Question

Compare and contrast the following costing methods: process costing, job order costing and activity based costing (ABC).

Answer 1

Process Costing

A Process Costing is a method of costing deployed in industries manufacturing non standardized products. For example, chemicals, sugar, paint, petroleum industry. They are manufactured on mass production and do not have customer identity to the production units. The units flow from one department to another. Cost is accumulated at department level and then cost is allocated to equivalent units produced.

Job Costing

A job costing is a method of costing which is deployed for customer driven orders. They have a identity and can be associated with orders given by customer. A job cost sheet is kept for each job and cost is accumulated to it. Cost includes direct material, direct labor and manufacturing overheads. Examples include aircraft, furniture orders given by customers, food catering industry.

	Process Costing	Job Costing
Customer driven orders	No	Yes
Mass production	Yes	No
Cost accumulated	Yes- Department level	Yes- Job order level

ABC Costing is a method of absorbing the indirect cost into product cost using activity cost driver. In traditional costing the indirect cost is absorbed into product using cost driver which is either labor hours or machine hours. Both methods are concerned with allocation of overhead cost to products but the way it is done makes the difference. In traditional costing pre-determined rate is calculating using machine hours or labor hours at beginning of the year and then allocation is done to product based on actual machine hours or labor hours. This method is simple and less time consuming. But is does not give accurate reflection of the cost. Hence to overcome this drawback Activity Based Costing can be applied which gives accurate product costing but it is time consuming and can be complicated at times. From decision making point of view ABC Costing makes more sense as management wants to make realistic decisions.

	Traditional Costing	ABC Costing
Technique	Traditional way of overhead allocation	Improved technique of overhead allocation
Basis of allocation	Machine hour or labor hour	Activity Cost driver
Cost allocation	Cost is aggregated and then machine or labor hour rate is pre-determined	Cost are aggregated into cost pool and then activity cost driver rate is pre-determined
Usefulness	Useful if overhead is directly related to machine or labor	Useful for product costing where activities can be identified for each cost