CONTENTS

1. Overview of Job-costing and Process-costing system

2. Introduction of Job-costing

3. Components of Job-costing

4. Steps of Job-costing

5. Advantages of Job-costing

6. Disadvantages of Job-costing

7. Introduction of Process-costing

8. Steps of Process-costing

9. Weighted Average Method

10. FIFO Method

11. Advantages of Process-costing

12. Example of Process-costing

13. Comparison of Job-costing & Process-costing

JOB-COSTING & PROCESS-COSTING SYSTEMS: AN OVERVIEW

JOB-COSTING SYSTEM

In job costing system, the cost object is a unit or multiple units of a distinct product or

service called a job. Each job generally uses different amounts of resources. The

product or service is often a single unit, such as specialized machine made by some

company, a job repair done at some service center or an advertising campaign for a

client by an advertising agency.

PROCESS-COSTING SYSTEM

In a process costing system, the unit cost of a product or service is obtained by

assigning total costs to many identical or similar units. In other words unit costs are

calculated by dividing total cost incurred by the number of units of output from the

production process. In a manufacturing process-costing setting, each unit receives the

same or similar amounts of direct material costs, direct manufacturing labor costs, and

indirect manufacturing costs (manufacturing overhead).

INTRODUCTION TO JOB-COSTING

A job order costing system is used in situations where many different products

are produced each period. For example clothing factory would typically made many

different types of jeans for both men and women during a month. In a job order costing

system, costs are traced to the jobs and then the costs of the job are divided by the

number of units in the job to arrive at an average cost per unit.

Job order costing system is also extensively used in service industries. Hospitals,

law firms, movie studios, accounting firms, advertising agencies and repair shops all

use a variety of job order costing system to accumulate costs for accounting and billing

purposes. The details here deal with a manufacturing firm, the same concept and

procedures are used by many service organizations.

Job order costing operations begin when a company decides to produce a

specific product for stock or in response to an order for a custom project. For example,

an electric motor manufacturer decides to build five model XL25 motors for stock. If the

company decides to accept the order, a job cost sheet is prepared. A job cost sheet is a

form, typically computer generated, used to accumulate the cost of producing the item

or items ordered i.e. the cost of the job.

The job cost sheet contains detailed information on the three categories of

product costs: direct material, direct labor and manufacturing overheads.

DIRECT MATERIAL COST- are the acquisition costs of all materials that eventually

become part of the cost object and can be traced to the cost object in an economically

feasible quay. Acquisition costs of direct materials include freight in charges, sales

taxes, and custom duties. Examples of direct material costs are the steel and tires used

to make the BMW X5, and the computer chips used to make cellular phones.

DIRECT MANUFACTURING LABOR COST- includes the compensation of all

manufacturing labor that can be traced to the cost object in an economically feasible

way. Examples include wages and fringe benefits paid to machine operators and

assembly line workers who convert direct materials purchased to finished goods.

MANUFACTURING OVERHEADS- are all manufacturing costs that are related to the

cost object but cannot be traced to that cost object in an economically feasible way.

Examples include supplies, indirect materials such as lubricants, indirect manufacturing

labor such as plant maintenance and cleaning labor, plant rent, plant insurance,

property taxes on the plant.

COMPONENTS OF JOB COSTING

There are numerous aspects to job costing, and we may use many, some or none of

them. If we want to use job costing, we need to:

1. Track the costs involved in the job

2. Make sure all of the costs are invoiced to the customer

3. Produce reports showing details of costs and revenues by job

The fundamental components of job costing are:

Quotes – also known as estimates, bids, or proposals

Fixed fee jobs

Time and materials jobs

Revenues

Items

Direct costs

Standard costs

1. Quotes

Quotes are non-posting transactions. They do not affect our financial statements

or our general ledger. We prepare a quote to give our customer an estimate of projected

costs, before a job is awarded. However, quotes also provide a means to track costs as

the job progresses, so that costs do not get out of line, or so that cost variances can be

identified and dealt with quickly.

