Question

When companies accumulate costs, they generally use either a job-order or a process costing system. The type of system used often varies based on the type of product or service provided. Identify and describe the type of cost accumulation system that is used. Explain how the system was used and, specifically, how overhead was allocated. Discuss how the use of cost accumulation enhanced the company’s operations.

Answer 1

Companies that produce goods and physical products need some sort of system to track costs and production levels. Process costing and job order costing are both viable methods for doing just that. Depending on the nature of the products and the amount of products created, one system may work better than the other.

Job Order Costing
Under job order costing, managers and workers track costs on a per-job basis. For example, an engineering firm that builds specialized computer motherboard may track the cost of the board on a per-job basis. Companies tend to use job order costing under the following conditions:

• The products created are unique or customized.
• Each product requires a different amount of material or labor hours.
• Production levels are relatively low.

Companies that use job order costing maintain a job cost sheet for every project they take on. If a job involves creating more than one unit, the total number of units manufactured is noted. The job cost sheet logs what components are used for the project and the component cost. It also tracks the number of labor hours incurred on the project and the cost of those hours. Managers also allocate a portion of manufacturing overhead costs to the project.

The sum of direct labor costs, direct materials cost and manufacturing overhead allocation is the project's total cost. Divide the total costs by the number of units produced in the job to find the product cost per unit.

Process Costing
If a company is creating a mass amount of products, maintaining hundreds or thousands of job order costing sheets can be burdensome. Companies in this situation choose process costing rather than job order costing. In process costing, the company tracks costs based on the entire production department rather than by individual jobs. Process costing works best under the following conditions:

• Products are identical or very similar in nature.
• Each product requires the same amount of time and materials to create.
• Production levels are high.

At the end of each reporting period, the production department will run a production report that details the total amount of units produced and direct labor, direct materials and manufacturing overhead incurred during the period. To find the product cost per unit, divide total costs by the number of units produced.

Overhead Allocation

The allocation of certain overhead costs to produced goods is required under the rules of various accounting frameworks. In many businesses, the amount of overhead to be allocated is substantially greater than the direct cost of goods, so the overhead allocation method can be of some importance.

There are two types of overhead, which are administrative overhead and manufacturing overhead. Administrative overhead includes those costs not involved in the development or production of goods or services, such as the costs of front office administration and sales; this is essentially all overhead that is not included in manufacturing overhead. Manufacturing overhead is all of the costs that a factory incurs, other than direct costs.

You need to allocate the costs of manufacturing overhead to any inventory items that are classified as work-in-process or finished goods. Overhead is not allocated to raw materials inventory, since the operations giving rise to overhead costs only impact work-in-process andfinished goods inventory.

The following items are usually included in manufacturing overhead:

Depreciation of factory equipment	Quality control and inspection
Factory administration expenses	Rent, facility and equipment
Indirect labor and production supervisory wages	Repair expenses
Indirect materials and supplies	Rework labor, scrap and spoilage
Maintenance, factory and production equipment	Taxes related to production assets
Officer salaries related to production	Uncapitalized tools and equipment
Production employees’ benefits	Utilities

Overhead Calculation

The typical procedure for allocating overhead is to accumulate all manufacturing overhead costs into one or more cost pools, and to then use an activity measure to apportion the overhead costs in the cost pools to inventory. Thus, the overhead allocation formula is:

Cost pool ÷ Total activity measure = Overhead allocation per unit

Why do we need to allocate total product costs to units of product?

A company may manufacture thousands or millions of units of product in a given period of time.

• products are manufactured in large quantities, but,
• products must be sold in small quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc.
• product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue.
• managers need to maintain cost control over the manufacturing process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets.
• a fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.

Job order costing Useful for

• Managing the costs of current jobs
• Determining inventory costs
• Providing data to predict future costs
• Identifying likely profitable or unprofitable jobs

​Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit