Definition of costing methods
Full costing: this is a costing method used in determining the complete end-to-end cost of producing services or products. This method factors in all variable, fixed, and direct overhead costs XX.
Variable costing: this method only assigns variable costs to inventory XX. Therefore, it charges all overhead costs to expense in the period incurred, while variable overhead and direct materials costs are assigned to inventory.
Target costing: in this method, a company plans in advance for margins, product costs, and price points it wants to achieve for a new product XX.
Lifecycle costing: this method compiles all costs to the producer or owner of an asset will incur during its lifespan.
Activity-based costing: this method assigns indirect costs and overheads, such as utilities and salaries, to products and services XX.
Uses of the costing methods by EEC
The company can use the full costing method to assign direct, fixed, and variable overhead costs related to the production of electricity to the end product (electricity provided to several states in the US). EEC can use variable costing method to assign rate per kWh to expenses directly incurred in the generation of electricity. The company can also use target costing when planning in advance for the costs of generating electricity and prices to charge. Lifecycle costing can help EEC in compiling all costs it will incur during generation and supply of electricity. Lastly, EEC can use activity-based costing method to assign overhead and indirect costs such as rent, utilities, and other administrative expenses to related services.
Advantages and disadvantages of the costing methods
Full costing method accounts for all production costs as well as makes it easier to track profits, which will be useful to the company. On the other hand, this costing method takes into account all expenses, including those not directly associated with the production of services, which would make it harder for the management of EEC to compare products of different service lines.
Variable costs would help EEC in pricing its services because it readily supplies data relating to the variable cost of producing electricity. This costing method is also useful in operations planning. On the other hand, variable costing would be disadvantageous because of inaccurate costs and under-valuation of inventory because fixed overhead in product cost XX.
Target costing also has advantages and disadvantages. Some of the advantages include ensuring that the company match its services to its customers’ needs. It also reduces the costs of services significantly XX. On the other side, target costing involves a large amount of mandatory cost-cutting, which can result in finger-pointing various parts of EEC.
Lifecycle costing would be advantageous to EEC because it would help the company better determine profitability as well as make better decisions that will result in higher profitability. It would also be disadvantageous because it can lead to a drop in productivity due to struggle for profitability.
Activity-based costing would be advantages to the company because it would provide a more accurate method of service costing, which leads to accurate pricing decisions XX. On the other hand, this method will be time-consuming for the company to collect and prepare data.
Recommendation for the best costing method
Activity-based costing is the most appropriate for EEC to use. Apart from providing more accurate pricing decisions, this costing method also increases understanding of cost drivers and overhead, which help the management in reducing or eliminate costly and non-value adding activities. Additionally, it ensures better allocation and elimination of overheads XX. Thus, this method is the best for growth of EEC.