5 1: Compare and Contrast Job Order Costing and Process Costing Business LibreTexts

In this example, two groups—administrative and manufacturing—report directly to the chief financial officer (CFO). The organizational chart also shows the departments that report to the production department, illustrating the production arrangement. The material storage unit stores the types of wood used (hickory, maple, and birch), the tips (nylon and felt), and packaging materials. You’ll also learn the concepts of conversion costs and equivalent units of production and how to use these for calculating the unit and total cost of items produced using a process costing system. The most difficult process costing method, FIFO is used to provide more precise product costing, particularly when expenses vary dramatically from one period to the next.

In process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. One way to reduce the cost per unit of output is to increase the efficiency of the production process. This can be done by reducing the amount of waste, increasing the utilization of resources, and improving the quality of the product.

Origins of cost accounting

Oil is pumped from the ground, transported, refined, and placed in storage. Throughout the process it is stirred, cracked, and blended so that it is not possible to trace a tank of gasoline back to a specific barrel of oil. The Coca-Cola Company is one of the world’slargest producers of nonalcoholic beverages. According to thecompany, more than 11,000 of its soft drinks are consumed everysecond of every day. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.

• For example, it would be impractical and inefficient for a company that bottles cola to separate and record the cost of each bottle of cola in the bottling process.
• The department’s costs would be allocated based on the number of cases processed.
• XYZ Inc makes paper products from wood pulp wherein raw materials go through a production cycle that ends with the production of identical reams of paper.
• We are going to discuss how these methods are used in a process costing system but first let’s have an understanding of what a process costing system is.

The carbonated drinks that the company produces pass through several production departments. Using this company as a process costing example, assume that during the month of May, $25,000 of direct material costs and $50,000 of conversion costs were accumulated by the filling department which processes 50,000 bottles. When using this method, the total number of units completed and transferred out is added to the equivalent units of work-in-progress to get the total number of units at the end of the period. Then, all the costs for the current period are summed up and divided by the total number of units.

Steps in Process Costing

Process costing is the optimal costing system when a standardized process is used to manufacture identical products and the direct material, direct labor, and manufacturing overhead cannot be easily or economically traced to a specific unit. Process costing is used most often when manufacturing a product in batches. Each department or production process or batch process tracks its direct material and direct labor costs as well as the number of units in production. The actual cost to produce each unit through a process costing system varies, but the average result is an adequate determination of the cost for each manufactured unit. Process costing is the optimal costing system when a standardized process is used to manufacture identical products and the direct material, direct labor, and manufacturing overhead cannot be easily or economically traced to a specific unit. Direct materials are materials that are consumed during the manufacture of a product.

Management accountants must evaluate where these unfinished goods are in the manufacturing process and assign expenses accordingly. Process costing uses the same standardized costing approach each period, allowing businesses to compare cost variations over time. This assists businesses in ensuring that costs are in accordance with budgeted expenses and identifying areas for further study.

Example of Process Cost Accounting

Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, food, banks, courier, cement, and soap. Process costing systems are used to track the costs of production at each stage in order to ensure that products are being produced efficiently. By understanding how much it costs to produce a product at each stage, companies can make changes to their production process in order to save money and become more efficient. Process costing is another method of keeping track of the costs of manufactured items.

As discussed earlier, direct materials are materials consumed during manufacture and conversion costs are direct labor costs and manufacturing overhead costs. Note in the above graphic the familiar inventory categories relating to raw materials, work in process, and finished goods. However, rather than observing work in process as being made up of many individual/discrete jobs, see that it instead consists of individual/discrete processes like melting, skimming, and extruding. Ore is introduced in the melting stage, alloys in the skimming stage, etc. (this is equally true for labor and overhead). This necessitates the employment of a separate Work in Process account for each major manufacturing activity. Examine the graphic below that compares job and process costing, noting in particular the difference in how costs are shifted out of work in process.

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A company has to analyze the flow of items during the production period to determine the amount of inventory at the beginning of the period. The number of items that were started during the period, the number of items that were completed and transferred out, and the number of items that were incomplete at the end of the period have to be determined and recorded. A process costing system is used in industries such as oil refineries, chemical plants, and textile process costing examples mills that carry out production in a continuous and repetitive manner. When using this costing system, it is assumed that the production process is homogeneous and that all products go through the same sequence of production stages. Hence, a process costing system is used to estimate product costs in manufacturing industries. Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process.