4 1 Distinguish between Job Order Costing and Process Costing Principles of Accounting, Volume 2: Managerial Accounting

For example, law firms, architects, and medical professionals have accounting systems to track the costs of serving individual clients. Although it might not be called job order costing, the basic approach is the same. Choosing between job order costing and process costing can feel overwhelming, but it all begins with understanding your business’s accounting needs.

Industries and applications 🔗

Job order costing systems assign costs directly to the product by assigning direct materials and direct labor to the work in process (WIP) inventory. The diagram in Figure 4.2 shows a partial organizational chart for sign manufacturer Dinosaur Vinyl. The CEO has job order costing vs process costing several direct reporting units—Financing, Production, Information Technology, Marketing, Human Resources, and Maintenance—each with a director responsible for several departments. However, there are significant differences between Job Order Costing and Process Costing.

This costing approach is adopted by entities that typically produce large quantities of homogeneous products or that provide repeated services of similar nature. They produce large quantities of standardized products using continuous production processes. The focus is on calculating the average cost per unit by dividing total production costs by the number of units produced. The choice between job order costing and process costing systems depends on the nature of production and each company’s financial control objectives. Both systems offer particular benefits but also present challenges that may impact cost management and operational efficiency.

Understanding Process Costing

• In process costing, costs flow through WIP accounts for each department as products move through sequential production stages, transferring with the units.
• The diagram in Figure 8.1 shows a partial organizational chart for sign manufacturer Dinosaur Vinyl.
• Each costing method offers specific advantages while presenting certain limitations, making the choice dependent on business circumstances and information needs.
• To truly grasp the distinction between Job Order Costing and Process Costing, it’s helpful to examine how different industries apply these methods in practice.
• The costs tracked for each job include direct materials, direct labor, and manufacturing overhead.

They’d also allocate a portion of their overhead costs (such as office rent and equipment depreciation) to that project. Material and labor costs that cannot be traced directly to the product produced are included in the overhead costs that are allocated in the production costing process. Overhead is applied to each product based on an activity base, which will be explained later in this chapter.

Work-in-Process (WIP) Inventory represents the partially completed units within each production department. This calculation yields an average cost per unit, which is then used for inventory valuation and cost of goods sold calculations. The flow of goods through production is more evident in Figure 8.2, which depicts Dinosaur Vinyl as a simple factory with three stages of production. Imagine running a company without really knowing how much it costs to produce what you’re selling. We optimize pricing and revenue through data-driven strategies and integrated planning.

• In a job order costing system, each job or order is treated as a separate unit, and costs are tracked individually for each job.
• Selecting a costing method isn’t simply about identifying the most applicable one; it also entails understanding the trade-offs.
• Before you can set up an effective job or processing costing system, you have to separate direct costs from indirect, or overhead costs.
• A furniture manufacturing company, for example, may use job order costing for its custom-made orders whereas it may rely on process costing for its mass-produced furniture products.

Jobs v. Processes

In a business that employs a job order costing system, each specific job or order is assigned a unique job number to distinguish it from the others. We’ll use a service business next to illustrate the basic idea of job costing, but first, check your understanding of the differences between job costing and process costing. No matter the chosen method, precise calculation of Manufacturing Costs remains paramount. These costs – encompassing direct materials, direct labor, and manufacturing overhead – form the bedrock of inventory valuation, cost of goods sold, and ultimately, profitability analysis.

The type of costing method you use depends on the type of business you’re running. Process costing is similar to splitting the check, where the total cost is spread equally over the number of units (or in the case of a meal, the number of people at the table). This simple method works well as long as the cost of each unit (or meal) is about the same. Accruing tax liabilities in accounting involves recognizing and recording taxes that a company owes but has not yet paid.

In contrast, period costs are not directly related to the production process and are expensed during the period in which they are incurred. This approach matches administrative and other expenses shown on the income statement in the same period in which the company earns income. Prior to the sale of the product, separating production costs and assigning them to the product results in these costs remaining with the inventory.

The last two types of production in use process costing methods described in another chapter, so we give just a brief overview here. Repetitive manufacturing lends itself to the use of automated equipment that minimizes the amount of manual material handling. Automobile assembly plants, bicycle assembly plants, and computer assembly plants use repetitive manufacturing. Pepsi-Cola makes soft drinks, Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long periods. Conversely, if your business churns out homogenous, standardized products – like canned goods or refined chemicals – Process Costing becomes the more efficient and practical choice. The focus shifts from tracking individual units to averaging costs across large production runs.