Question

1-Describe job order costing, process costing and activity-based costing. Provide examples of the type of companies that would use these costing methods (i.e., three company examples, one for each type of method).

2-Discuss the differences between relevant costs, opportunity costs and sunk costs. Provide examples with respect to how these costs pertain to incremental analysis.

3-Define a static budget and a flexible budget. Which is more useful for companies and why? How could you use variance analysis in your personal life for budgeting?

Answer 1

1)

A) Job Order Costing :-  Job order costing system is generally used by companies that manufacture a number of different products. It is a widely used costing system in manufacturing as well as service industries. Manufacturing companies using job order costing system usually receive orders for customized products and services. These customized orders are known as jobs or batches. A clothing factory, for example, may receive an order for men shirts with particular size, color, and design. When companies accept orders or jobs for different products, the assignment of cost to products becomes a difficult task. In these circumstances, the cost record for each individual job is kept because each job have a different product and, therefore, different cost associated with it.

Example:- Manufacturing businesses that use job order costing system include clothing factories, food companies, air craft manufacturing companies etc.

B) Process Costing :- Process Costing is defined as a branch of operation costing, that determines the cost of a product at each stage, i.e. process of production. It is an accounting method which is adopted by the factories or industries where the standardized identical product is produced, as well as it passes through multiple processes for being transformed into the final product. Process costing is a cost accounting technique, in which the costs incurred during production are charged to processes and averaged over the total units manufactured. For this purpose, process accounts are opened in the books of accounts, for each process and all the expenses relating to the process for the period is charged to the respective process account.

Example:- Process Costing is mainly used by Oil, Chemicals, Milk, Pencils, Paper, Clothes etc. industries.

C) Activity Based Costing :- Activity Based Costing is an accounting methodology that assigns costs to activities rather than products or services. This enables resources & overhead costs to be more accurately assigned to products & services that consume them.

Example:- ABC can be applied commonly in automobile manufacturers and power companies.

2)

A) Relevant Cost :- Relevant cost is a managerial accounting term that describes avoidable costs that are incurred when making business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision-making process. As an example, relevant cost is used to determine whether to sell or keep a business unit.

B) Opportunity Cost :- The value of the benefit sacrificed when one course of action is chosen in preference to an alternative. The Opportunity cost is represented by the foregone potential benefit from the best rejected course of action.

C) Sunk Cost :- A sunk cost is a cost that has already been incurred and cannot be recovered. A sunk cost differs from future costs that a business may face, such as decisions about inventory purchase costs or product pricing. Sunk costs (past costs) are excluded from future business decisions because the cost will be the same regardless of the outcome of a decision.

3)

A) Static Budget :- A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins. When compared to the actual results that are received after the fact, the numbers from static budgets are often quite different from the actual results.

B) Flexible Budget :- A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity.

Flexible budget is more useful for the companies as it changes with the Volume of activity and can be changed when there is a change in circumstances.

A budget variance is the difference between the budgeted or baseline amount of expense or revenue, and the actual amount. The budget variance is favorable when the actual revenue is higher than the budget or when the actual expense is less than the budget. Hence through budget variance analysis, difference between budgeted figures and actual figures can be easily identified.