Costing Systems

🍕 The Pizza Factory Story: Understanding Costing Systems

Imagine you own a magical pizza factory. But here’s the thing—you need to know exactly how much each pizza costs to make. Otherwise, how would you know if you’re making money or losing it?

That’s what costing systems do. They’re like special recipe calculators that help businesses figure out the true cost of making stuff.

🎯 What Are Costing Systems?

Think of costing systems as different ways to count your spending.

Just like you might count your candy differently depending on whether you’re sharing one big bag or giving out individual wrapped candies—businesses count their costs differently based on what they make.

The Big Question Every Factory Asks:

“How much did THIS product cost me to make?”

There are two main ways to answer this question, plus some super-smart tricks to make it even more accurate.

🎨 Job Order Costing: The Custom Order Tracker

What Is It?

Imagine someone orders a special birthday pizza with their name written in pepperoni, shaped like a dinosaur, with exactly 47 olives.

That’s a custom job! And you need to track exactly what THAT pizza costs—not any other pizza.

Job Order Costing = Tracking costs for ONE specific order or project.

Simple Example

🦖 Tommy's Dinosaur Pizza Order #101
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Materials:
  • Dough (special size)    = $3
  • Cheese (extra)          = $4
  • Pepperoni letters       = $2
  • 47 olives               = $1

Labor:
  • Chef time (1 hour)      = $15

Total Cost for Order #101   = $25

When Do We Use It?

✅ Custom furniture shops ✅ Movie productions ✅ Construction projects ✅ Wedding cake bakeries ✅ Advertising agencies

Key Idea: Each job gets its own “cost folder” where we put all the receipts.

🏭 Process Costing: The Assembly Line Counter

What Is It?

Now imagine your factory makes 10,000 identical cheese pizzas every day. They all look the same, taste the same, and go through the same conveyor belt.

Would you track each pizza separately? That’s crazy! 🤪

Instead, you count the TOTAL costs and divide by how many pizzas you made.

Process Costing = Total costs ÷ Total units = Cost per unit

Simple Example

📊 Today's Cheese Pizza Production
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Total Costs Today:
  • All ingredients     = $20,000
  • All worker wages    = $10,000
  • Factory costs       = $5,000

Total                   = $35,000
Pizzas Made             = 10,000

Cost Per Pizza = $35,000 ÷ 10,000 = $3.50 each!

When Do We Use It?

✅ Soda companies (millions of identical bottles) ✅ Paper mills (rolls and rolls of paper) ✅ Oil refineries ✅ Cereal factories ✅ Paint manufacturers

Key Idea: When everything’s the same, just divide the total!

🧩 Equivalent Units: The Half-Baked Problem

The Puzzle

Here’s a tricky question: At the end of the day, what if some pizzas are only half-made?

Maybe you have:

• 8,000 fully finished pizzas 🍕
• 4,000 pizzas that only have sauce and cheese (no toppings yet) 🔴

How do you count the half-done ones?

The Solution: Equivalent Units!

Equivalent Units = How many “complete” units your half-done stuff equals

If a pizza is 50% complete, two of them equal ONE fully complete pizza.

graph TD
    A["4,000 Half-Done Pizzas<br/>at 50% complete"] --> B["= 2,000 Equivalent Units"]
    C["8,000 Finished Pizzas<br/>at 100% complete"] --> D["= 8,000 Equivalent Units"]
    B --> E["TOTAL: 10,000<br/>Equivalent Units"]
    D --> E

Simple Example

🔢 End of Day Count
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Finished pizzas:     8,000 × 100% = 8,000 EU
Half-done pizzas:    4,000 × 50%  = 2,000 EU
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Total Equivalent Units            = 10,000 EU

Now divide total costs by 10,000 EU
to get the true cost per unit!

Why It Matters: Without equivalent units, you’d either ignore half-done items (wrong!) or count them as complete (also wrong!).

🎯 Activity-Based Costing (ABC): The Detective Method

The Old Problem

Traditional costing has a flaw. It spreads factory costs evenly across all products.

But what if:

• Pizza A goes through 3 machines
• Pizza B goes through 10 machines

They shouldn’t share costs equally! Pizza B uses MORE factory resources.

ABC: The Smarter Way

Activity-Based Costing = Track costs by WHAT activities each product actually uses

Instead of splitting costs evenly, we:

1. List all the ACTIVITIES (mixing, baking, packaging)
2. Figure out which products use which activities
3. Assign costs based on actual usage

Simple Example

📋 Activities in Our Factory
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Activity        │ Total Cost │ What drives it?
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Machine Setup   │ $6,000     │ # of setups
Quality Checks  │ $4,000     │ # of inspections
Packaging       │ $2,000     │ # of boxes

🍕 Regular Pizza: 2 setups, 1 inspection, 100 boxes
🦖 Dino Pizza:    10 setups, 5 inspections, 10 boxes

ABC shows Dino Pizza costs MORE per unit
(even though we make fewer of them!)

Why ABC Rocks

✅ More accurate costs ✅ Helps find products that secretly lose money ✅ Shows where to cut waste

🏊 Cost Drivers & Cost Pools: The Sorting System

Cost Pools = Money Buckets

A Cost Pool is like a bucket where we collect similar costs.

🪣 Example Cost Pools
━━━━━━━━━━━━━━━━━━━━
Pool 1: Machine-related costs
Pool 2: Labor-related costs
Pool 3: Quality-related costs
Pool 4: Delivery-related costs

Cost Drivers = The Cause of Costs

A Cost Driver is whatever makes that cost go UP or DOWN.

Think: “What activity drives this cost?”

🎛️ Matching Pools to Drivers
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Cost Pool           │ Cost Driver
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
Machine costs       │ Machine hours used
Setup costs         │ Number of setups
Inspection costs    │ Number of inspections
Shipping costs      │ Number of deliveries
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━

Simple Example

📊 The Shipping Cost Pool
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Total Shipping Costs = $10,000
Cost Driver = Number of deliveries
Total Deliveries = 500

Cost per Delivery = $10,000 ÷ 500 = $20

Product A needs 50 deliveries → $1,000
Product B needs 100 deliveries → $2,000

The Connection:

Cost Pools collect the money. Cost Drivers distribute it fairly.

🗺️ The Big Picture

graph TD
    A["🏭 Costing Systems"] --> B["Job Order Costing"]
    A --> C["Process Costing"]
    A --> D["Activity-Based Costing"]

    B --> B1["Track costs per<br/>UNIQUE order"]
    C --> C1["Divide total costs by<br/>IDENTICAL units"]
    D --> D1["Track costs by<br/>ACTIVITIES used"]

    D --> E["Uses Cost Pools<br/>& Cost Drivers"]
    C --> F["Uses Equivalent Units<br/>for partial work"]

🎓 Quick Summary

💡 Remember This!

Job Order = “How much did THIS one project cost?” Process = “How much does EACH identical item cost?” Equivalent Units = “How do I count half-finished stuff?” ABC = “Which activities actually use the money?” Cost Pools = Buckets to collect similar costs Cost Drivers = What makes those costs go up or down

You now understand how factories know the true cost of everything they make! 🎉