In managerial accounting, there are two primary methods of costing used by manufacturing companies: job order costing and process costing. While both methods have similarities, they also have significant differences.
Job Order Costing
Job order costing is used when a company produces unique, custom-made products or services. Each job is distinct from the other, and costs can be traced to each individual job. For example, a printing company that produces custom wedding invitations would use job order costing. Each order would be unique and require different materials, labor, and other costs. In job order costing, costs are accumulated by job, and each job has its own cost sheet.
The steps in job order costing include:
- Identify the job: The first step is to identify the job and assign it a unique job number or job order.
- Accumulate costs: All direct materials, direct labor, and overhead costs associated with the job are tracked and accumulated on the job order cost sheet.
- Calculate total costs: Once the job is completed, the total costs are calculated by adding up the direct materials, direct labor, and overhead costs.
- Determine the unit cost: The unit cost is calculated by dividing the total cost by the number of units produced.
- Prepare an invoice: The final step is to prepare an invoice for the customer based on the unit cost.
Examples of companies that might use job order costing include custom home builders, graphic design firms, and machine shops.
Process Costing
Process costing is used when a company produces a large number of identical products or services. The production process is continuous and involves a series of identical, repetitive steps. For example, a chemical company that produces large quantities of bleach would use process costing. Each batch of bleach produced would be identical and require the same materials, labor, and other costs.
The steps in process costing include:
- Identify the process: The first step is to identify the production process and assign it a unique process number.
- Accumulate costs: All direct materials, direct labor, and overhead costs associated with the production process are tracked and accumulated on a work in process (WIP) report.
- Calculate the unit cost: The unit cost is calculated by dividing the total cost of the WIP report by the number of units produced.
- Transfer costs: Once the production process is complete, the total cost is transferred to the finished goods inventory account.
Examples of companies that might use process costing include chemical companies, food and beverage manufacturers, and paper mills.
Difference Between Job Order Costing and Process Costing
The main difference between job order costing and process costing is the way costs are accumulated. In job order costing, costs are accumulated by job, while in process costing, costs are accumulated by production process. Job order costing is used for custom-made products, while process costing is used for identical, repetitive products. Companies that use job order costing tend to have a lower volume of production, while companies that use process costing tend to have a higher volume of production.
In conclusion, job order costing and process costing are two methods of costing used by manufacturing companies. They have differences in the way costs are accumulated, and they are used by different types of companies. It’s essential to understand which method to use based on the company’s production process to ensure accurate cost calculations.