The choice of cost accumulation system depends on the variety and type of products or services sold, or the type of manufacturing processes employed. The system used should be determined by weighing the cost of collecting the data and the benefit of having that information.
Companies use different costing systems for determining the cost of custom products than they do for determining the cost of mass-produced products. When products are custom ordered, knowing the cost of the materials, labor, and overhead is critical to determining the sales price.
As an easy example, think of a tailor who alters, repairs, and makes custom clothes for customers. If a customer orders a custom-made suit, the specific fabric, detail of any special features, and the time involved in sewing are all factors that will determine the total cost and, therefore, the selling price of the garment.
Each component of the cost of producing the clothing will be tracked as it occurs, thus improving the accuracy of determining the price. However, in mass production, wherein one batch leads to a second batch, stopping the process to properly identify the materials, labor, and overhead costs used for each batch does not provide enough valuable data to justify determining the individual costing of each product.
It would be difficult, and not cost effective, to track the cost of each individual clothing item; rather, it is more efficient to track the costs in each phase of the clothing-making process. This process allows them to determine the cost of each item.
Even retail companies need to know the cost of the purchased products before the sales price is set. While it seems simple to think of the sales price as the purchase price plus a markup, determining the markup costs needs to be an accurate process in order to ensure the sale price is higher than the product cost.
To properly capture the information necessary for decision-making, there are different costing systems that track costs in order to determine sales prices, and to measure profits and manufacturing efficiency. As previously mentioned, the two traditional types of costing systems are job order costing and process costing.
Companies may decide to use only one or a combination of methods. This chapter examines job order costing and demonstrates how it differs from process costing. Process Costing and other costing systems Activity-Based, Variable, and Absorption Costing are covered in other chapters. In this chapter, you will also learn the terminology used to track costs within the job order cost system and how to segregate and aggregate these costs to determine the costs of production in a job order costing environment.
You will also learn how to record these job costs and where they appear on financial statements. Job order costing is an accounting system that traces the individual costs directly to a final job or service, instead of to the production department. It is used when goods are made to order or when individual costs are easy to trace to individual jobs, assuming that the additional information provides value.
In these circumstances, the individual costs are easy to trace to the individual jobs. For example, assume that a homeowner wants to have a custom deck added to her home. Her contractor will design the deck, price the necessary components in this case, the direct materials, direct labor, and overhead , and construct it.
The final cost will be unique to this project. If another homeowner wanted the contractor to construct a deck, the contractor would go through the same design and pricing process, and you would expect that the design and costs would not be the same as those of the deck in the first example, since the decks would differ from one another.
The job order costing method also works well for companies such as movie production companies, print service providers, advertising agencies, building contractors, accounting firms, consulting entities, and repair service providers. The production processes for both films differed significantly, so that the accumulated costs for each job also differed significantly. Both were made in In contrast, process costing is used when the manufacturing process is continuous, so it is difficult to establish how much of each material is used and exactly how much time is invested in each unit of finished product.
Therefore, in process costing, costs are accounted for by the production process or production department instead of by the product or by the job. However, process costing is not limited to basic manufacturing activities: It can also be used in the manufacturing of more complex items, such as small engines. A process costing system assigns costs to each department as the costs are incurred, and the costs to produce one unit are calculated based on the information from the production department.
Unit costs are determined after total production costs are determined. One factor that can complicate the choice between job order costing and process costing is the growth of automation in the production process, which typically is accompanied by a reduction in direct labor. The cost of the increase in equipment typically reflected as a depreciation expense is allocated to overhead, while the decreased need for labor usually reduces the direct labor cost.
Because of these issues, some companies choose a hybrid system, using process costing to account for mass producing a part and using job order costing to account for assembling some of those individual parts into a custom product. Figure summarizes the use of these two systems.
To illustrate how a company can determine whether to use job order costing or process costing, consider the cost accounting options for a local restaurant.
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