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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 1 200 55% 30%
Units started in production during May 5,000
Units completed in May and transferred to the 4,800 100%* 100%*
400 40% 25%
next department
Work in Process, May31

*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 4,800 4,800
department
Work in Process, May 31 160
400 units × 40% 100
-------- --------
400 units × 25% 4,900
4,960
===== =====
Equivalent units of production
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%)* 90
200 units × (100% − 30%)* 140
Units started and completed in May **4,600 **4,600
Work in process, May 31:
400 units × 40% 160
400 units × 25% 100
-------- --------
Equivalent Units of Production 4,850 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.