Companies that produce goods and physical products need some sort of system to track costs and production levels. Process costing and job order costing are both viable methods for doing just that. Depending on the nature of the products and the amount of products created, one system may work better than the other.
Job Order Costing
Under job order costing, managers and workers track costs on a per-job basis. For example, an engineering firm that builds specialized computer motherboard may track the cost of the board on a per-job basis. Companies tend to use job order costing under the following conditions:
- The products created are unique or customized.
- Each product requires a different amount of material or labor hours.
- Production levels are relatively low.
Companies that use job order costing maintain a job cost sheet for every project they take on. If a job involves creating more than one unit, the total number of units manufactured is noted. The job cost sheet logs what components are used for the project and the component cost. It also tracks the number of labor hours incurred on the project and the cost of those hours. Managers also allocate a portion of manufacturing overhead costs to the project.
The sum of direct labor costs, direct materials cost and manufacturing overhead allocation is the project's total cost. Divide the total costs by the number of units produced in the job to find the product cost per unit.
If a company is creating a mass amount of products, maintaining hundreds or thousands of job order costing sheets can be burdensome. Companies in this situation choose process costing rather than job order costing. In process costing, the company tracks costs based on the entire production department rather than by individual jobs. Process costing works best under the following conditions:
- Products are identical or very similar in nature.
- Each product requires the same amount of time and materials to create.
- Production levels are high.
At the end of each reporting period, the production department will run a production report that details the total amount of units produced and direct labor, direct materials and manufacturing overhead incurred during the period. To find the product cost per unit, divide total costs by the number of units produced.