Write a 2 pages paper on assignment 2b scenario. Joe Morgan, Controller From Me, Accounting Analyst On analyzing two costing methods ie. Job order costing as against Process costing following emerge:
Job Order Costing: In this system of costing, direct and indirect costs are allocated to batches or jobs rather than processes. All the direct costs are recorded on job order cost sheets. Indirect factory overheads (both labor and material) are allocated as per predetermined rates estimated in advance. More suitable for service industry, large order executors, ship builders, computer repair, etc.
Process Costing: This system applies all the manufacturing costs to processes and assumes uniform consumption by all the units produced. It is suitable for continuous / homogeneous production.
Job order costing is more applicable to Pharmafin, for the following reasons:
The production is neither continuous nor homogeneous.
Each equipment is manufactured separately by integrating 20 modules, 15 of which are supplied by third parties. Thus actual cost cannot be assumed to be uniform.
Cost of manufacture of each equipment can be ascertained with more accuracy
Pharmafin can easily determine the overhead allocation rate as the number of units and the overheads are already quantified based on the target orders and past years cost incurred.
The Job Order Costing system for Pharmafin would as follows:
Identify Direct and Indirect Costs
Cost of the modules purchased and manufactured would be the main direct material costs and labor hours spent on assembling and on quality assurance would be the direct labor cost. These can be easily ascertained with the help of job sheets
Estimate the indirect / overhead cost for the manufacture of the equipments for the entire year
Estimate the number of units manufactured for the year ( 100 for this year)
Determine the overhead rate for allocating the overhead rate to know the cost of goods manufactured. This we can take based on last year’s financial reports
Apply the over head rate to the units manufactured.
As we have considerable experience in production process and fairly good idea of the number of units needed, not many issues are seen in the implementation of job order costing system for both the models. The only point to be kept in mind is the comparison of the allocated overheads to actual overheads at the end of the year, if the difference is negligible, then the entire difference can be adjusted to the cost of goods sold otherwise if there has been significant under allocation, the same will have to be allocated to the work in progress, cost of manufacture and cost of goods sold.
The detailed information needed to be tracked by Pharmafin to implement Job Order Costing would be as follows:
Cost of Material-
Cost of construction of 5 in house modules. These include all direct and indirect costs which are already known to us.
Invoices of the 15 modules procured from other vendors. As the shipping cost is included in the invoices there no need to track them separately.
Direct Labor – Man hours in integrating the modules and performing quality assurance procedures.
Indirect costs – The rate determined based on the prior estimate of the overhead cost and production level.
Year end comparison – Actual overhead cost with allocated overheads based on the actual cost and units produced, to see under or over allocation of overheads and take appropriate action.
I hope this memo would help us to take the right decision.