Job Order Costing Process Costing and Activity Based Costing
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A cost accounting system is the sum methods and techniques used by businesses allowing them to track resources consumed in production and distribution of services or goods to consumers. These methods and techniques are used by the management in order to evaluate and reward staff performance, by employees in order to manage recourses efficiently while the cost accounting system is also used for external reporting requirements meaning balance sheets and income statements. The cost accounting system is usually designed to meet particular needs of individual companies, for that reason there are three main systems businesses apply according to their needs.
Job Order Costing is a cost system used to accumulate costs of jobs also called batches. Job order costing is used when individual production centres or departments work on a variety of products rather than one king of a product during a specific period of time. Prime costs and factory overhead costs are the two categories of production costs monitored with this method.
Process costing is a type of costing system used for production of small identical, low-cost items. Process costing averages the costs and can't be directly traced to individual products.
Activity based costing (ABC) is designed to assign costs to activities. This method has become popular because of the fact that the complexity of businesses keeps growing and so does their need to assign increasingly large indirect costs to the appropriate department or activity. ABC is the process where costing is assigned based on the cause and effect relationship between costs and activities that drive costs.
What are major objectives of a cost accounting system in a hospitality establishment?
Within hospitality establishments cost accounting systems help successfully achieve the following management objectives:
- Measuring the various needs and generated revenues of departments
- Monitoring and controlling the progress of each department
- Department related data gathered is used to evaluate costs and make proper adjustments and corrections in operating procedures
What are the major objectives of a cost accounting system system in a manufacturing company?
In manufacturing and service companies cost accounting systems help achieve the following management objectives. They provide the managers with helpful information regarding planning, cost control procedures and determining unit production costs. In most cases manufacturing companies also use a complete job cost sheet which contains Cost Summary and Unit Cost information since manufacturing costs are not immediately recorded as current period expenses. These information include total and costs per unit for:
- Direct materials, which are the raw materials used in production which costs are directly traceable throughout the product manufacturing process.
- Direct labour, which are the wages and other pay roll costs of employees whose efforts are directly traceable throughout the product manufacturing process.
- Manufacturing overhead, is the category including all other manufacturing costs like utilities aside for the above mentioned ones.
What are the procedures in job order costing, process costing and activity based costing.
Job order costing process is a specific set of events which will usually occur with each job. Generally the process is as follows: an order (or sale order) is received for the batch of products, a production order is issued from the sale order materials and labour are ordered and tracked for the set of products, manufacturing overhead is allocated to the job using a predetermined rate (usually per labour or per machine hour). In fact manufacturing overhead will not affect the work in process account; instead it is changed to a control account. Direct labour and materials are charged by the accountant to the work in process accounts using the actual quantity acquired. These quantities are all tracked using a job costing sheet which will likely be already a computerized ledger and use used for each job. Spoilage which surpasses expected levels based on the job at hand is considered a period cost and is reclassified from work in process account into a separate account so it can be addressed by the management.
Process costing procedures follow specific procedures and while exact procedures may differ between different companies and businesses, but they generally follow these steps.
While other types of costing are initiated when a sale order is issued, a sale order is not required for process costing as it is a continuous process.
The work in process accounts are separated departments and are named according to the department they reflect on e.g. Work in process- F&B department.
The first department in the production process makes the first entry into the work in process account, generally for the raw materials.
While the products move from department to department entries are made to each work in process account of each department.
Direct labour costs are recorded at each period.
Actual overhead costs are recorded; no contra-account in needed because there is no over- or under-applied overhead due to the actual costs being applied.
Indirect costs are applied to the overhead account in actual amounts.
Activity based costing procedures can be more complicated to set up and operate than other costing systems. The activity based costing procedures are:
Only if a cost driver can't be recognized a cost can be assigned on an allocative basis.
Related cost pools are assigned to an overhead rate on costs drivers.
Cost pools are used to assign costs; the basis depends on the business and industry.
Costs can be assigned to units, batches or products.
These pools can be combined to look at facilities, divisions, or other levels of cost classifications.
Costs can then be evaluated in order to see how and where they are occurring, knowing this the management can discern what cists are controllable and how they arise.
Which costing methods (job order costing, process costing and activity costing) are best suited to the following businesses and why:
Old Home Bakery, Inc (a bakery that produces to order): It will be able to use job order costing because it is designed for businesses which work with orders rather than mass production.
Apache Oil and Gas Refinery: Because the products are similar or identical the process costing is the appropriate method the business should apply. It is also recommended because the company uses an automated continuous process.
The Sea View Resort Hotel: the hotel is best recommended to use the job order costing because it offers services and the method is designed for such businesses.
Willie Wonker's Chocolate Factory: because the business produces a standard item which units are identical it is best to apply the process costing method.
Harris and Harris Law Firm: Since this business offers services in the form of legal counselling or legal representation is it best to use the job order costing which refers to a desired unit which might not be identical to another offered service.
Explain and evaluate LIFO, FIFO and AVCO techniques.
LIFO stands for last-in first-out what means that recent purchases will be stored recorded and sold before the items that already existed in stock when the purchase was received. LIFO valuation is permitted due to the belief that an ongoing business does not realize an economic profit only from inflation. When prices are rising they must replace the inventory currently being sold with items oh higher prices. It also matches better current cost against current revenue and defers paying taxes on phantom income arising exclusively from inflation. LIFO is preferred by businesses because it delays a major negative effect of inflation; higher taxes.
FIFO is the most commonly used method used by businesses to record the value of inventory. It is appropriate when dealing with many different batches of similar products. The method assumes that the next item that will be purchased will be placed at the end of the line of to-be-sold items of that kind meaning what was purchased first will be sold first. In an economy of rising prices (during inflation), it is common for new companies to use this method to report the value of merchandise to boost their balance sheet. While the older and cheaper good are sold the new and more expensive goods remain as assets in the business's books, financial statement boosted by FIFO also increase the chances a business has to get a loan.
AVCO is used to establish the value of an inventory by calculating the costs of units. In practice it provides us the results we want by dividing the total cost of good available for sale with the number of items for sale.
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