Nature of a process cost systemMany businesses produce large quantities of a single product or similar products. Pepsi-Cola makes soft drinks, Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long periods. For these kinds of products, companies do not have separate jobs. Instead, production is an ongoing process. Show
Job costing and process costing have important similarities:
Job costing and process costing systems also have their significant differences:
A process cost system (process costing) accumulates costs incurred to produce a product according to the processes or departments a product goes through on its way to completion. Companies making paint, gasoline, steel, rubber, plastic, and similar products using process costing. In these types of operations, accountants must accumulate costs for each process or department involved in making the product. As an example, view this How’s It Made video. Can you imagine having to determine the cost of making just ONE lego when we can make 1.7 million legos per hour? Cost accountants have to do this. They will use process costing! Accountants compute the cost per unit by first accumulating costs for the entire period (usually a month) for each process or department. Second, they divide the accumulated costs by the number of units produced (tons, pounds, gallons, or feet) in that process or department. The next picture shows the cost flows in a process cost system that processes the products in a specified sequential order. That is, the production and processing of products begin in Department A. From Department A, products go to Department B. Department B inputs direct materials and further processes the products. Then Department B transfers the products to Finished Goods Inventory. There are two methods for using process costs: Weighted Average and FIFO (First In First Out). Each method uses equivalent units and cost per equivalent units but calculates them just a little differently. Job order costing and process costing are systems of collecting and allocating costs to units of production. The key difference between job order costing and process costing is that job costing is used when products are manufactured based on customer specific orders whereas process costing is used to allocate costs in standardized manufacturing environments. Accurate cost allocation is vital irrespective of whether the product is tailor-made or standardized since costing affects the pricing decisions. CONTENTS What is Job Order Costing?The job order costing system is used when products are made based on specific customer orders where each unit produced is considered a job. When the products are unique in nature, the cost of producing two different products cannot be compared effectively since the amounts of materials, labor and overheads will vary from one job to another. Each job will be assigned a unique identifier and a ‘job cost sheet’ will be used to record all job-related information. Figure 1: Sample Job Cost Sheet E.g. ABV is a customized dress manufacturer that makes bridal wear. ABV will charge the cost of the dress plus a 30% profit margin on cost. The job code is HG201. Consider the following costs.
Job costing helps to identify costs and profit earned for individual jobs. Thus, it is very convenient to identify each job’s contribution to firm’s profit. Based on the cost to serve a particular customer, the company can decide whether it is lucrative to continue business relationships with such customers. However, job costing can also result in information overload since the company has to keep track of all the usage of cost components such as materials and labor. For overall management decisions such as assessing company profitability, these individual job information is of limited use. What is Process Costing?In contrast to job costing, process costing is used in standardized production processes where the units manufactured are identical in nature. In a setting of this nature, the costs will be assigned to different departments or workgroups. The cost per unit will be calculated by dividing the total cost for the department or workgroup by the number of units produced. E.g. DRA Company manufactures plastic bottles, and the production process operates with 3 departments and produced 6,500 bottles for the last month. Consider the following costs for each department. An advantage of process costing is that it allows businesses to get detailed information on the production from individual departments or workgroups. This method is more appropriate for continuous manufacturing settings, such as factories and utility companies. However, it should be noted that process costing may allow certain non-production expenses incurred by the department such as office expenses to be included in the costing which will ultimately result in higher selling prices. What is the difference between Job Order Costing and Process Costing?
Summary – Job Order Costing vs Process CostingJob costing and process costing are two commonly used cost allocation methods. The objectives of the two are largely similar in nature; the difference between job costing and process costing exists depending on the nature of organizations who use them. If the product is unique in nature, job costing provides a suitable platform to calculate the unit cost. If the production process has uniformity, then process costing will assist effective cost allocation and better pricing decisions. References What are the similarities between process costing and job order costing?Both process costing and job order costing maintain the costs of direct material, direct labor, and manufacturing overhead. The process of production does not change because of the costing method. The costing method is chosen based on the production process.
What is the difference between job order costing and process costing?Job order costing is a costing system in which each product or job has traceable costs. Process costing is a costing system in which a product is mass produced, so costs are determined by equivalent units produced.
What is the difference between job order and process costing How are they similar and different for a manufacturing company and a service company?Businesses use job order costing for small batches of customizable or unique products and individual job orders, while businesses use process costing for mass-produced or standardized products. Typically, in process costing, the products produced are the same or very similar.
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