The analysis of the cost structure is one of the pricing methods. Knowing the production costs allows the manufacturing companies to determine profitability and appreciate how inflation affects the development of the company; and if these costs can be more detailed (by the department, a method of manufacture, process and so on..) they will be more useful because they can modify certain variables and be more competitive. In the specific case of costing by the process, this method consists, as its name suggests, in determining the cost in each of the processes involved in the manufacture of the finished product, and its use can represent numerous advantages.
In essence, this costing system is a method by which production costs are discriminated according to the processes or departments involved. And although it is ideal for manufacturers of finished products (assembly, manufacturing and furthermore processes) it is also applicable in service companies, for example, financial institutions or legal consultants interested in establishing a system of costs according to the types of services provided.
What are the advantages of using the process costing method?
The manufacturers of different products in series (appliances, vehicles, toys, etc.) that differ in some specific components usually use this method because it allows them to set a price for each product based on the cost of the parts. For example, suppose a company dedicated to the assembly of the same type of car but in two versions, the familiar or classic and the luxury. This business would suffice a general calculation and know the costs of the parties that differentiate both models to get to determine the price that each model should have.
The fixing of the price through this method will allow the Management of costs of this type of industries to save time and effort because it will not need to continuously evaluate the costs, it will be enough to do it periodically.
Similarly, with this costing calculation manufacturers can prepare different versions of a product, although this has not been the initial idea since once they see the differences in costs due to some components, they can prepare products with different prices. just add, remove or modify a specific component. For example, a manufacturer of frying pans, in addition to varying the price of the same model by changing the type of handle (wood, plastic …), can launch a pan with non-stick material on the market and another that does not have this attachment.
Other industries that benefit from this costing system are those that adopt the strategy of marketing the parts with which they manufacture, for example, computer manufacturers that use interchangeable components for equipment of the same model. The estimation of the cost of these parts will allow them to know which ones should be integrated to a certain model and which ones should be sold separately, that is, destined to the spare parts market.
Advantage of costing by processes for organizational efficiency
The implementation of this costing method also makes it possible to evaluate the organizational efficiency, since under this type of calculation it is possible to determine the accumulated costs for each department, that is, there may be a department where the preparation of the raw material is carried out, which entails a certain cost, just as there may be another department where the raw material is used to manufacture the product, resulting in a different cost, and in this sense it is possible to know in which of these departments there is a greater investment, as well as the best use of the investment.
To the management, it will be enough to see the costs in each department to appreciate which are the processes or activities that make the product more expensive. Also, the administration can see with these costs where there is a greater amount of waste, being able to take action in this regard.
Likewise, the analysis that this costing system allows identifying additional costs, this is the activities or processes that can be reduced or modified to reduce manufacturing costs.
On the other hand, in the face of unforeseen circumstances, such as an unexpected increase in production costs or the temporary shortage of raw material, the determination of costs by process allows identifying the part of the process, department where adjustments or cuts must be made to reduce costs, as well as taking alternative measures (for example, substitution of inputs) to deal with these unforeseen scenarios.
Costing by processes strengthens the capacity for innovation in the organization
One of the challenges faced by many manufacturing companies in a highly competitive market (for example, cell phone manufacturers) is to offer a different product than the competition that satisfies the tastes of customers. In this sense, to manufacture products that distinguish themselves in the market they must incorporate additional components, but this must be done knowing in advance the cost of such incorporation, because not only compete in design or quality, but also in price, and only through The establishment of these costs can determine if the new product will have a competitive price.