Manufacturing companies use either job order costing or process costing. The records may reflect either actual values or estimated amounts based on standard costs and are adjusted later.
The most commonly contrasted cost systems are "job order costing" and "process costing". Other systems include: standard costing, hybrid, backflush, and activity-based. In this article, we will introduce you to the different cost systems and how they work.
Let us take a look at the following cost accumulation systems:
Under job order costing, costs are accumulated per job. For example: Job 101, Job 102, Job 103, etc. This product costing system is used by firms with limited quantities of products. This method is used for unique or dissimilar products such as customized furniture, buildings, large boats, custom dresses, and others.
Job order costing calculates the cost of a unit or set of units in a given order. An order is often termed as "job", "batch", or "lot". The costs of materials, labor, and overhead of each job are summarized in the job order cost sheet.
Under process costing, costs are not accumulated per job, batch, or lot. Instead, materials, labor, and overhead costs are accumulated per production process or production department (cleaning, mixing, assembly, packaging, etc.).
Process costing is commonly used by companies operating in mass production of similar or identical products since the products go through the same processes. Job order costing, on the other hand, is applicable to dissimilar or customized products.
Some companies use job order costing and process costing at the same time. This is known as hybrid costing. For example, a company might use job order costing for materials and process costing for labor and factory overhead.
Standard costing is used together with other cost accounting systems such as job order costing and process costing. Under standard costing, estimated costs based on predetermined values are used even if actual costs are not yet available. The estimated costs are adjusted later to reflect the effect of actual costs incurred.
Backflush costing is most applicable to products that have short production cycles and use the just-in-time inventory (JIT) system. Under JIT, a company maintains no or very minimal inventory. Inventories are sent by the supplier to the company only at the exact time they are needed.
Under backflush costing, detailed tracking of the movement of costs is eliminated. Once materials, labor and overhead are used, they are directly entered or "flushed" into finished goods (sometimes, just directly to cost of sales once they are sold). Backflush costing simplifies the accounting process by eliminating the details of work-in-process.
When computing for standard costs, the traditional system computes for a single overhead rate using only one basis (usually direct labor hours or machine hours). For example, $500,000 factory overhead cost over 100,000 direct labor hours results in $5 FOH per direct labor hour. If 150,000 labor hours are used, then the estimated factory overhead cost would be $750,000 (150,000 hours x $5).
However, under activity-based costing, several bases (known as cost drivers) are used. Costs are accumulated per activity (ordering, processing, assembly, packaging, maintenance, etc.). The costs are then allocated using different cost drivers such as number of orders, processing time, machine hours, floor space, and others.