Product Costing Calculation: What Is Product Costing?

The product costing method helps business owners and financial professionals keep track of the total manufacturing costs for any given product. To complete this sort of cost accounting, calculate the cost of each individual element in the finished goods. This includes labor, material, and overhead expenditures, as well as more indirect fees. While product costing is not exhaustive, it’s a very helpful tool to gain insight into why you’re paying what you are to manufacture a given good.

Product costing requires an incisive and honest look at various outgoing expenses. Here are the most prominent cost elements to consider:

• Labor costs: To complete any type of activity-based costing, you need to track how much you spend on labor to create the goods in the first place. Direct labor costs include wages you pay to your own employees, as well as any other benefits you provide them. By contrast, indirect labor costs denote expenses associated with tangentially related supervisors or outside contracts.
• Manufacturing overhead costs: You’ll need to monitor all your manufacturing overheads to ensure accurate product costing. For instance, these might include lease or insurance payments on your factory. These are also essential elements to feature on financial statements according to GAAP (generally accepted accounting principles).
• Raw materials: Keep track of any direct or indirect materials you use in the production process of a specific good. Direct materials refer to the building blocks of a product, while indirect ones might include screws, glue, and other small items necessary to actualize the design.

Calculating product costing requires a relatively simple methodology. Follow these steps to ensure you price your products with accuracy:

• Identify the new product. Figure out what product you’ll be running the numbers on before you get started. The goal is to find the unit cost of just one product, so try to be as specific as possible. After you can figure out the price of one object, you can then extrapolate this same expenditure onto a wider scale. This is much easier than looking at costs in aggregate and trying to break them down to a smaller scope.
• Quantify overhead cost allocation. It’s easier to quantify the labor and material costs required to make a product than to do the same for its overhead expenses. To calculate overhead cost allocation, tally up all indirect expenses and divide them by the number of hours your company uses to make this specific product. If you use this standard cost formula, routing the overhead information into the rest of your calculations will be simple.
• Track individual cost components. Factor in the cost of materials and direct labor at this point. Look at each aspect of the manufacturing life cycle from beginning to end. Ask yourself how many hours your workers spend making one of these products and multiply that by the cost of their wages and benefits per hour. Tally up the cost of each material you use in the manufacturing process.
• Work on cost control. Use the data you’ve accrued to extrapolate out a total cost estimate for an individual product, as well as what it would cost to produce it in the aggregate. Now that you have this information, you can work on decreasing expenditures to hit a less expensive target cost so you can save money and maximize profits.

Product costing might be helpful, but that doesn’t mean it’s perfect. You might still run into some issues when using this type of management accounting.

For one thing, you need to be very precise to obtain the actual costs of goods when using this method. If even one small data point is inaccurate, all the calculations will go awry. If you’re planning on using this information for financial reporting, it’s even more essential to get things right the first time on your expenditure and income statements.

Additionally, even though product costing will give you an incisive look at the variable cost of a product, it won’t allow you to compare it against the cost of similar goods your competitors sell. To compete in the marketplace, aim to price your product in a way that generates a profit beyond just recouping the costs this method indicates. Still, look at similar goods on the market so you don’t set your own price too high, as this might turn off consumers.

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