Question

Compare and contrast the following costing methods: process costing, job order costing and activity-based costing (ABC), including the advantages and disadvantages of using each one of them.

Answer 1

Job Order Costing:

Job costing may be defined as a system of costing where different elements of cost are tracked and compiled separately for each job / order in hand with the company. Job Order Costing is a method of allocating costs in industries where the production is done as as per the requirements and specifications of individual client. In such type of industries, the production of goods or provision of service is done only when an order from customers is received. Type of Job may not be standard and may vary as per specification of customer. Such companies work on wide varieties of service or customized goods. Examples of such companies include printing shops, tax and accounting firms, construction companies, etc. Service industry companies are more likely to use job costing system because each job tends to be different from another one.

Advantage: Management can track accurately which jobs are profitable and which are not and hence can have better control on Jobs.

Disadvantages: It is complicated and time consuming since each job has to be tracked separately and there may be hundreds of Jobs in process

Process Costing:

Process costing is a method costing which is used where standardized goods are produced by the company. This costing method is manufacturing industries such as textiles, chemicals, steel, rubber, sugar, petrol, etc. To determine cost under process costing, cost of production during the is divided by the number of units manufactured or produced during that period to arrive at the cost per unit. Process costing is a method of costing where all costs are accumulated for each stage of production process, and the cost per unit of product is ascertained at each stage process by dividing the cost of each process by the production of that process. This would be used in industries where identical items are produced and jobs are not different from each other.

Advantages: it is comparatively simpler as costs are compiled for each process only and not for each job. It would require less clerical efforts

Disadvantages: As it uses average costs of each process hence cost allocation may not be actual and based on averages. It cannot be used in industries where products are not homogeneous

Activity Based Costing:

The Activity-Based Costing (ABC) is a costing system, which identifies the various activities performed to produce products and tracks and assigns costs based on specific activities. In ABC a cost are first traced to activities and then activities are traced to products. Costs are assigned based on quantum of activities needed for a particular product or services. This costing system assumes that activities are responsible for incurring various costs Example of firms which uses ABC are accounting and taxation firm; Colleges etc. Costs are charged to products based on use of each activity.

Activity-based costing (ABC) is a two-stage product costing method that first assigns costs to activities and then allocates them to products based on the each product’s consumption of activities.

Advantages: As ABC focuses on different activities involved in a production process, it helps to identify activities which involve high costs so that steps can be taken to reduce costs. It also helps identify non value adding activities and related costs.

Disadvantages: It is time consuming and costly process to install ABC system of costing.