At its core, product costing aims to allocate all costs—both direct and indirect—associated with the production of goods or services. This allows executives to gain a granular view of where resources are consumed and to what extent those costs contribute to the overall profitability of individual products or services. Accurate product costing ensures that pricing strategies are aligned with production costs, profit margins are optimised, and waste is minimised.
For senior leadership, product costing is integral to:

1. Pricing Strategy: Understanding the total cost per product or service enables the company to set prices that cover costs while ensuring competitive market positioning.
2. Profitability Analysis: Product costing helps in identifying the most and least profitable products, guiding resource allocation and product portfolio decisions.
3. Cost Control: By breaking down the components of product costs, companies can identify inefficiencies and implement cost-saving measures.
4. Financial Forecasting and Budgeting: Detailed product costing provides a foundation for accurate forecasting and budgeting, ensuring financial sustainability.

Product costing is typically divided into direct costs and indirect costs, each of which plays a significant role in determining the total cost of production.

1. Direct Costs: Direct costs are those that can be directly attributed to the production of a specific product or service. These costs vary depending on the production volume and are often referred to as variable costs. The key elements of direct costs include:
2. Direct Materials: This encompasses the raw materials and components used in the production process. For manufacturing companies, the cost of materials represents a significant portion of the overall product cost. Management accounting tracks these costs to ensure that resources are being used efficiently and cost-effectively.
3. Direct Labour: Labour costs directly associated with the production of goods or services are another major component of direct costs. In service industries, this includes the wages of employees directly involved in service delivery. Labour efficiency and productivity are closely monitored to control these costs.
4. Indirect Costs (Overheads): Indirect costs, or overhead costs, are expenses that cannot be traced directly to a specific product or service but are necessary for the overall production process. These include both fixed costs and variable overheads. Key examples of indirect costs are:
5. Factory Overheads: These include costs related to factory utilities, depreciation of machinery, maintenance, and supervisory labour. While not directly tied to a specific product, these costs must be allocated across all products produced to ensure an accurate calculation of total cost.
6. Administrative Overheads: This includes costs associated with the administration, such as office rent, salaries of non-production staff, and IT services. Proper allocation of administrative overheads ensures that all products or services bear their fair share of these expenses.

Different costing methods are used in management accounting to allocate costs accurately to products, each providing a unique perspective on how costs are assigned and managed.
Absorption Costing Absorption costing, also known as full costing, includes both direct and indirect costs in the total product cost. This method allocates fixed overheads to each unit produced, ensuring that all production costs, including overheads, are recovered through the sale of the product. Absorption costing is often used for financial reporting purposes as it aligns with generally accepted accounting principles (GAAP).

1. Advantages:
   • Provides a comprehensive view of product cost by including all costs.
   • Aligns with external financial reporting requirements.
2. Limitations:
   • Can obscure the relationship between fixed and variable costs, making it difficult to see how costs behave at different levels of production.
   • Variable (Marginal) Costing Variable costing, in contrast, only considers variable production costs (direct materials, direct labour, and variable overhead) when calculating the cost of a product. Fixed overheads are treated as period costs and are not allocated to individual products.
3. Advantages:
   • Provides clearer insights into how costs vary with production volume.
   • Useful for short-term decision-making, such as pricing and cost control.
4. Limitations:
   • Does not provide a full picture of total product cost, as it excludes fixed overheads.
   • Activity-Based Costing (ABC) Activity-Based Costing (ABC) is a more refined method of costing that allocates overhead costs based on the activities that drive those costs. ABC assigns costs to products based on their consumption of activities, offering a more accurate picture of the cost structure, particularly for companies with complex production processes or a wide product mix.
5. Advantages:
   • More accurately reflects the true cost of products by allocating overheads based on actual resource consumption.
   • Helps identify non-value-added activities and areas for cost reduction.
6. Limitations:
   • More complex and time-consuming to implement than traditional costing methods.
   • May require significant changes in cost allocation systems and processes.

For senior executives, product costing serves as a critical tool in strategic decision-making. Detailed product cost data provides insights that directly influence pricing, profitability analysis, and resource allocation. Key strategic applications include:

1. Pricing Decisions: One of the primary uses of product costing is to inform pricing strategies. By understanding the total cost of production, including direct and indirect costs, companies can ensure that prices are set at a level that covers all expenses while achieving target profit margins. Cost-plus pricing is one common strategy, where a fixed percentage is added to the total cost to determine the selling price.
2. Profitability Analysis and Product Portfolio Management: Product costing helps identify which products contribute most to the company’s bottom line. By analysing contribution margins and overall profitability, management can make informed decisions about which products to promote, discontinue, or invest in further. This data also informs product portfolio optimisation, ensuring that resources are allocated to high-margin products and less profitable lines are re-evaluated.
3. Cost Control and Process Improvement: Through detailed analysis of product costs, management accounting identifies inefficiencies and areas where cost savings can be realised. Whether through streamlining production processes, renegotiating supplier contracts, or improving labour productivity, accurate product costing enables better cost management and efficiency improvements.
4. Budgeting and Financial Forecasting: Accurate product costing forms the foundation of reliable financial forecasts and budgets. By projecting future production costs, companies can forecast revenues, plan capital expenditures, and allocate resources effectively. This data is crucial for long-term financial planning and sustainability.