In the previous article, we have discussed absorption and variable costing in detail. This article is going to build upon the concepts discussed in the earlier article. If you have not yet read it, please read it before proceeding with this one.
In the previous article, we discussed absorption costing. The principles of total absorption costing can be applied to the operation of any business. How these principles are used depends on the type of business. In general, there are two main types of companies if we look at the manufacturing sector.
- Continuous operations
- Specific order
Continuous operation businesses are those where goods are produced due to the constant or sequential operation or process. Companies with ongoing operations usually have any of the following costing systems.
- Process costing
- Service costing
Businesses that work based on a specific order take work or orders in different jobs, batches, or contracts. Such companies can have any of the following costing systems.
- Job costing
- Batch costing
- Contract
In this article, therefore, we are going to discuss process costing and job costing systems.
Process costing and job costing are two accounting methods used to manage the accounting for manufacturing processes. Both of them are used to account for the cost of a product.
In process costing, the production costs are divided into the cost of a product based on processing. On the other hand, all the direct and indirect costs are accumulated based on each project in job costing.
What is Process Costing?
Process costing is used in businesses where the goods are produced in a series of continuous or repetitive operations or processes. The units in a process costing system have to be homogeneous or identical.
The cost in a process costing system is allocated on the basis of costs attributable to each process. Thus, all costs involved in a particular process, including the cost of wastage and idle time, are included in the process cost.
The per-unit cost in a process costing system is found by dividing the total cost of the process by the number of units produced by that process. For this reason, the goods being produced in a process costing system should be identical and of low value.
The product is broken into smaller pieces, and each unit is accounted for separately. The cost of each smaller part is determined by adding the
- direct material costs,
- direct labor costs,
- variable overhead costs, and
- fixed overhead costs.
The sum of these costs is recorded as the cost of that product.
The diagram shown above shows how the costs in a process costing system build up over each process and add to the finished goods or the completed product at the end of the final process.
If we look at the above picture, we can see that process 1 is the first process with takes the input in the form of
- Direct material
- Direct labour
- Overheads
The output of process 1 is transferred to process 2 in the form of input from process 1. Process 2 then takes additional input of material, labor, and overheads and then gives the output in the form of completed units or finished goods.
Equivalent Processing Units
Usually, at the end of each period, there is the leftover stock of partially completed unfinished goods. These partially completed units or work-in-progress stock needs to be accounted for in terms of their equivalent value in finished goods.
For instance, if at the end of a month, there are 50 half complete units, then the equivalent units in finished goods would be 25 fully complete units. Equivalent units are a way of allocating the cost of partially completed units.
Losses, Joint and By-Products
Process costing is one of those costing methods that has room for cost reduction by increasing the efficiency of the processes. The opposite is also true, which means that the cost can increase if efficiency falls. If the cost increases, it results in abnormal loss, and if it reduces beyond the expected margin, it is called abnormal profit.
Apart from this, joint and byproducts also impact the process costing. Certain processes result in joint products that may require additional processes to finalize the finished goods. Similarly, byproducts are also a part of many manufacturing processes. Byproducts can be sold, and the income earned through the sale of byproducts can be used to reduce the cost of the process and finished goods under process costing.
What is Job Costing?
Job costing is a type of specific order costing. The term “job” refers to any work done when a customer or client places an order. Usually, clients ask for quotes before they place an order. Quotes allow clients to compare different manufacturers and then make an informed decision based on the quote offered.
This means that when a business offers a quote to a client, that business must use the information given by the client to estimate the quantity of input that will be required for the specific job. This means that the business has to consider the following costs
- Direct material cost and quantity
- Direct labour cost and hours
- Overheads
- Profit margin
Job quotes are usually numbered and prepared on a job cost sheet, which can be in the following format.
| Job #25 Cost Sheet | Estimated | Actual | Variance |
| Direct material | xxx | yyy | zzz |
| Direct labor | xxx | yyy | zzz |
| Overhead | xxx | yyy | zzz |
| Total cost | XXX | YYY | ZZZ |
| Profit margin | xxx | yyy | zzz |
| Price | XXX | YYY | ZZZ |
Job costing is an essential part of total manufacturing costing. Job costing can be done by analyzing which jobs have different cost amounts and performing some work. It is a comprehensive approach that includes all production phases, from the raw material purchase to finished goods.
Now that we have looked briefly at process and job costing methods. Let us summarize their key differences.
| Process Costing | Job Costing |
| Calculates the cost of each process and then the units produced, where the production is done for a large number of homogenous items of low value. | Calculates the cost of a particular job, contract, or assignment, where the order is made to the specification of the client. |
| The process is standardized for all units. Thus it is suitable for mass production of the same items. | The job costing is customized for each job or order. Thus suitable for customized goods. |
| High likelihood of cost reduction due to process efficiency, low wastage, and joint or by-products. | Low or no likelihood of cost reduction or cost savings. |
| Ideal for mass production. | Suitable for industries with customized goods production. |
| Losses can be separated based on the processes. | Losses can be separately identified. |
It can thus be concluded that both process and job costing are two different costing methods that have their own merits and demerits. It is important to know and understand their differences, to apply them appropriately in relevant situations.