Every company is duty bound to keep accounting records to
prepare annual accounts. Besides, a
company has to watch its performance and to take corrective action to keep
itself on the right path. For this purpose, it needs both operational and
financial information. The latter is
provided by a sound accounting system which is nothing but a formal arrangement
by which a company develops its financial database eventually turning into
financial statements.
What is a costing system?
Cost accounting system is part of the main accounting system
to provide useful information for planning and control. It collects raw
information from accounting records, process them and segregates them into
various cost components. An ideal
costing system can easily provide any cost information about a process,
product, project, or technique. It can generate and compare financial
performance across product lines and different processes for producing the same
products. It helps minimize waste, use resources in a productive way and weed
out money losing products or services.
How to choose a suitable system?
Basically, there are two costing systems: (i) Job-order
costing and (ii) Process costing.
Another is called hybrid which is blend of the two. Still there is one more system called
Backflush.
Some words about Backflush
Traditional costing system are sequential in nature as they
track costs when raw materials move to working in process to finished goods and
finally to sales. Backflush works
backwards. No costing is done until goods are finished. Standards costs are
then flushed backward through the system to assign costs to products. But this
system is used where operating cycle is short and inventory levels are low or negligible.
The type of costing system that is right for your business can be determined
firstly by what you do or make. If you manufacture a homogeneous product
(meaning you do not have differentiated products), then process costing would
probably be most appropriate. If you manufacture products that come in
differentiated batches, job-order costing would be more appropriate than
process costing. Hybrid costing (also called operational costing) is a
combination of these two types of costing that is used for products that are
similar but produced in batches. For example, a printing press is publishing
10,000 diaries which are similar in nature.
It must start from process costing where the work would be
departmentalized into to paper cutting, printing and gluing. The final product may
be in different bindings such as paper, plastic, hardboard, leather and cloth. Here the printing press would be dealing in
batches and job order costing would be most suitable.
WHAT IS JOB ORDER COSTING SYSTEM
The
system accumulates cost by jobs. It may be for one unit like a custom-made
luxury boat or a dozen boats of the same design termed as a batch. Each job or
each batch is unique. If not, it is
better to use process costing.
COST FLOW
As shown in the diagram, materials
and labor are directly added to work-in-process inventory for each job. This work in process is in fact a control
account and when an amount is added, the same is also debited to cost sheet
relating to a particular job.
Actual overheads costs are not
allocated to any specific job since these represent indirect costs or shared
costs or common costs. These are allocated using a pre-determined rate (which
would be discussed later). From work-in-process, completed jobs are transferred
to finished goods and on delivery to customers, the relevant cost is added to
cost of goods sold.
Job Costing is used in shipbuilding,
service industries like hospital, constructions, special order printing, movie
studios and professional services as audit firms.
Material Costs
All material purchases are entered in raw material
account. This includes direct materials
like fabric and indirect materials like button, stitching yarn etc. For each
job, materials requirements are ascertained and the requisite quantity is
obtained from the storeroom. Material Requisition Form is the main document
which identifies specific job, types and quantity of material required.
While direct materials are allocated to work
in process, the requisite indirect materials are transferred to Manufacturing
Overheads. (Later, these would be
prorated to different jobs).
Labor Cost
An account is maintained for labor
cost. It can be named as Manufacturing
Wages or simply Labor. At the same time, another document is used known as Time
Sheet or Time ticket is maintained by each employee in which he or she record
time spent on each job and each task.
The time-sheets are consolidated and
total wages payable are recorded in manufacturing wages, as shown in the side diagram. Side by side, each time sheet is studied and
any time spent on a job is transferred to work in process while the time spent
on task is transferred to manufacturing overhead. (Entries in accounts are
always in monetary term. The time spent
by an employee is multiplied by applicable wage rate and amount is transferred
in wage or manufacturing overhead account as the case maybe.)
Manufacturing Overheads
Manufacturing Overheads consist of
all manufacturing costs other than direct materials and direct labor. Since these are not traceable to jobs, there
must be a way to allocate the same.
At the time of production planning,
a company would decide how much would be produced in the plan period. Next using standard rate, variable
manufacturing overhead would be calculated based on production level and added
in “estimated overheads”. The fixed
manufacturing overheads represent fixed cost like depreciation, rental, salaries of permanent staff, minimum utility
cost like fixed power charges, line rent for telephone. This fixed also would be added in
the estimated overheads. When all
possible future costs have been added, a total is obtained and divided by
estimated units of production. This gives us
Overhead Applied Rate which is the same as Standard Rate.
These rates are applied to individual
jobs using some base like Direct Labor Hours or Machine Hours, Raw Material
Quantity or Costs. Once a particular base is selected, the same is applied for
each job. Which particular base would be selected depends upon (i) industrial practices or (ii) cause and effect relationship.
If it is decided to use Direct
Labor Hours as base and a job has taken 200 labor hour, the applied overheads
would be 200 x 20 (rate)=400.Similarly, all jobs would be charged with some overheads. At the end, the applied overheads may exceed the actual or be less than actual. Necessary adjustment are made either by transferring the balance to Cost of Goods Sold or dividing the balance, whether positive or negative, among Work in Process Inventory, Finished Goods Inventory and Cost of Good Sold according to quantum of each account.
Conclusion
A step by step approach has been narrated in the foregoing paragraphs. The rest of the procedure is standard and not restricted to job-order costing i.e. transferring costs from work in process to finished inventory when completed and to cost of good sold when sold. Any difference between sale revenues and cost of goods sold would represent gross profit.
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