Costing and Production Systems: Job Order and Process Costing

Unit 6: Costing and Production Systems

1. Production Systems

The two common cost accumulation systems are job order costing and process costing. The election to use one or the other of these systems depends primarily on the nature of the product and the manufacturing process by which it is created. Process production and job-order production are the extreme possibilities when considering the heterogeneity of products. The difference between order accounting and section accounting is the aim of the cost system, and the difference between process costing and job costing is the method to assign the cost to products.

1.1. Job Order Costing System

Job order costing suits the processes where it is necessary to assign costs to a specific amount of production because every batch or order is different from the rest of them and independent from the rest. As such, its costs are individualized, and the unit cost is not important. Job order production is typically characterized by the specialized nature of the product, such as buildings, weapons systems, movies, and cargo ships. The value of work-in-progress inventory can be determined at any point of the manufacturing process by summarizing costs accumulated on all incomplete work orders.

1.2. Process Costing System

The most distinctive characteristic is that the manufacturing process is continuous because of the homogeneous nature of the product. Process costing considers the production costs during a specific period and, as products are highly homogeneous, it is possible to assume that every unit has received the same amount of resources. Then, the calculation methods can be based on proportional principles. Now the management can only estimate the degree of completion of work in progress at each stage in the production cycle. This is an accounting problem, and the solution is the concept of equivalent whole units.

2. Process Costing Systems

There are some specificities that must be considered in the cost system:

1. A work-in-progress inventory is found at the accounting closing date and must be valued.
2. The production unit cost varies every accounting period.
3. Quality controls typically detect several non-compliant products.
4. Predetermined rates simplify the process of cost assignment.

2.1. Work in Progress and Semi-finished Inventories

It is necessary to identify the resources consumed and their cost to measure the work-in-progress inventory. We could also find a beginning stock of unfinished products. If the beginning stock of work in progress differs from the ending stock, the number of units initiated during the period is not the same as the finished units. Semi-finished products are products subject to a transformation process with multiple stages. The product is processed in one of the steps and then it moves to the next one, for which the semi-finished product is an input. The product continues through the manufacturing sequence until the last step, where the output is the finished product.

2.2. Equivalent Production Calculations: Five-step Model

How many equivalent whole units were completed during the period?

The production of a period includes the units that were not completed during the previous period but are finished at present, and the units that should be completed in the following period. In both cases, it is necessary to estimate the degree of completion. This allows the conversion of the work-in-progress inventory in equivalent units of finished product. The finished-goods production is the units completed during the period.

More detailed is Horngren's five-step method:

1. Find the number of physical units produced.
2. Transform the number of units produced in equivalent-production units.
3. Accumulate the costs to be assigned to the units produced.
4. Calculate the unit cost of the equivalent-production unit.
5. Calculate the production cost of the period.