Types of Product Costing Systems
There are two costing methods or systems commonly used in production, and these include Job costing and Process costing systems.
Job costing method involves the accumulation of data about the costs identified with a specific production or service. This cost data is useful in determining correct and accurate price quote that enable the company to make a reasonable profit (Vanderbeck,2012). The cost data is also helpful for assigning inventorial costs to the manufactured goods. Job costing focus on the three types of data;
- Direct material cost – Job costing should track total material cost used during the job. Please note, the consideration here must be the only materials using during the task.
- Direct labor – the process must track the cost of associated work used. Only direct labor associated with the job can be recorded
- Overheads- This system assigns overheads cost to cost pools, and at the end of the accounting period, amounts in each cost pool are attached to the different job based on some allocation methodology. Job costing tailored to the requirements of the customer or consumer.
Note, Job costing is preferred when a batch is significantly different from the other quantities (Drury, 2013)
On the other hand, process costing method is preferably used where there is mass production of the similar products, that is, individual unit cost of output cannot be separated or differentiated from each other for instance, oil refining, food production, chemical processing among others. Under this system, the cost data is recorded over the fixed period for each department, summed together and then allocated to the number of units produced during that time on consistent basis contrast Job costing where cost is assigned to specific product unit (Turner, 2014).
Note, where the process is costing is associated with the mass production and customized element, and then the hybrid costing method is used. Process costing is categorized into three;
Weighted average cost – This assumes the total value whether from the preceding period and the current period are summed together and assigned to the product unit.
Standard cost – is calculated similar to weighted average price but the standard value is assigned to unit products rather than actual cost, then the actual cost is compared to the standard cost, and the difference is reported as variance in a variance account.
First –In– First – Out (FIFO) –This system creates a layer of cost, that is, the previous layer and the current layer. Its valuation is based on the assumption that goods are used or sold in chronological order.
In our case of Australian dairy producers, the costing system may depend on the stages of milk production, for instance where the production is primary then, the producer can use job costing method, but where the milk production involves a lot of stages, then the producer can employ process costing method.
I can boldly comment Australian dairy producers use both costing systems in producing milk because it involves various stages and some independently like raring dairy cows, logistics and labor among others. Refer to Norco Co-operative Society, our company of reference, the expense data and the cash flow information shows different activities with some consolidated, and with no clear insight departmental relevant cost (Norco annual report, 2010).
Determining which Product Costing System is Used in Australian Dairy Production
Where final milk product is to process, it will have to undergo various stages such as storage, cleaning and screaming, homogenization, fat standardization, heat treatment, chilling, intermediate storage and finally filling and packaging. Since all this, is done by different department, then the best costing system is the process costing.
Additionally, at the initial stages of the production specifically from the farmers, they can use job costing system since the production methods are very dependent.
Please note, the data provided below is hypothetical, and not real data for the purposes of our calculation. The financial data of the most production companies in Australia, including Norco Co-operative society (Reference Company) is consolidated, with no descriptions of the various production departments, and therefore inappropriate to use for this part.
So in our case, I will use the hypothetical data.
Assume Norco Co-operative Ssociety (our company of reference) uses a process costing system and has eight departments, that is;
Main storage – Cleaning and Dreaming – Homogenization – Fat Standardization –Heat treatment –Chilling – Intermediate storage – Filling and Packaging – are involved in the production process.
Assuming the following data are provided by Norco;
Each production department incurs the following direct labor cost
|
Main storage |
$500 |
|
Cleaning and Dreaming |
$700 |
|
Homogenization |
$300 |
|
Fat standardization |
$400 |
|
Heating treatment |
$300 |
|
Chilling |
$300 |
|
Intermediate Storage |
$400 |
|
Filling and Packaging |
$1400 |
Overhead cost associated with each department
|
Main storage |
$300 |
|
Cleaning and Dreaming |
$700 |
|
Homogenization |
$600 |
|
Fat standardization |
$400 |
|
Heating treatment |
$800 |
|
Chilling |
$200 |
|
Intermediate Storage |
$200 |
|
Filling and Packaging |
$900 |
During the processing, stages are associated with the following looses;
|
Main storage |
0 Ltrs |
|
Cleaning and Dreaming |
15 Ltrs |
|
Homogenization |
0 Ltrs |
|
Fat standardization |
20 Ltrs |
|
Heating treatment |
5 Ltrs |
|
Chilling |
5 Ltrs |
|
Intermediate Storage |
5 Ltrs |
|
Filling and Packaging |
10 Ltrs |
Assuming the two thousand liters of milk products cost of $80,000. Then, the product cost outline will be;
Process 1(Storage)
Qty cost Qty Cost
Ingredient 2,000 80,000 Normal loss 0
Labor 500 Transfer to Process 2 2,000
Overheads 300 80,800
2,000 80,800
Process 2
Qty cost Qty Cost
Transfer from Process 1 2,000 80,800 Normal loss 15
Labor 700 Transfer to P 3 1,985
Overheads 700 82,200
2,000 82,200
Process 3
Qty cost Qty Cost
Transfer from Process 2 1,985 82,200 Normal loss 0
Labor 300 Transfer to P 4 1,985
Overheads 600 83,100
1,985 83,100
Process 4
Qty cost Qty Cost
Transfer from Process 3 1,985 83,100 Normal loss 20
Labor 400 Transfer to P 5 1,985
Overheads 400 83,900
1,965 83,900
Process 5
Qty cost Qty Cost
Transfer from Process 4 1,965 83,900 Normal loss 5
Labor 300 Transfer to P 6 1,960
Overheads 800 85,000
1,965 85,000
Process 6
Qty cost Qty Cost
Transfer from Process 5 1,960 85,000 Normal loss 5
Labor 300 Transfer to P 7 1,955
Product Cost Outline for Australian Dairy Production
Overheads 200 85,500
1,960 85,500
Process 7
Qty cost Qty Cost
Transfer from Process 6 1,955 85,500 Normal loss 5
Labor 400 Transfer to P 8 1,950
Overheads 200 86,100
1,955 86,100
Process 8
Qty cost Qty Cost
Transfer from Process 7 1,950 86,100 Normal loss 10
Labor 1,400 Transfer to P 8 1,940
Overheads 900 88,400
Normal loss (10)
1,940 88,400
Therefore, cost per unit = Cost of input/Expected cost per unit
= 88,400/1,940
= 45.57/unit
Again, please note, the data provided is hypothetical.
