Question

Phil and Jim were roommates in college and have always competed against each other. Since graduating from college, both men were hired at the same company. The company pays bonuses at the end of year based on performance, which also includes a weekend on their boss's yacht. Two years in a row Phil managed to surpass Jim's performance. This year, Jim is determined to get the highest bonus. Imagine you are the accountant and knowing that these two men are rivals, answer the following questions

1. Compare and contrast job order and ABC costing.

2. Determine which costing method would make it easier to detect budget variances or discrepancies.

Answer 1

1.

Job Order Costing:

Job order costing or job costing is a traditional costing system used for assigning and accumulating manufacturing costs of an individual unit of output. The job order costing system is used when the various items produced are sufficiently different from each other and each has a significant cost.

The job costing system allows you to assign costs separately to individual operations and calculate the profit margin you’ll be getting on each job. This way, you can decide which operations are more profitable for producing a specific product.

Examples of Job order costing:

• A company that designs and produces custom-made machines and/or machine tooling
• A company that constructs custom-designed buildings

Activity Based Costing:

Activity Based Costing is an accounting methodology that assigns costs to activities rather than products or services. This enables resources & overhead costs to be more accurately assigned to products & services that consume them. ABC is a technique which involves identification of cost with each cost driving activity and making it as the basis for apportionment of costs over different cost objects/jobs/ products/ custom- ers or services ABC assigns cost to activities based on their use of resources. It then assigns cost to cost objects, such as products or customers, based on their use of activities. ABC can track the flow of activities in organization by creating a link between the activity (re- source consumption) and the cost object. CIMA defines 'Activity Based Costing' as "An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consump- tion estimates. The latter utilise cost drivers to attach activity costs to outputs."

2. Costing method easier to to detect Budget Variances & discrepancies:

If ABC & Job order costing are compared then:

1. In ABC the overheads are changed to activities while in Job or other traditional approach the cost is charged to the cost center or departments

2. Since in ABC cost are charged to activities, therefore same are more realistic then cost charged to cost centers.

3. In traditional or job order costing the time is only factor considered for allocating cost while in ABC other factor are also considered.

Essential activities can be simplified and unnecessary activities can be eliminated. Thus corresponding cost are also reduced or minimized while in job order or traditional method since cost are allocated to departments, the departments cannot be eliminated.

Hence, Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the job order costing approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead.Thus ABC aids cost control.