Process Costing

Process Costing Vs. Job Order Costing Manufacturers use different types of costing systems to allocate production costs to their products and services. Two types of common product costing systems are process costing and job-order costing. While each system applies the same production costs to products, there are distinct variances in the application method. Process Costing oProcess costing applies production costs to products based on the process they go through in the manufacturing process. Each process has a standard amount of overhead, labor and materials that are applied to each batch run the individual manufacturing processes.

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Reconciliations are used after batches are processed to ensure that all appropriate costs are applied to the manufactured goods. Uses oProcess costing is primarily used in the production of homogeneous goods through repeated manufacturing processes. Products that use process costing include beverages, food, nails and screws. These items are processed through individual processes where costs are applied to each batch of produced goods. Manufacturers must be careful in streamlining their manufacturing process to ensure that each batch has production costs applied in similar amounts.

Job-Order Costing oJob-order costing is a method where overhead, labor and material are applied to different products, based on how much of each production material is used. Some items may use more labor, while other products may require more raw materials. Costs are applied, based on the cost of each portion of materials used, rather than through the production process used to manufacture the good. Manufacturers who produce several different types of goods will use job-order costing. Uses oProducts like clothing, repair shops and hospitals all use a form of job-order costing.

These companies have readily identifiable raw material costs that can be applied directly to each unit produced or serviced. Labor is also identifiable to each product because of the differences in the products produced. Most companies use job-order costing because of the various products they produce and the different manufacturing processes needed for each product. Overhead Application oProcess costing is the best costing method when producing large amounts of similar items. Casts are applied at the production process level, creating simple cost allocations for manufacturers.

Overhead is applied by each department as the products are moved through the individual production processes. Job-order costing may use several different types of overhead application processes, based on the cost driver of the manufacturer. Cost drivers are selected by accountants as the best way to apply overhead, based on how the products are produced. Number of direct labor hours, machine hours or activities is common cost drivers for job-order costing. Overhead is applied by dividing the amount of overhead by the total number of costs drivers used when producing products.

Explanation of Process Costing Product costing is used to calculate gross profits and to calculate ending inventory values. It is also used for making pricing decisions. Understanding your product cost is essential to understanding if you are making a profit. There are two primary methods used for product costing — job order costing and process costing. Why Use Process Costing oProcess costing is generally used for the continuous production of identical products. As the name implies, it is used when there is an ongoing process of multiple items coming down the line.

Materials and labor are added continuously to the production process. Why Not Use Process Costing oFor all of its benefits, process costing is not always the best choice. Process costing is not the preferred costing method for customized products or services or for items produced in a single batch. These items are not produced continuously and are not identical in nature. Job order costing is a better fit for these types of items. Bill of Material oThere is a bill of material associated with each product being produced. This is sometimes called a process cost worksheet.

It details out the materials and labor requirements for each item to be produced. While the products are not produced individually, the material and labor requirements for one unit are calculated based on the typical production quantity. Standard Costing oStandard costing is often used in conjunction with process costing. Standard costs are determined on an annual basis and use the material and labor requirements from the bill of material along with the standard cost per unit of material or hour of labor to determine a standard unit cost.

A standard overhead cost is also calculated annually and included in the product cost. Variances oOn a regular basis, the standard cost is compared with the actual costs. The difference between the standard cost and the actual cost is called the variance. There are material variances, labor variances and overhead variances. High variances need to be investigated to determine if the product cost is reasonable or if there are production problems. Explanation of Process Costing Why Use Job Order Costing oJob order costing system is used in situations where many different products are produced each period.

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. The record keeping and cost assignment problems are more complex in a job order costing system when a company sells many different products and services than when it has only a single product or service.

Since the products are different, the costs are typically different. Consequently, cost records must be maintained for each distinct product or job. For example, an attorney in a large criminal law practice would ordinarily keep separate records of the costs of advising and defending each of her clients. And a clothing factory would keep separate track of the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing system requires more effort than a process costing system. Companies classify manufacturing costs into three broad categories: 1. irect materials 2. direct labor 3. manufacturing overhead Similarities between Job Order and Process Costing Systems 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. Differences between Job Order Costing and Process Costing

The first is that the flow of units in a process costing system is more or less continuous, and the second is that these units are indistinguishable from one another. Under process costing it makes no sense to try to identify materials, labor, and overhead costs with a particular order from a customer ( as we do with job order costing ), since each order is just one of many that are filled from a continuous flow of virtually identical units from the production line. Under process costing, we accumulate costs by department rather than by order, assign these costs uniformly to all units that pass through the department during a period.

A further difference between the two costing systems is that the job cost sheet is not used in process costing, since the focal point of process costing is on departments. Instead of using job cost sheet a production report is prepared for each department in which work is done on products. The production report serves several functions. It provides a summary of number of units moving through a department during a period and it also provides a computation of unit costs. In addition it shows what costs were charged to the department and what disposition was made on these costs.

The department production report is a key document in a process costing system. These differences are summarized below: Job Order CostingProcess Costing Many different jobs are worked on during each period, with each job having different production requirements. A single product is produced either on continuous basis or for long periods. All units of product are identical. Costs are accumulated by individual job. Costs are accumulated by departments. Job cost sheet is the key document controlling the accumulation of costs by a job..

The department production report is the key document showing the accumulation and disposition of costs. Unit costs are computed by job on the job cost sheet. Unit costs are computed by department on the department production report. The Flow of Documents in a Job Order Costing System A sales order is prepared as a basis for issuing a….. A production order initiates work on a job, whereby costs are charged through… >Materials requisition formThese production costs are accumulated on a form, prepared by the accounting department known as…

The job cost sheet is used to compute unit product costs that in turn are used to value ending inventories and to determine cost of goods sold Sales Order>Production OrderDirect labor time ticket>Job cost sheet Predetermined overhead rates Which Type of Firms Would Use Process Costing Rather Than Job Order Costing? Process costing is a technique used in managerial accounting to determine costs. This technique is applied in situations where there are repetitive operations, mass production and products that are homogeneous, or essentially identical.

On the other hand, job order costing is an accounting technique applicable to distinct products tailored for a specific user, and the price is accumulated for each specific unit. Homogeneous Products oFirms that produce products with little differentiation use process costing. This is because these products incur the same costs, use same inputs and do not require special attention. Their costs can therefore be computed as a whole. Examples include paper mills and companies that process food. Many Processes Some firms specialize in products that must go through various processes. The production processes are divided into various stages, such as assembly, manufacturing and packaging. These companies therefore use process costing. The output of one stage forms the input of the next stage, with the final stage giving the finished product. Process costing is used to accumulate costs incurred in each stage. Continuous Production oFirms whose production process takes place continuously without stopping, except when the machines are stopped for maintenance, use process costing.

Here goods follow a sequence of recurring and continuous processes, and the cost of each process is computed. Unit costs are computed by dividing the process cost by total output. Mass Production oProcess costing is best suited to firms that produce large quantities of standardized products. It is sometimes impossible to compute specific process costs for each product such as in mass production of pins and needles. The unit cost of each product can be computed only by dividing the total costs of all processes by the number of units of output produced.

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