JOB-ORDER COSTING VERSUS PROCESS COSTING Denisia Gheorghina Anta, Mihaela Ioana Iacob Universitatea Aurel Vlaicu, Arad, Romania Abstract: A process costing system, like a job-order costing system is a cost-accumulation system that produce the unit manufacturing cost for a given process. Per-unit manufacturing costs are used primarily for product costing, inventory valuation, and income determination. Per-unit cost data are vital for pricing purposes. They are used not only for pricing finished products but also for selecting the right product mix in order to maximize production. Perhaps the most effective way to utilize process cost data is to integrate the output into the standard costing system of the firm. Job-order cost accounting accumulates costs by specific jobs, contracts, or orders. The job-order cost method is appropriate when the products are manufactured in identifiable lots or batches, or when the products are manufactured to customer specifications. Job-order costing is widely used by custom manufacturers such as printing, aircraft, construction, auto repair, and professional services. Process costing is cost system in which manufacturing costs are accumulated for similar products. A company can use process costing for some products and job-order costing for others. For example, a hightechnology company uses process costing for most of their furnace thermostats and job costing for their specialized defense and space contracting work. Process costing aggregates manufacturing costs by departments or by production processes. Total manufacturing costs are accumulated under two major categories direct materials and conversion costs (the sum of direct labor and factory overhead applied). Unit cost is 213
determined by dividing the total costs charged to a cost center by the output of that cost center. In that sense, the unit costs are averages. Process costing is appropriate for companies that produce a continuous mass of like units through a series of operations or processes. Process costing is generally used in such industries as petroleum, coal mining, chemicals, textiles, paper, plastics, glass and food processing. Identification of system problems and choice of systems Since the unit costs under process cost are like averages, the process costing system requires less bookkeeping than does a job-order costing system. A lot of companies prefer to use a process costing system for this reason. However, before any particular system is chosen, the principal system problem(s) must be identified in a broader perspective. Typically, which method of costing to use depends more upon the characteristics of the production process and the types of products manufactured. If the products are alike and move from one processing department to another in a continuous chain, a processcosting method is desirable. If, however, there are significant differences among the costs of the various products, a process costing system would not provide adequate product cost information and a job-order costing method is more appropriate. For example, a job-order costing system would invariably be used if the customer paid for the specific item, production order, or service on the basis of its cost, which is often the casein repair shops and custom work. Some companies might find it necessary to use a hybrid of these two systems, depending on how product flows though the factory. For example, in a parallel 214
processing situation, some form o hybrid of the two systems has proved to be the optimal system. Those industries that are most suitable for process costing have the following characteristics: Production quantity is uniform. One order does not affect the production process. Customer orders are filled from the manufacturer s stock. Continuous mass production through an assembly line approach. A standardization of the process and products exists. Cost control on a departmental basis rather than on a customer or product basis is desired. Continuity of demand for the output. Quality standards can be implemented on a departmental basis for example, on-line inspection as processing proceeds. There are four basic steps in accounting for process costs: Summarize the flow of physical units. The first step will encompass a summary of all units on which some work done in the department during the period. Input must equal output. This step helps detect lost units during the process. The relationship may be expressed in the following equation: Beginning inventory + Units started for the period = Units completed and transferred out + Ending inventory Compute output in terms of equivalent units. In order to determine the unit costs of a product in a processing environment, it is important to measure the total amount of work done during an accounting period. A special problem arises in processing industries in connection with how to deal with work still in process. Partially completed units are measured on an equivalent whole unit basis for process costing purpose. Equivalent units are measure of how many whole units of production are represented by the units completed plus partially completed units. 215
Summarize the total costs to be accounted for and compute unit costs per equivalent unit. This step summarizes the total costs assigned to the department during the period. The unit costs per equivalent is compute as follows: Total cost incurred during the period Unit cost = Equivalent units of production during the period Account for units completed and transferred out and units in ending work-in-progress. The process costing method uses what is called the cost of production report. It summarizes both total costs and unit costs charged to a department and indicates the allocation of total costs between wok in progress inventory and the units completed and transferred out to the next department (or the finished goods inventory). The cost of production report covers all four steps and is the source for monthly journal entries. It is a convenient compilation from which cost data may be presented to management. Estimating degree of completion Estimating the degree of completion for work in progress is critical. Inaccurate estimates will lead to inaccurate computation of unit costs, especially for conversion. Estimating the degree of completion is easier for materials than for processing or conversion costs. The degree of completion for materials is usually 100% unless the material is added during or the end of the process. The stage of completion for conversion costs requires specific knowledge about the conversion sequence. The sequence consists of a standard number of processing operations or standard number of days, weeks, or months for mixing, refining, aging, and finishing, etc. 216
To estimate the degree of completion for conversion, determine what proportions of the total effort (in terms of direct labor and overhead) are needed to complete one unit or one batch of production. Industrial engineers should be able to measure the proportion of conversion needed with reasonable accuracy.instead of putting effort into estimating the actual stage of completion, the assumption is often made that work still in process at the end of the accounting period is 50% complete. Some companies ignore the work in process completely and show no work in process inventory account. However, this approach is acceptable only if the work in process inventory is insignificant in amount or if it remains relatively constant in size. Using process cost data Combined with standard costing, the process cost data provides the basis for management to judge the cost performance of a processing department as a cost center in all categories, such as direct material, direct labor, and overhead. An increase in any one of these cost components is a red light to management, indicating inefficient operation in a department. Process cost data also aids management in processing decisions. In a multiproduct and joint product situation, management is often faced with the decision about selling the product at the split off point (juncture of production where joint products become individually identifiable) or processing it further. For external reporting purposes, process cost data, whether in total or in units, help management allocate joint manufacturing costs to different joint products so they can produce income statements by product. In designing the system to meet the needs of both product costing and cost control, management should identify cost centers. Cost centers may be assigned to each 217
division, department or section. The number of processing departments designated as cost centers will depend on the detail desired by management. Cost centers should be setup along organizational lines for control purposes. Management weights the cost-benefit relationship in deciding on the number of cost centers desired. Conclusion A job-order cost system is used when heterogeneous products are involved. A capacity measure should be chosen that best suits the company s planning and performance evaluation objectives. For example, if management wants to establish a more rigid production goal to increase productivity, it would use practical capacity rather than normal capacity. Process costing is a primary approach to assigning manufacturing cost to units produced. It is used by manufacturers whose products are produced on a continuous basis, with units receiving equal attention in each processing center. The four steps in process costing are the computation of equivalent units, calculation of the unit cost, figuring the cost of completed production, and the valuation of the ending work-in-progress. If units are spoiled or defective, the per-unit cost of good units will increase. References: [1] Andrew Wileman - Driving Down Cost: How to Manage and Cut Costs--Intelligently, Hardcover - Jul 7, 2008 [2] Jae K. Shim., Joel G. Siegel - Modern Cost Management and Analysis, Barron's Business Library, 2002 [3]. Wilson R. - Strategic Cost Management, Ashgate Publishing Limited, Vermont, 1997; [4]. John J. Sabarro, Linda A. Hill, Managing Performance, Harvard Business School Publishing, Boston M1, 1996 218