2. Fixed fee jobs

Fixed fee jobs are an agreement to complete a job for a customer for a set price,

no matter what costs are incurred. While this may seem like a good deal for the

customer, an experienced estimator will set a price high enough to cover any

contingencies, which may result in a higher price than a time and materials job.

3. Time and materials job

On a time and materials job, costs of labor and materials are passed on to the

customer. A markup for overhead and profit may be built-in as a percentage of each

item or stated as a separate line item. Time and materials jobs are often preferred by

the seller, as any unforeseen costs may be passed on to the customer.

4. Revenues

Revenues are critical to the life of any business. In job costing, revenues are not

only categorized by account, but also by customer, job and item. Think of jobs as sub-

categories of customers and items as sub-categories of revenue/expense. This creates

a new way of analyzing our revenues and the costs incurred to produce them.

Expenses become revenues; as costs are incurred for a job, they are marked up

and passed on to the customer as revenues. To be able to compare our costs to the

revenues they produce, we should create matching categories in our revenue accounts

and cost of goods sold accounts (COGS).

5. Items

Items represent the products and services that our business sells. We may have

many items for each of the revenue/expense account categories in our chart of

accounts. Using items, we enter the details about what we buy and sell, then “map” or

link the detailed items to the more generalized accounts in the chart of accounts. We

can map many detailed items to a single account in our chart of accounts. This allows a

greater level of detail in the item list while keeping the chart of accounts list concise.

Items focus on revenues; they are the goods and services our company sells.

Use service items for labor, and non-inventory items for materials. The non-inventory

name just indicates that we are not tracking unit quantities or unit costs; they are still

goods and materials that we hold in inventory.

To track unit quantities and unit costs, use inventory items, but be forewarned; do

not use inventory items lightly. Using inventory items means that we are tracking and

entering unit quantities when we buy and sell as well as reconciling our accounting

records to the physical quantities on hand in between buying and selling. This is not an

item type for the faint-hearted!

6. Direct costs

Direct costs are the costs of the products and services sold. These are the costs

involved in job costing. Direct costs can be directly associated with a job and can be

identified as a part of the finished product. For a mason, direct costs would include the

costs of bricks and mortar, as well as the cost of the labor to prepare the mortar and lay

the bricks.

Direct costs are distinguished from indirect costs, or overhead. Indirect costs are

costs that cannot be identified in the finished product, even though they were incurred,

indirectly, in the process of completing the job. Examples of indirect costs are rent,

insurance and administrative payroll. Indirect costs are not included in job cost reports.

Direct costs are categorized on the profit and loss report as cost of goods sold, whereas

indirect costs are categorized as operating expenses.

7. Standard costs

Standard costs represent direct costs that include a calculated (or estimated)

portion of related costs that are not billed separately to our customers. They are often

theoretical calculations, done in a spreadsheet, that give a more accurate picture of the

direct costs involved in a job. Examples of standard costs include:

o For every 100 feet of electrical cable installed, on the average we use 20

staples, 6 wire nuts and 2 electrical connectors. The staples, wire nuts and

connectors are purchased in bulk and not individually billed to the job. The

purchase price for this item is the cost of the electrical cable alone. The standard

cost for the item includes the cost of the cable, staples, wire nuts and connectors.

o For every hour of labor paid, we also incur 8.9% in payroll taxes and 5% in

worker’s compensation. When creating this labor item, the purchase price is the

hourly cost of the labor. The standard cost includes the hourly cost of the labor,

plus the payroll taxes and worker’s compensation.

While we should carefully identify our standard costs, they are used only in job

cost reports; they are not the costs stored in the general ledger or reported in our

financial statements.

STEPS IN JOB COSTING METHOD

STEP 1: Identify the job that is chosen cost object-

Cost object are chosen using source documents. Source document is an original

record (such as a labor time card on which an employee’s work hours are recorded) that

supports journal entries in an accounting system.

