Introduction
Calculating the cost of doing business is one of the most important aspects of a business. It helps in taking critical decisions and also points out the several areas which are the company’s strength or some other areas where the company to improve (Drury, 2008). At all times, the prime concern of the company regarding the cost aspect is to minimize it. However, the step before that involves the actual calculation and allocation of cost. This is a sensitive and highly regulated area; allocating costs in a wrong manner can end up in poor decision making and regulatory problems, as well.
Job Order Cost System
Job order costing involves calculation and allocation of cost of any job on the basis of discrete units. Using this method the manager can accumulate costs wither by batch or individual units (Horngren, Foster, & Datar, 2005). The manager needs to find out the typical cost sources such as direct labor, indirect labor, cost of raw materials and equipment. These costs are then accrued until the production is complete. Then the manager needs to add the overhead costs, which can be done by using several different ways. However, after allocating the overhead costs, the manager can establish the cost of the job. This method is very useful when the manger needs to find the actual costs incurred during a job and not some average value (Young, 1985).
Process Costing System
It can be said that Job costing and Process costing lie at the opposite ends of the continuum. Process costing attempts to find the total incurred cost of a process, and then attempts to allocate these cost on average basis (Edwards & Hermanson, 2007). The manager needs to calculate all the direct, indirect and overhead costs for an entire process, which may be the production of products for an entire month, and then divides the total cost by the number of produced units, to get the average cost per unit. Process costing is the preferred method when the companies are involved in mass production, and finding the cost of individual units is not important.
Project Decision and Method
SAC was right to use the process costing method for the regular spark plugs, and it is also right in thinking about using job costing for the special-order spark plugs. I would suggest them to use job costing for the special order production and continue using process costing for the regular spark plugs, for the reason that these spark plugs are made to order, they are different from other units. Each client may want the spark plugs to have different characteristics, which would obviously change the cost structure for the unit. Therefore, to track and allocate the cost in a better manner, it seems like a wise choice to use job order costing. This way SAC would know the exact costs incurred, and thus charge prices accordingly, by changing the profit margins.
Cost Driver
Cost driver is the factor that influences or drives the cost of the production process or a specific step of the process (Smith, 2007). The objective of the manager is to identify these cost drivers, and make the more efficient as to minimize the cost. Generally, and in this case too, the cost driver is the volume of activity or output, and it determines the overall cost of production. For instance, in SAC’s case higher level of output would demand more machine hours, and indirectly more human hours would be needed to run those machines. The raw material costs would be higher, and so would be the overhead costs. In this way the cost driver influences the entire production cost of a job. The process of tracking the cost starts with identifying the basic sources of costs and then tracking them throughout the production process. By keeping a track of these costs the overall costs can be allocated effectively, and consequentially the process of cost minimization can also start.
Job Order Examples
Job order system is best suited when calculating the exact unit cost is important, like in the case of SAC. Other examples include jobs where each unit produced is priced differently and is unique, for instance Air Craft manufacturing, or custom car manufacturing, or a custom guitar manufacturing etc.
Process Order Examples
Anytime when the exact unit cost calculations are not important enough, process costing is used. For instance, in case of regular spark plugs for SAC, or mass production of Paint or oil, or the production of Frozen Pizzas at a factory.
Conclusion
The conclusion is that, none of the two costing system is superior to the other in absolute terms. They have different advantages and disadvantages, and hence they should be used accordingly.
References
Drury, C. (2008). Management and Cost Accounting. London: Ceneage Learning.
Edwards, J., & Hermanson, R. (2007). Accounting Principles: A Business Perspective. New York: Prentice Hall.
Horngren, C. T., Foster, G., & Datar, S. M. (2005). Cost Accounting: a managerial emphasis. New York: McGraw-Hill.
Smith, J. (2007). Handbook Of Management Accounting (4th ed.). Oxford: CIMA publication.
Young, P. (1985). Fair Allocation. New Jersey: American Methimetical Society.