Cost Accounting Systems are the methods and techniques used by enterprises to track resources consumed in creating and delivering products and services to consumers. The information that comes up from this methods and techniques are used by employees to manage resources efficiently. The information used by management to evaluate and reward employee performance and also are used for external reporting requirements (balance sheet and income statement). Cost accounting systems helps manufacturing and service companies to achieve two significant management objectives: to determine unit manufacturing costs and to provide managers with useful information for planning and cost control functions. Cost accounting systems are typically designed to accommodate the specific needs of individual companies. The three main Cost Accounting Systems are:
Job Order Costing is used by companies that adapt their goods or services to the specific needs of individual customers. In job order costing, the costs of direct materials, direct labor and overhead are accumulated separately for each job. These jobs could also be called batches. Job order costing is used when individual production centers work on a variety of products rather than just one. Construction companies use job order cost systems because each construction project has unique characteristics that influence its costs. Other costing methods are used for production processes that produce mass quantities of identical units that use the same amounts and types of direct labor, direct materials and overhead.
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Process Costing is a method for accumulating the direct and indirect costs of a production process and averaging those costs over the identical units produced by that process. Many companies produce identical units, such as bottles of beer. When identical products are produced in a continuous stream there are no distinct jobs. Consequently companies engaging in mass production often use process costing rather than job order costing. Mass production includes a series of specific steps or manufacturing processes. Process costing measures the cost of performing each process and then allocates these costs to the units processed during the month. Process costing measures the cost of goods manufactured on both a total and per unit basis and also provides management with information about the per unit cost of performing each step in the production process.
Activity Based Costing (ABC) is designed to assign costs to activities. Activity based costing is an overhead allocation method that uses multiple overhead rates to track indirect costs by the activities that consume those costs. ABC has become popular due to the fact that as businesses grow in complexity, so does their need to assign increasingly large indirect costs to the appropriate area or activity. Examples of activities that consume overhead resources include purchasing and storing materials for production, supervising direct labor, consuming electricity etc. ABC provides management with information about the cost of performing various overhead activities.
What are the major objectives of a cost accounting system in a hospitality establishment?
A cost accounting system helps a hospitality establishment to achieve the following objectives: to evaluate and reward employee performance, to track the services to customers, to measure the different departments needs and their revenues. However hotels must use a cost accounting system in order to monitor and to control all the departments and the information produced by this system helps managers with cost control functions.
What are the major objectives of a cost accounting system in a manufacturing company?
In manufacturing and service companies, cost accounting systems help to attain two important management objectives: to determine unit manufacturing costs and to provide managers with useful information for planning and cost control functions.
What are the procedures in job order costing, process costing and activity based costing?
The Job-Order Costing Procedures is a specific set of events which will usually happen with each job. Normally, the process is as follows: first the order is taken for the group of products, after the production order is issued from the sales order, materials and labour are ordered and track for the set of products. After that, manufacturing overhead is allocated to the job using a predetermined rate (usually per labour hour). The actual manufacturing overhead will not affect the work-in-process account, as an alternative it is charged to a control account. Direct labour and materials are charged by the accountant to the work-in-process accounts using the actual amounts incurred. These amounts are all tracked using a job-costing sheet, which will most likely be in a computerized format and an additional ledger is kept for each job. Abnormal spoilage is considered a period cost and is reclassified from the work-in-process account into a separate account so it can be addressed by management.
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Process Costing Procedures follow particular procedures, and while precise procedures may vary by company or by industry, they will generally follow these steps:
While certain types of costing start with a sales order, a sales order is not necessary for process costing as it is a continuous process
The work-in-process accounts are separated by department and are named as such ââ‚¬" for example: Work-in-process ââ‚¬" Department Name
The first department in the process makes the first entry into the work-in-process account, usually for the direct raw materials
While the products move from department to department, entries are made to each work-in-process department account
Direct labour costs are recorded by period
Actual overhead costs are recorded; no contra-account is necessary because there is no over- or under-applied overhead due to the actual cost being applied
Indirect costs are applied to the overhead account in actual amounts
Standard spoilage is recorded as a cost to the work-in-process account; nonstandard spoilage is separated from the work-in-process account and applied to a separate account so it can be addressed by management.
Activity-Based Costing Procedures can be more complex to set up and operate than other costing systems. The activity based procedures are the following:
All the activities that use resources are identified and the cost pools are set up for each of the activities identified
Overhead costs are assigned to the cost pools based on a cost driver. A cost driver is an activity that has a proven cause and effect relationship with the costs associated with the cost pool. Cost drivers can be based off of resources or activities
Only if a cost driver cannot be recognized will a cost be assigned on an allocative basis
Related cost pools are assigned an overhead rate based on cost drivers
Cost pools are used to assign costs; the basis depends on the company and industry
Costs can then be assigned to units, batches, or products
These pools can be combined to look at facility, division, or other levels of cost categories
Costs can then be evaluated to see where and how costs are occurring, from that point management can discern what costs are controllable and how they arise.
Which costing methods (job order costing, process costing and activity based costing) are best suited to the following businesses and why:
Old Home Bakery, Inc (a bakery that produces to order) will use the job order costing because companies that sell item in batches will use this method more effectively and it is intended to order to a certain extent than mass production.
Apache Oil and Gas Refinery will use the process costing because this company produces identical products and we have to do with continuous production process.
The sea View Resort Hotel will use the job order costing because is the most appropriate for all the businesses that offer services.
Willie Wonkerââ‚¬â„¢s Chocolate Factory will use the process costing because this type of system is used for identical products. Process costing averages the costs over all units to come to the per unit cost. Companies engaging in mass production often use process costing rather than job order costing.
Harris and Harris Law Firm will use the job order costing because this is a service company.
Explain and evaluate LIFO, FIFO and AVCO techniques.
LIFO stands for last-in, first-out which means that the most recently purchased items are sold first and that the older items remain in inventory. During periods of rising inventory replacement costs the LIFO method results in the lowest valuation of inventory and measurement of net income. The LIFO assigns the most recent inventory purchased costs to the cost of goods sold. In a situation of rising prices, these most recent costs are also the highest costs, so in this case they must replace inventory currently being sold with higher priced goods. Income tax considerations are the principal strategic reason for the popularity of the LIFO method. Income tax regulations allow a company to use LIFO in its income tax return only if the company also uses it in its financial statements.
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FIFO stands for first-in, first-out which means that the oldest purchase costs are transferred to the cost of goods sold, while the most recent costs remain in inventory. When purchase costs are rising, the FIFO method assigns lower costs to the costs of goods sold and the higher costs to the goods remaining in inventory. By assigning lower costs to the cost of goods sold, FIFO causes a business to report rather higher profits that would be reported under the other valuation methods. Some companies favor the FIFO method for financial reporting purposes because their goal is to report the highest net income possible. For income tax purposes, reporting more income than necessary results in paying more income taxes than necessary.
AVCO (average cost) under this method, identical products will have the same accounting values. It is a method of valuing all units in inventory at the same average per-unit cost, which is recomputed after every purchase.