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Costing Methods

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Process costing is a method used in management in order to determine all production costs in the process of making one unit of product. In fact, raw materials go through different stages before manufactures ship them on the shelves of stores. According to Hilton (2008), “In manufacturing operations with sequential production departments, the costs assigned to the units transferred out of one department remain assigned to those units as they enter the next department.” In order to consider all costs, the company takes into account costs of separate departments putting them together.

One of the main advantages and peculiarities of process costing method is that it is easier to use than job order costing and activity-based costing. Management system allocates resources according to the costs of every process aimed at manufacturing one unit of the product. It takes into account costs of every department avoiding costs of every specific job, which reduces the volume of data and makes the process of allocating costs easy and quick. Another advantage of this method is that it does not exhaust the company’s time and resources. It does not require outstanding accounting skills or extra financial resources. Process costing is also more flexible than job order costing and activity-based costing. It allows companies to regulate processes and remove those which decrease the company’s productivity.

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A company can apply this method only in case of producing homogenous goods. If the company uses one process to make different goods, it cannot provide accurate information regarding total cost of products. In addition, this method can hardly relate to the current costs reflecting the history of tracking costs. Finally, process-costing method uses an average cost method, which is not appropriate for performance analysis of the organization.

In contrast to process-costing method, job order costing system helps a mangement team allocate resources according to every completed job. According to Kinney and Raiborn (2011), “If multiple outputs are produced, a per-unit cost can be computed nly if the units are similar or if costs are accumulated for each separate unit (such as through an identification number).” It allows the company to examine expenses involved in every job. In addition, proper record of expenditures according to this method allows the company to see the roots of costs and define the way to regulate them. Managers also can easily evaluate the reason of spending an extra set of resources needed to rework the product. The main distinguishing feature of this method is that it gives the company an opportunity to change records before closing them if there are mistakes in the allocation of resources. Job costing system also helps to regulate the amount of resources needed to complete the product in the manufacturing process.

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However, there are significant disadvantages of this method in light of other costing methods. First, it centers on goods, not on activities or departments. Another drawback is that it takes into account overhead rates rather than actual data, which can reflect the current costs of the manufacturing processes. In addition, this system changes the overhead rate only once a year, which does not let the company have accurate information about costs. However, the biggest issue of job order costing is that it requires firms to enter all the information into the system in order to allocate costs according to the job. It wastes the company’s time and resources. In contrast to process-costing method, job order costing does not take into account costs per activity. As a result, the company may waste much time and get inaccurate information, which will further lead to poor quality of products.

Another method is activity-based costing, which allocates expenses by assigning overhead costs to the company’s total direct ones. This method allocates costs of every activity to all products according to the resource requirements of every activity. The main advantage of activity-based costing in light of other two methods is that it allows the company to evaluate the costs of every product. In addition, it helps to identify products which are inefficient to the company’s performance or those which are the mmost beneficial for the company’s profitability. With the help of this method, the firm can use a value-added approach of resources to the production of goods. At the same time, it helps to boost profitability without increasing prices. Activity-based costing helps to identify the contribution of every employee, the amount of resources spent on production of goods, and total costs of the activity. The main peculiarity of ABC costing method is that it reflects the performance of the company and helps it to build an effective strategic plan. In contrast to other two methods, it identifies the current amount of resources spent on production of one unit of the product and plans the future costs of the company. ABC is an effective method helping to outline inefficient processes in the short-term perspective and evaluate whether to outsource them or make improvements. Finally, this method penetrates total quality management techniques, which means that it is important to the company’s general profitability.

The main disadvantage of activity-based costing is that its implementation takes more time and resources to than that of job order costing and process-costing methods. At the same time, it is difficult to maintain this system. It takes much time and resources. Job order costing and process-costing methods require less time and resources to both implement and maintain the system. Another demerit is that it can hardly contribute to effective decision-making process. According to Ray (2012), “When the production volumes change, ABC cannot predict profits, therefore it is not adequate for decision-making. Therefore, ABC is based on subjective arbitrary cost allocations.”

In conclusion, it is important to mention that process-costing, job order costing and activity-based costing methods are different. They vary in expenses of implementation and maintenance. Every company should take into consideration advantages and disadvantages of every method, which will reflect the most appropriate methodology of costs allocation. Finally, the company should think about building an effective management system according to the selected costing method.

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