Cost accounting helps managers determine the costs of running a business by recording the costs of materials, processes, and projects. Analyzing trends on costs of production and overhead along with revenue helps management make informed decisions on how to improve, scale, or grow effectively. Cost accounting utilizes either job costing, process costing, or a hybrid of both. In this article, we will discuss the differences between job costing and process costing as well as advantages or disadvantages of each.
What is Process Costing?
Companies adopt process costing when they need to assign product costs to units of output. Mass production of identical units such as beverages, pharmaceuticals, cereal, utilize process costing to determine the cost of each unit. Companies that produce identical units such as lumber, tile, brick manufacturers, cereal makers, or pharmaceutical companies utilize process costing. Generally, companies utilize process costing when:
- Mass production of identical products
- Output of products is of low value
- The inability to track costs to an individual product
Because of those factors, managers track costs by each department. Each department has its budgets to track the costs as a product moves through procurement, manufacturing, quality assurance, and distribution.
Advantages of Process Costing
Process costing is straightforward to track versus the detailed record keeping in job costing. Each department tracks their material and labor costs as the product moves through their department. Accountants divide costs by the number of units to total an average production cost.
With the standardization of products, managers track performance, productivity, and costs over time. Process costing allows for greater flexibility when making changes in the production process. Managers can target specific departments’ processes or materials to lower production costs.
Disadvantages of process costing
In process costing, it is easy to create cost errors. Tracking all costs as a production cost, including non-production costs such as overhead, inflates the production price. This creates a higher priced product to consumers. Leaving out non-production costs, under-costs the production price. This will have a lower price, but can potentially lower a company’s profits.
What is Job Costing?
While companies utilize process costing to track costs of mass-produced items, other companies utilize job costing to track costs of producing unique products. In Job Costing, product costs are tied to specific jobs. Examples of companies that utilize job costing include:
- Service oriented businesses such as law firms or accounting companies that need to track hours worked against client activity
- Hospitals or medical services that tracking materials and labor to a patient activity
- Construction, film studios, or companies that do custom fabrication in order to track labor and material costs from project to project
Job costs are broken down into specific cost codes and tracked specifically to particular projects. Managers can track actual costs against the budget to determine how costs and work are progressing on the project.
Advantages of Job Costing
In job costing, companies can track profit on specific jobs to determine which types of projects are most profitable. After several projects, a construction company may determine that their profit margins are higher in hospitality than healthcare. They may choose to specialize in hospitality projects to maintain higher profit margins throughout all projects.
Job costing reporting is very detailed. Managers can determine which tasks are taking longer than estimated or perhaps which crews are productive. By tracking these items in real time, companies utilizing job costing can make adjustments as needed to keep projects profitable.
Disadvantages of Job Costing
To get the detailed reporting provided by job costing, employees must keep accurate records. Materials and all labor activity including lunches and breaks must be accurately documented and tracked. If not done correctly in project management or accounting software, this can be time-consuming and a source of frustration among employees.
A hybrid cost accounting system is one that includes parts of job costing and process costing. It can be beneficial depending on the business. When a business creates or manages products in batches and charges based on the batch as well as costs labor as an individual unit, hybrid costing can help. Prefabrication contractors are an example of those who benefit from hybrid costing. Each unit prefabricated for a project, or batch, is cost based on the batch. While the workers are usually cost based on the hours worked on an individual unit level. This can ensure that the overall rice is still low enough to remain competitive while covering all operational, material and labor costs.
Job Costing and Project Management Software
As many subcontractors and trade contractors migrate from paper to digital project management, it’s important to know whether your project management system can manage it. Some project management systems do offer job costing, which can be a useful tool. The best project management systems will integrate with many accounting packages so users can use the best software for them. By integrating with accounting software, it reduces double data entry and provides one hub for all data. That way trade contractors and subcontractors can make real-time financial decisions in the field, can log job costs quickly, and search them at a later date.
Being able to log information from the field is crucial since it can improve the quality of data associated with a project. The foreman or supervisory can directly input information as it is available to them. This ensures that not just the field but the back office have access to the most up-to-date and relevant information. When the back office has access to accurate job costing it is easier to use that good data to improve bid qualities on projects. By improving bid quality, estimators will be able to help the business increase revenue.
We have outlined the differences, advantages, and disadvantages between process costing and job costing. Your company may use to use either process costing, job costing, or maybe a hybrid of both. The essential factor is to utilize a form of cost accounting that is appropriate for your business model.