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