Factors to consider in order increasing profitability in the production industry – Key study Norco co-operative society
Prevent wastage or spoilage – This should be viewed as a quality issue in the production. Especially in food industries, the inventory/raw materials should not exceed the production capacity and the market demand to avoid wastage. Note, a spoiled raw material is an expense to the company and therefore, the less the wastage, the less the expense and the higher the gross profit.
Client retention – Retention is associated with attrition costs. Retaining the customers reduces the cost associated with acquiring new ones. The production industry should focus on the “drop point” in clients purchase history to keep them actively. Remember, courting your current clients significantly reduces the acquisition or marketing cost even in the later date.
Creating the market segmentation- This will be able to devise customers according to their needs. It will also increase the sales per unit and consequently the profit margin since every customer is valued. Market segmentation will also assist the sales and marketing department to aggressively work towards reaching the customers fast where the demand is high and therefore increasing purchase velocity.
Velocity matters – This is the difference between the order and delivery time. The less the time, the lower the overhead cost per product unit and this mean higher the profit margin. Please note, the shorter the order to delivery cycle, the more the profit.
Do away with low – margin clients and product and focus on higher producing part of your business – This enables the production industry focus more on higher margin product and at the same time, save time and money on production. The company will also concentrate on the high profile customers and work towards increasing efficiency and quality and therefore increasing profit margin.
Competition – Production Company should at all the time remain on top of their competitors. The intensely competitive market will automatically reduce the profitability of the company since the customer will buy from the cheapest supply. Therefore, the production company should employ an outstanding competitive strategy to enable them to beat their competitors and remain active in the market.
State of the economy – Production market should invest more in where the economy is growing. If there is economic growth the demand is high and the profit margin increases and therefore I would suggest the company to invest more where the economy is growing.
Price discrimination – charging different prices of the same product depending on the market environment will automatically increase company sale and at the same time, increase the profit margin.
Exchange rate – If the industry relies on exports, depreciation in the exchange rate should increase the profitability. Therefore the firm should always consider exchange rate whenever doing the export so that can remain in the money.
Employee skills – Where the production company employee high skilled employees, the work is done effectively and in efficient way and therefore reducing the cost associated with training and coaching leading to high profit margin.
Infrastructure – Where the production infrastructure are in good condition, the production tends to be high since the products are able to reach the market on time and therefore reducing any cost associated with delay and order cancellation.
References
Horngren, C. T., Bhimani, A., Datar, S. M., Foster, G., & Horngren, C. T. (2002). Management and cost accounting. Harlow: Financial Times/Prentice Hall.
Horngren, C. T. (2009). Cost accounting: A managerial emphasis, 13/e. Pearson Education.
Hilton, R. W., & Platt, D.E.(2013). Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.
DRURY, C. M. (2013). Management and cost accounting. Springer.
Blocher, E., Chen, K.H., & Lin, W.T. (2002). Cost management: A strategic emphasis.
Garrison, R. H., Noreen, E.W., Brewer, P.C., & McGowan, A. (2010). Managerial accounting. Issues in Accounting Education, 25(4), 792-793.
Vanderbeck, E. J. (2012). The Principles of cost accounting. Cengage Learning.
Fisher, J.G., & Krumwiede, K.(2012). Product costing systems: Finding the right approach. Journal of Corporate Accounting & Finance, 23(3), 43-51.
Rumble, G. (2012). The costs and economics of open and distance learning. Routledge.
Blocher, E, Chen, K. H., & Lin, W. T. (2002). Cost management: A strategic emphasis.
Drury, C. (2013). Costing: an introduction. Springer.
Laudon, K.C., & Traver, C.G. (2013). E-commerce. Pearson.
Turner, J. R. (2014). Handbook of project-based management (Vol. 92). New York, NY: McGraw-hill.
Puterman, M. L. (2014). Markov decision processes: discrete stochastic dynamic programming.
John Wiley & Sons.
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