Accounting communicates the information that owners, managers and investors need for the evaluation of company’s performance. It is the language of business. Accounting also allows companies to create financial reports that can be compared with other companies’ reports within the industry. Major costing systems include job order costing, activity based costing (ABC) and process costing. Given paper will compare and contrast these three costing systems, explain their importance as well as when they are used and how regulated.
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Comparing the Costing Systems
The similarity between these costing systems is that all three are used in the manufacturing department and involve accumulation of costs that can be attributed to specific units or a group of units. The costing systems are useful in inventory management. The flow of costs in the manufacturing account is also the same in all systems. The costing systems also aid in the creation of cost records, which report direct materials, direct labor and the manufacturing overheads (Drury, 2013). Similarly, the costing systems track how the manufacturing costs flow through the work-in-process, finished goods and sold goods. Moreover, process costing, job order costing and activity based costing have the same basic purpose of allocating materials, labor and overhead costs (Kaplan & Anderson, 2013). Another similarity is that the costing systems use similar product costs to come up with unit costs needed for management’s decision making purposes. Besides, used inventory accounts include work-in-process inventory, raw materials inventory and finished goods inventory.
Contrasting the Costing Systems
The three costing systems differ in how they are used in the production processes. For instance, job order costing involves allocation of costs by jobs and uses job order costs. In contrast, process costing allocates costs by departments, which gives every department a separate work-in-process (WIP) account unlike in case of job costing, which allows one work-in-process inventory account. The account can be used in calculating and allocating costs during different fiscal periods (Kinney & Raiborn, 2012). However, activity based costing expands the cost pools that can be used in the assembly of overhead costs.
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Another difference is that job order costing calculates the cost of every job individually. Besides, the cost of one job is different from the cost of any other job hence is accounted for differently (Drury, 2013). However, in process-based costing all jobs are similar hence accounted for on a cost per job basis. This also differs from activity based costing, which assigns costs to products on the basis of activities they perform as well as the resources employed in specific activities. Therefore, ABC aims at identifying the areas of high overhead costs and directs attention to finding ways to reduce these costs or charge more for the products with higher costs of production (Kaplan & Anderson, 2013). In addition, unlike activity based costing, job costing and process costing can be used in the manual and computerized environments.
Importance of the Costing Systems
The costing systems are important in establishing company’s expenses on a production of a particular product. This is vital in determining product’s selling price as well as other pricing decisions. Besides, an organization that is price competitive would like to ensure that its product is cheaper than the product of competitors (Vanderbeck & Mitchell, 2015). Therefore, the costing systems are helpful in ensuring that a product is not underpriced because this will incur losses. In fact, a business that sells its products lower than its costs of production does not stay in business for long. Additionally, costing systems are useful in making decisions on whether or not to take special orders at lower prices (Kinney & Raiborn, 2012).
Another importance of costing systems is the evaluation of company’s performance across the industry. The costing methods exhibit uniformity, which enables decision makers to rely on the consistence of decision techniques. The costing methods can be also important while deciding whether to sell a particular product or to process it further. For instance, a dairy company can consider selling raw milk to a creamery, processing and pasteurizing the milk or making butter or cheese. The costing systems can also help managers appreciate scarce resources in complex business operations (Vanderbeck & Mitchell, 2015). In addition, having an understanding of the costing system enlightens one about cost control, cost awareness and cost management.
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When the Costing Systems are used
An organization uses costing systems when it is looking forward to sustain its costs and exercise cost control. As a result, an organization will spend less on its inputs and charge more for its outputs, which will be important for the consumers because cost reduction will be passed on to consumers in a form of lower prices (Kinney & Raiborn, 2012). Besides, an organization can consider the costing systems to pinpoint possible inefficiencies or areas of necessary improvements. Similarly, managers can find the costing systems useful in making decisions on cost-cutting and improving company’s profitability because these systems can be also tailored to the specific needs of every firm. Besides, the costing systems also ensure that organizations provide reliable data to internal and external properties (Vanderbeck & Mitchell, 2015). In fact, the formulation of tax and industrial policies is based on the cost accounting information.
Regulation of the Costing Systems
The costing systems are regulated by the Cost Accounting Standards issued by the United States Government. However, the standards are prescribed and amended by the Cost Accounting Standards Board. The board also ensures uniformity and consistency of the accounting standards. The standards are principle based and deal with providing guidance on the preparation of general purpose cost statements (Vanderbeck & Mitchell, 2015).
In addition, these standards dictate how various accounting aspects ought to be regulated across different industries. Examples of these aspects include the depreciation of tangible assets, capitalization of tangible assets and accounting for unallowable costs. Accounting standards also emphasize the importance of ensuring consistent estimation, accumulation and reporting of cost of sales as well as advise on the use of standard costs for direct material and direct labor (Drury, 2013). The cost accounting standards are important in the regulation of accounting systems because they integrate, harmonize and standardize the cost accounting principles.
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The costing systems are used in the manufacturing industry to determine the total production cost of a single unit or merchandise. However, the systems might have similarities or differences depending on their usage in the production process. For instance, activity based costing, job costing and process costing have a similar flow of costs in the manufacturing account. However, the process of cost allocation differs in every system. The costing systems are primarily useful in pricing decisions because product pricing determines the profitability of a business. Besides, it is important to establish how much the target market will pay for a particular product or service. The systems also offer useful information that influence pricing decisions. The costing systems are regulated by the Cost Accounting Standards.