STEP 2: Identify the direct costs of the job-

The direct costs identified in the job are the direct materials cost and the direct

manufacturing labor costs.

STEP 3: Select the cost-allocation bases to use for allocating indirect costs

to the job-

Indirect manufacturing costs are costs that are necessary to do a job but that

cannot be traced to a specific job. It would be impossible to complete a job without

incurring indirect costs such as supervision, manufacturing engineering, utilities and

repairs. Because these costs cannot be traced to a specific job, they must be allocated

to all jobs in a systematic way. Different jobs require different quantities of indirect

resources. The objective is to allocate the costs of indirect resources in a systematic

way to their related jobs.

Companies often use multiple cost allocation bases to allocate indirect

costs because different indirect costs have different cost drivers.

STEP 4: Identify the indirect costs associated with each cost-allocation

base-

As we see in step 3 &4 that managers first identify cost allocation bases and then

identify the costs related to each cost allocation base, not the other way round. That’s

because firstly the cost driver must be understood, the reasons why costs are being

incurred (for example, setting up machines, moving materials or designing jobs), before

they can determine the costs associated with each cost driver. The reason for not doing

step 4 before step 3 is that there is nothing to guide the creation of the cost pools. As a

result, the cost pools created may not have cost allocation bases that are cost drivers of

the costs in the cost pool.

STEP 5: Compute the Rate per Unit of each cost allocation base used to

allocate indirect costs to the job-

For each cost pool, the actual indirect cost rate is calculated by dividing actual

total indirect costs in the pool by the actual total quantity of the cost allocation base. The

rate per unit of actual manufacturing overhead is calculated as follows:

Actual manufacturing overhead rate= actual manufacturing overhead costs

Actual total quantity of cost allocation base

STEP 6: Compute the indirect costs allocated to the job-

The indirect costs of a job are computed by multiplying the actual quantity of

each different allocation base (one allocation base for each cost pool) associated with

the job by the indirect cost rate of each allocation base which was computed in step 5.

STEP 7: Compute the total cost of the by adding all direct and indirect

costs assigned to the job-

The total cost of the job is calculated by adding all the direct and indirect costs as

follows.

Direct manufacturing costs

Direct materials

Direct manufacturing labor

Manufacturing overhead costs

Total manufacturing cost of the job = direct materials + direct manufacturing labor

+manufacturing overhead costs

ADVANTAGES OF JOB-COSTING SYSTEM

1. It provides detailed analysis of costs which enable the management to determine

the operating efficiency of the different factors of production.

2. It helps in comparing the two set of works and hence it is of great use while

deciding on the efficiency of the department’s within an organization.

3. Since precise order is to be completed by the company can allocate the resource

according to order and hence there is no chances of any spoilage and hence it saves

lot of money for the company.

4. Company can know precisely how much profit it made from the completion of the

order immediately after completing it.

5. It lays down the standard for future similar contacts so that company can follow

those standards and complete the next similar jobs effectively and efficiently.

DISADVANTAGES OF JOB-COSTING SYSTEM

1. Job costing is very expensive as more clerical work is involved in identifying each

element of cost with specific department and/or jobs.

2. The costs are ascertained, even compiled promptly, are historical as they are

compiled after incidence.

3. The costs compiled under job costing system represent the cost incurred under

actual conditions of operation. The system does not have any specific basis to indicate

what the cost should be or should have been, unless standard costing is employed.

4. With the increase in clerical processes, chances of errors are enhanced.

5. In case of inflation, comparison of cost of a job for one period with that of another

becomes meaningless. Distortion of cost occurs even when the batch quantities are

different.

INTRODUCTION TO PROCESS-COSTING

Under a process cost system, costs are accumulated according to each

Department, cost center, or process. For simplicity, this discussion of cost accumulation

will refer to departments rather than to cost centers or processes. Note, however, that

there may be two or more processes performed in one department (and therefore, more

than one cost center in a department). In such cases, costs may vary significantly

between cost centers, so it is desirable in practice to accumulate costs according to cost

center or process rather than by department.

