Question

Describe the differences between job order costing, process costing, and Activity Based Costing (ABC). What are the advantages and disadvantages of each system? Imagine a company that you might be a manager for. Describe that company and what their major product or service would be. Then, tell which cost system would be best suited to that firm and why.

Answer 1

Job-Order Costing is the development of a list of expenses you will incur to complete a specific job. Example: You want to build a deck onto the back of your house. This is a "one-time" project - i.e. you're not planning to go into business manufacturing decks. That would be....

Process Costing. Process Costing is when you begin manufacturing the same deck over and over. Each deck is identical, and they pop out of the end of your production process at regular intervals. Process Costing is an in depth look at the expenses incurred in producing one deck off of your production line.

Activity Based Costing. Activity Based Costing is used to manage Key Indicator activities throughout your company. There are various levels of Activity Based Costing:
Per Unit Activities would be used to measure costing for individual aspects of a unit of output. Example: reducing cost while improving the process used to measure a product's impact resistance.

• Uniqueness of product. Job costing is used for unique products, and process costing is used for standardized products.
• Size of job. Job costing is used for very small production runs, and process costing is used for large production runs.
• Record keeping. Much more record keeping is required for job costing, since time and materials must be charged to specific jobs. Process costing aggregates costs, and so requires less record keeping.
• Customer billing. Job costing is more likely to be used for billings to customers, since it details the exact costs consumed by projects commissioned by customers.

ADVANTAGES AND DISADVANTAGES

JOB COSTING

One advantage of job order costing is that it allows managers to calculate the profit earned on individual jobs, helping them to better ascertain whether specific jobs are desirable to pursue in the future. This is best for businesses that do highly custom work, such as construction contractors and consultants.

Job order costing also gives managers the advantage of being able to keep track of individuals' and teams' performance in terms of cost-control, efficiency and productivity.

A disadvantage of job order costing is that employees are required to track all materials and labor used during the job. As an example, consider a construction contractor using a job order costing system. The contractor has to keep track of all the wood, nails, screws, electrical fixtures, paint and other materials used on the job, as well as tracking workers' lunch breaks and hours worked.

PROCESS COSTING

Process costing simplifies record keeping by relying on statistical calculations rather than actual inputs. Another advantage of process costing is that it allows managers to get detailed information on the production statistics of individual departments or work groups. This is best suited for continuous manufacturing settings, such as factories and utility companies.

In a factory setting, for instance, materials are calculated using an average of units produced, and salaries expenses are often relatively consistent between pay periods. Process costing in this scenario gives managers the advantage of being able to ascertain the same qualities in entire departments and compare performance over time.

ACTIVITY BASED COSTING

Advantages of Activity-Based Costing

• Provides realistic costs of manufacturing for specific products
• Allocates manufacturing overhead more accurately to products and processes that use the activity
• Identifies inefficient processes and target for improvements
• Determines product profit margins more precisely
• Discovers which processes have unnecessary and wasted costs

Disadvantages of Activity-Based Costing

• Collection and preparation of data is time-consuming
• Costs more to accumulate and analyze information
• Source data isn't always readily available from normal accounting reports
• Reports from ABC don't always conform to generally accepted accounting principles and can't be used for external reporting
• Data produced by ABC may conflict with managerial performance standards previously established from traditional costing methods
• May not be as useful for companies where overhead is small in proportion to total operating costs

ABC produces more accurate costing of products by essentially converting broad indirect costs into direct costs of production. It determines the costs of the various sources of indirect costs and allocates these expenses to the specific activities that use them.

Medical services businesses, including hospitals, small doctor's offices and medical billing companies, can use job order costing to consider each patient or bill as an individual job. Record-keeping for job order costing in service industries, including the medical field, can be more complex than in other industries because these businesses offer a wide array of services, according to Accounting For Management, a business accounting information website.

This requires medical service businesses and other service companies to keep detailed records of each specific job to determine costs correctly. For example, a doctor's office may order patients based on the purpose of visits and the cost of treatments administered.

• Offers better understanding and justification of costs in manufacturing overhead