Businesses incur several types of costs in the course of carrying out their operations. Measuring these costs is important to take pricing decisions and analyzing them is crucial to implement cost control and management measures to boost entity’s profitability. Costing is the key business function which involves ascertaining and apportioning costs to specific products, processes or functions. It is through this function that costs can be measured and analyzed to assist management in a variety of business decisions related to cost and profitability.
Costing involves several different methodologies to arrive at product cost. This article looks at meaning of and differences between two types of costing methodologies – job order costing and process costing.
Definitions and meanings
Job order posting:
Job order costing involves ascertaining and allocating costs to each distinct product manufactured or each distinct service provided by the entity. This process of costing is adopted when an entity produces products or services which are all considerably different from each other and involve high costs, typically in a made to order businesses.
The term job order costing is used for such costing technique because each time a new order is received, a separate job sheet is prepared and cost determination is done. Each time a new order for a product or job is received, a separate documentation is maintained to accumulate the costs associated with that product or job. This documentation typically includes material requisition forms and time sheet records etc. A job sheet is then prepared to summarize and log in consumption of materials, labor, machine hours and any other direct costs consumed by the job or product in question.
Example: Manufacturing entity M/s ABC Inc. manufactures custom made designer furniture sets. Since each product manufactured is unique and custom made to the specifications of each customer, its production involves varied costs depending on the types of materials and finish used, intricacy of design, sizing etc. Every time a new order is received, a separate job sheet is prepared logging in the materials consumed, the number of hours employed by carpenters. On this basis, the costs associated with each job order is independently and separately identified.
The steps involved in job order costing include:
- Identifying each distinct product
- Preparation of job sheets for each identified product to record materials and labor employed
- Ascertaining direct materials consumed by each product
- Ascertaining direct labor employed in the production of each distinct product and allocating direct wages accordingly
- Ascertaining an appropriate cost driver for allocation of direct overheads such as machine hours, labor hours etc.
- Allocating direct overheads to each product based on the determined cost driver
- Arriving at the cumulative manufacturing cost of each product (direct material + wages + allocated overhead)
Unlike job order costing which ascertains and allocates cost to individual jobs, a process costing system involves ascertaining, accumulating and allocating costs to the whole manufacturing processes of the entity. This costing approach is adopted by entities that typically produce large quantities of homogeneous products or that provide repeated services of similar nature.
In mass production entities, a product may go through several processes through several departments and the output of one process becomes input of the next process to ultimately reach the stage of finished goods. Process costing identifies and accumulates direct costs incurred at each process. These are then added up to arrive at the total production cost of the products manufactured in a given period.
Example: M/s XYZ Inc manufactures wafer packets on a large scale – 10,000 units a month. The production involves several processes; from sorting, peeling and cutting potatoes, to frying process, to seasoning to packaging and branding. To ascertain the per unit production cost of each wafer packet, the entity will calculate and allocate direct costs involved in each process per month. The total costs of all processes will be accumulated and divided over the number of units produced to arrive at the per unit production cost of wafer packets.
The steps involved in process costing include:
- Ascertaining direct costs involved in each process/incurred by each department
- Accumulating the total costs
- Determining total production quantity – after considering any opening and closing inventory in process
- Dividing total of all process costs by the determined production quantity
Difference between job order costing and process costing
The main points of difference between job order costing and process costing have been detailed below:
- Job costing is the identification and allocation of direct costs associated with each unique product or job order.
- Process costing is the identification and allocation of direct costs associated with each process that is involved in production of goods, to ultimately arrive at the production cost of goods
2. Costs accumulated for
- In job order costing, the costs are directly determined for each product itself.
- In process costing costs are accumulated for each process first and then allocated to the products manufactured.
3. Nature of products
- Job order costing is followed where products are unique and generally customized or made to order as per customers’ specifications.
- Process costing is followed where products are largely homogenous and more or less identical to each other.
4. Size and value of orders
- Job order costing is adopted for products or orders that are produced in relatively smaller quantities and are individually higher in value.
- Process costing is adopted for bulk order products that are produced in larger quantities and lower per unit value.
5. Documentation involved
- Job order costing involves more extensive documentation as consumption has to be tracked and assigned to each individual job.
- Process costing requires lesser documentation as costs are to be accumulated and assigned to processes.
6. Periodicity of cost ascertainment
- In job order costing, costs are ascertained on the completion of each job or order.
- In process costing, costs are ascertained at periodic intervals such as weekly or monthly, depending on the entity’s production/batch schedule.
7. Suitable to type of entities
- Job order costing is suitable to ‘made to order’ businesses.
- Process costing is suitable to generic and mass production businesses.
- Job order costing is typically used in entities such as custom furniture production, machine production businesses, architects, lawyers etc.
- Process costing is typically used in entities such as food processing industries, consumer good manufacturers, generic service providers etc.
Conclusion – job order costing vs process costing:
The main purpose of both job order costing and process costing is to ultimately arrive at the product cost so as to take pricing decisions. They apply to different types of industries/products and are chosen accordingly. Some industries may in fact use a combination of both these costing methods. 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.