The average unit cost for a day, week, or year is obtained by dividing the

department cost by the number of units (tons, gallons, etc.) produced during the

particular period.

The process cost system is commonly used where products are manufactured

under mass production methods or by continuous processing. Industries using process

costs are paper, steel, chemicals, and textiles. Assembly-type processes such as

washing machines and electrical appliances would also use process costs.

STEPS IN PROCESS COSTING SYSTEM

STEP 1: Summarize the flow of physical units- the first step of accounting

provides a summary of all units on which some work was done in the department during

the period. Input must equal output. This step helps in determining the lost unit during

the process. The basic relationship may be expressed in the following equation:

Beginning inventory + Units started in the period = Units completed and

transferred out + Ending inventories

STEP 2: Compute output in terms of equivalent units- In order to determine the

unit costs of the product in the 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, that is,

work partially completed at the end of the period. The partially completed units are

measured on an equivalent whole unit basis for process costing purposes.

Equivalent units are measured on how many whole units of production are

represented by the units completed plus the units partially completed.

STEP 3: Summarize total cost to be accounted for by cost categories- This

step summarizes the total cost assigned to the department during the period.

Step 4: Compute the unit cost per equivalent unit- The unit cost per equivalent

unit is computed using following formula:

Total cost incurred during the period

Unit Cost =

Equivalents unit of production during the period

Step 5: Apply total costs to units completed and transferred out and to

units in ending work in process

Weighted Average Method

Weighted Average method blends together units and costs from the current

period with units and costs from the prior period. In a weighted average method the

equivalent units of production for a department are the number of units transferred to

the next department of finished goods plus the equivalent units in the department's

ending work in process inventory.

Example: Following is the data from Shaping and Milling department, one of the departments at Five Star Company

Shaping and Milling Department Percent Complete

Units Materials Conversion

Work in process, May 1Units started in production during MayUnits completed in May and transferred to the next departmentWork in Process, May31

2005,0004,800400

55%

100%*40%

30%

100%*25%

*It is always assumed that units transferred out of a department are 100% complete with

respect to the processing done in that department.

Note that the May1 beginning Work in Process is 55% complete with respect to

materials costs, and 30% complete with respect to conversion costs. This means that

55% of the materials costs required to complete the units in the department has already

been incurred. Likewise, 30% of the conversion cost required to complete the units has

already been incurred.

Since Five Star's work in process inventories are at different stages of completion

in terms of amounts of materials cost and conversion cost that have been added in the

department, two equivalent unit figure must be completed. The equivalent units

computations are shown below.

Shaping and Milling Department Materials Conversion

Units transferred to the next departmentWork in Process, May 31400 units × 40%400 units × 25%

Equivalent units of production

4,800   

160   

--------   4,960   

=====

4,800  

100   --------

4,900   =====

FIRST-IN-FIRST-OUT (FIFO) METHOD:

The computation of equivalent units under FIFO method differs from weighted

average method in two ways. First the units transferred out figure are divided into two

parts. One part consists of the units from beginning inventory that were completed and

transferred out, and the other part consists of the units that were both started and

completed during the current period. Second full consideration is given to the amount of

work expended during the current period on units in the beginning work in process

inventory as well as units in the ending inventory. Thus, under the FIFO method, it is

necessary to convert both beginning and ending inventories to an equivalent unit basis.

For the beginning inventory, the equivalent units represent the work done to complete

the units; for the ending inventory, the equivalent units represent the work done to bring

the units to a stage of partial completion at the end of the period (the same as with the

weighted average method). The formula for computing equivalent units of production is

more complex under FIFO method than under weighted average method.

Formula for Calculating Equivalent Units―FIFO method:

Equivalent Units of Production = Equivalent units to complete beginning inventory* + Units started and completed during the period + Equivalent units in ending work in process inventory

The equivalent units of production can also be determined as follows:

Equivalent Units of Production = Units transferred out + Equivalent units in ending work in process inventory − Equivalent units in beginning inventory.

