Question

1. What is absorption costing? 2. How is job-order costing different from process costing? 3. Why would a company choose one method over the other? 4. Provide a real-world example of a company that might use job-order costing (use an example not listed in the textbook).

Answer 1

1. Absorption costing is a cost accounting method which is used for valuation of inventory. It not only considers direct material & labour costs but also the fixed and variable manufacturing overheads in the valuation of inventory which is why it is also often referred to as full costing. Hence to summarize, following costs form a part of valuation of inventory under absorption costing :

1. Direct Material

2. Direct Labour

3. Fixed manufacturing overheads

4. Variable manufacturing overheads

2. For understanding the differences between job order & process costing, let's first understand the meaning of both.

Job-order Costing : It is a method of cost accounting which assigns and tracks manufacturing costs as per the number of jobs. Jobs here can refer to construction of a single product or carrying out a small process. Job-order costing is generally used when the products are differentiated and none of them have similar processes.

Process costing : It is method of cost accounting which assigns and tracks manufacturing costs attributable to various manufacturing processes instead of a single job. It is generally used by companies where different products have a standardized process of production.

Now that we have understood the meaning of both methods of costing above, we can numerate the following differences :

a) Job costing is used for unique products whereas process costing is used for standardized products.

b) For larger production runs involving complex processes, process costing is always preferred as compared to job order costing which is preferred in short production runs.

c) Job costing is preferable where every customer places a customized order as the manufacturer can calculate cost per job and add a reasonable margin to bill the customer whereas process costing is not suitable in such cases.

d) Job-costing might involve more cost due to additional documentation involved as in a humongous organization it might require a lot of people to prepare cost records for each job whereas cost involved in process costing will be less as it will be standardized processes and can be done by few people.

3. Company will choose one method over the other because it is only possible that any one method will be more suitable for a company and accordingly the company will follow that method.

For example : as stated above if the company manufacturers customized products then the company will prefer job order costing since the process will not be same for all products whereas if the company is manufacturing large quantities of similar products, process costing would be more suitable for the company.

4. Chartered Accountant firms / accounting firms which perform audit like Price Waterhouse Coopers use Job order costing. They treat an assignment for each client as separate jobs. For example : If ABC is a client of PWC and PWC performs both statutory audit and tax audit for ABC, then these will be treated as 2 separate jobs and costing will be done accordingly.

Hence real-world example of a firm which uses job order costing is Price Waterhouse Coopers.