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Process Costing Versus Job Order Costing

Managerial Accounting, Plugs

Let’s imagine that you are operating a business in the auto parts industry and you have come up with a new way to revolutionize your production techniques to be able to offer a new line of specialty spark plugs for consumers in the auto racing market. And let’s further assume that you are currently utilizing a process costing system, but would like to explore the possibility of using a job costing system for this new line of spark plugs. To help you make the right decision, let’s explore the similarities and differences between these two types of costing systems.

First off, let’s define each one of these costing systems.

Process costing is a costing system that is designed to allocate the manufacturing costs evenly to the products being produced. It is used mainly by businesses that mass produce similar or identical products on a continual basis. An example of this would be a brick company. A brick company mass produces bricks that are identical in size, shape, and texture, so a process costing system would be the best choice for their business needs.

A job costing system allocates the manufacturing costs to individual products. It is commonly used by businesses who want to know what manufacturing costs are associated with different jobs, products, or services. A good example of company that might use this type of costing system is a hospital. A hospital is generally broken into different departments and each department offers different services to its customers. For instance, the emergency department offers emergency services and the radiology department offers x-rays and ultrasounds to their customers. So because a hospital operates in this manner, they need to be able to correctly identify which costs are associated with which department.

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As you can see, from the above definitions, each costing system is very unique and they both have some similar characteristics. For instance, both costing have the main goal of allocating the manufacturing costs to the products being produced and they also use the same manufacturing accounts (i.e. overhead, raw materials, and WIP) for financial reporting purposes.

Now putting their similarities aside, let’s look into how they are different.

The first main difference is how each costing system accumulates and allocates it costs. In process costing, all the manufacturing costs are accumulated by specific departments and the costs are then evenly allocated to the products. Now since all the products are basically indistinguishable from each other, companies will determine the cost per unit by dividing the total product cost by the number of units produced for that period. This costing method can only produce average individual product costs, because it does not identify the exact costs per individual products or batches. On the other hand, a job order costing system accumulates its costs by specific jobs and the manufacturing costs are allocated to those specific jobs. To illustrate this, let’s assume that you want to manufacture a line of blue colored spark plugs and each batch of spark plugs will require certain employees to manufacture them, special raw materials, and a certain amount of labor hours. So the costs that are incurred in making each batch of spark plugs will be allocate to that specific batch and not the entire line of blue spark plugs coming out of the factory.

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Another main difference between these two methods is the way the costs flow through the financial accounts of a business. As I noted earlier, both methods use the same financial accounts and the flow of costs through these accounts are basically the same, but the flow of costs through WIP finished goods inventory is a little different in each type of costing system.

Under a process costing system, costs are accumulated by a series of departments and each department will have its own WIP account. To illustrate this process easier, we will take your company a little off subject here and assume that your company now manufactures tomato sauce, instead of spark plugs. Under a process costing system, the tomatoes would be ran through the extraction department where the tomatoes are crushed, and then they move from the extraction department to the mixing department, on through to the canning department, and finally to the packing and shipping department. While the tomatoes are in each department, all costs incurred will be recorded on each department’s individual WIP account. The totals recorded and these WIP accounts become the beginning raw material amount for each succeeding department (i.e. the WIP amount from the extraction department is the beginning raw materials amounts for the mixing department) (Edmonds et al, 2006).

Under a job order costing system, product costs are accumulated by specific jobs, instead of departments. So let’s assume our example, again, of the new line of blue sparks plugs. Each batch of spark plugs would be a specific job and assigned an identification number to be recorded in a subsidiary account of the WIP inventory. Only the costs associated with making that specific batch of spark plugs will be recorded under that identification number instead of combining all the product costs from the whole line of sparkplugs, as in a process costing system. The costs will then flow through the finished goods inventory where they will be placed into specific individual job subsidiary accounts until the products are sold. Under process costing, all the products costs from each department would be combined in the finished goods inventory, whereas, under job order costing the separate specific job accounts will still be present until the products are sold.

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After reviewing each system, I would recommend that if you are a new or small company and/or looking at introducing a new product line into the market, you will want to use a job order costing system. This type of system breaks up costs and assigns them to specific jobs that will allow you to more accurately track your costs. On the other hand, if you are a company that produces mass amounts of identical products or is a company that is organized into departmental categories and does not have a need to accurately predict/track specific costs, then a process costing system will suit your overall needs.

Edmonds, T.P., Edmonds, C.D., Tsay, B., Olds, P.R. (2006). Fundamental Managerial Accounting Concepts.3rdED. McGraw Irwing Hill.