, the cost of cloth needs to be evaluated. The third process is converting cloth in to finished product such as shirt or trouser etc. Each process is to be evaluated separately as the out put of each process can be treated as a finished good as well as consumed as a raw material for the next process. In such industries process costing is used to ascertaining the cost at each stage of production.
Multiple Costing: When the output comprises many assembled parts or components such as in television, motor Car or electronics gadgets, costs have to be ascertained or each component as well as the finished product. Such costing may involve different methods of costing for different components. Therefore this type of costing is known as composite costing or multiple costing.

Uniform Costing: This is not a separate method of costing. This is a system of using the same method of costing by a number of firms in the same industry. It is treated as a common system of using agreed principles and standard accounting practices in the identical firms or industry. This helps in fixation of price of the product and inter-firm comparisons.

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