Example:

To illustrate the FIFO method, refer again the data of shaping and milling department

of Five Star Company.

Shaping and Milling Department Materials Conversion

Work in Process May 1:200 units × (100% − 55%)*200 units × (100% − 30%)*Units started and completed in MayWork in process, May 31:400 units × 40%400 units × 25%Equivalent Units of Production

90

**4,600

160

--------4,850

 

140**4,600

100--------4,840

ADVANTAGES OF PROCESS-COSTING SYSTEM

A company may manufacture thousands or millions of units of product in a given

period of time.

Products are manufactured in large quantities, but products may be sold in small

quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two

at a time (eggs, cookies), etc.

Product costs must be transferred from Finished Goods to Cost of Goods Sold as

sales are made. This requires a correct and accurate accounting of product costs

per unit, to have a proper matching of product costs against related sales revenue.

*Managers need to maintain cost control over the manufacturing process. Process

costing provides managers with feedback that can be used to compare similar

product costs from one month to the next, keeping costs in line with projected

manufacturing budgets.

A fraction-of-a-cent cost change can represent a large dollar change in

overall profitability, when selling millions of units of product a month. Managers must

carefully watch per unit costs on a daily basis through the production process, while

at the same time dealing with materials and output in huge quantities.

Materials part way through a process (e.g. chemicals) might need to be given a

value, process costing allows for this. By determining what cost the part processed

material has incurred such as labor or overhead an "equivalent unit" relative to the

value of a finished process can be calculated.

EXAMPLE OF AN AREA WHERE PROCESS COSTING IS APPLIED

A common example of an industry where process costing may be applied is "Sugar

Manufacturing Industry".

The processes in this industry are

Cane Shredding

The cane is broken/cut into small pieces to enable easier movement through the

milling machine.

Milling

The shredded cane is passed through rollers which crush them to extract cane

juice. [Similar to the cane juice extracted by the vendors who sell you sugar cane

juice.]

Heating and Adding lime

The extracted juice is then heated to make it a concentrate and lime is added to

the heated juice.

Clarification

Muddy substance is removed from the concentrate through this process

Evaporation

Water is removed from the juice by evaporation.

Crystallization and Separation

Sugar crystals are grown from the dry juice concentrate in this process.

Spinning

Molasses are separated from sugar using Centrifugals in this process.

Drying

Sugar is obtained by drying the wet raw sugar obtained in the spinning process.

  

COMPARISON OF JOB-COSTING AND PROCESS-COSTING SYSTEM

DIFFERENCES

Job costing is used in industries where production is carried on according to

specific job order while process costing is used on continuous and mass production

industries where products are similar and of same specifications.

1. In job costing the basis of cost allocation is work order meaning the cost of each

unit in production is separately identified while in process costing the basis of cost

allocation is on time basis meaning the total cost for production during the period is

spread over units produced because separate identity of units is lost due to

continuous production

2. In job costing there may well be work in progress at the end of accounting period

while in process costing there is always work in progress both at the beginning and at

the end of the accounting period.

3. In job costing one can calculate the costs and revenues after completion of the

particular job or order while in process costing revenue and costs can be calculated

only at the end of accounting period.

4. In job costing there is no transfer of work from one job to another job till there is

surplus production or when the work is completed while in process costing costs of

one procedure are transferred to costs of next procedure until the goods are entirely

manufactured.

SIMILARITIES

Similarities between job order and process costing systems can be summarized as

follows.

1. Both systems have the same basic purposes-to assign material, labor, and

overhead costs to products and to provide mechanism for computing unit product

cost.

2. Both systems use the same basic manufacturing accountants, including

manufacturing overhead, Raw materials, Work in process, and Finished Good.

3. The flow of costs through the manufacturing accounts is basically the same in

both systems.