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Tradional Approach to Product Costing and Pricing

Updated on October 1, 2012

The traditional, and still widely used, approach to job costing and product pricing developed when the notion of trying to determine the cost of industrial production first emerged. This was around the time of the UK Industrial Revolution when industry displayed the following characteristics:

Direct-labour-intensive and direct-labour-paced production

Labour was at the heart of production

To the extent that machinery was used, it was to support the efforts of direct labour, and the speed of production was dictated by direct labour.

A low level of indirect cost relative to direct cost

Little was spent on power, personnel services, machinery (leading to low depreciation charges) or other areas typical of the indirect cost (overheads) of modern businesses.

A relatively uncompetitive market

Transport difficulties, limited industrial production worldwide and a lack of knowledge by customers of competitors’ prices meant that businesses could prosper without being too scientific in costing and pricing their output. Customers would have tended to accept what the supplier had to offer, rather than demanding precisely what they wanted.

Since overheads at that time represented a pretty small element of total cost, it was acceptable and practical to deal with them in a fairly arbitrary manner. Not too much effort was devoted to trying to control overheads because the potential rewards of better control were relatively small, certainly when compared with the benefits from firmer control of direct labour and material costs. It was also reasonable to charge overheads to individual jobs on a direct labour hour basis. Most of the overheads were incurred directly in support of direct labour: providing direct workers with a place to work, heating and lighting the workplace, employing people to supervise the direct workers, and so on. Direct workers, perhaps aided by machinery, carried out all production.

At that time, service industries were a relatively unimportant part of the economy and would have largely consisted of self-employed individuals. These individuals would probably have been uninterested in trying to do more than work out a rough hourly or daily rate for their time and to try to base prices on this.

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