Advantages and Disadvantages of Job Order Costing System:
Learning objectives of the article:
- What are the advantages and
disadvantages of job order costing system?
One of the primary advantages of
job order
costing system is that the management team has ready access to all the
costs incurred for each job being completed. This allows the team to examine
each cost incurred, finding out why it happened, and determine how it can be
controlled better in the future, thereby contributing to better ongoing
levels of profitability. For example, a proper job record contains any
special reworking costs, which a
manager can then use to trace back to the
specific reason why the rework was needed. Similarly, overhead allocations
based on machine usage reveal problems with excess use, which might be the
result of lengthy machine setups or break downs as well as longer than
expected machine cycle times.
Another reason for using
job order costing
system is that it yields ongoing results for each job. In today's world of
fully computerized production tracking data bases, one can use a job order
costing system to track costs as they are added rather than waiting until
the job has been completed. This gives a company several advantages. One is
that the accounting staff can monitor job accounts to see if costs are being
posted to the wrong accounts and correct them right away, rather than
waiting until the job closes and having to frantically review records to see
why the results are different from expectations. Another advantage is that a
company can monitor the costs incurred for longer jobs and have enough time
to make changes before they close, based on the costing information revealed
by the job costing system. For example, a lengthy new product development
project might be over budget after just 25% of the work has been completed;
If the management team is made aware of this costing problem early in the
project, it will still have 75% of the project in which to make corrections
and bring costs back down to budgeted levels. Yet a third advantages is that
changes in the cost of a job can result in negotiations with cost-plus
customers who are paying for all the costs incurred, so that they are fully
aware of cost overruns well in advance and are prepared to pay the
additional amounts. All these factors are the main advantages of using
job order costing
system in a computerized environment.
There are also several problems with
job order costing
system. One is that it focuses attention primarily on
products rather than on departments or activities. This is not an issue if
there are supplemental systems in place that record information about these
other cost categories, but it leaves
management with inadequate information
if this is not the case. An other difficulty is that overhead is generally
allocated based on rates that are changed only about once a year.
Considerable fluctuation in overhead costs over the course of a year can
result both in over and under allocation of overhead costs to jobs during
that period. Another problem is specific to the use of normal costing. This
practice involves the use of standards overhead rate rather than one that is
based on actual costs and requires adjustment from time to time. If it is
management's intention to charge individual jobs for the variance between
standard and actual overhead rates, this may not be possible if some jobs
have already been closed by the time the variance allocation takes place.
This is not just a technical accounting issue, for some jobs are fully
reimbursed by customers who pay on a cost plus basis; if the overhead
variance is a positive one, a company may not be able to charge its
customers for the added costs if the related job have already been closed.
Another issue is that job costing has little
relevance in some environments. For example, the soft ware industry have
high development costs but almost zero direct costs associated with the sale
of its products. The use of a job order costing system to records these
costs makes little sense if the associated costs represent only a few
percent of the total revenue gained from each one. The same problem
arises in service industries, such as retailing, where there is no
discernible product. These situations limit the most effective use of job
order costing system to two areas--production and professionals services.
The first case, production is an obvious use for the concept since there are
high material costs that can be specifically identified with a job. The same
is true of professional services, but here the main cost is direct labor
rather than direct materials. In most other cases job costing does not
provide management with sufficient quantity of information to be useful.
The most important problem with job order
costing is that it requires a major amount of data entry and data
accuracy in order to yield effective results. Data related to materials,
labor, overhead, indirect labor, scrap, spoilage, and supplies must be
entered into system capable of accurately assigning these costs to the
correct jobs every time. In reality such systems are rife with mistakes due
to the sheer volume of data transactions, keying errors, misidentification
of jobs, and the like. Problems can be resolved with a sufficient amount of
error tracing by the accounting staff, but there may be so many that there
are not enough staff members to keep up with them. Though these issues can
to some degree be resolved through the use of computerized data entry system
outweighs the benefits to be gained from it. A final issue is that a large
proportion of the costs assigned to a job, frequently more 50%, comes from
allocated overhead. When there is no fully proven method for accurately
allocating overhead, such as through an
activity based costing system the results of the allocation yield
meaningless information. This has been a particular problems for the
companies that persist in allocating overhead costs based on the direct
labor used by each job, Since a small amount of labor is generally being
used to allocate a much larger amount of overhead, resulting in large shifts
in overhead allocations based on small amount of labor is generally being
used to allocate a much larger amount of overhead, resulting in large shifts
in overhead allocations based on small changes in labor costs. Some
companies avoid this problem by ignoring overhead for job order costing
purposes or by reducing overhead cost pools to include only overhead
directly traceable at the job level. In this way, many costs are not
allocated to jobs at all, but those that are allocated are fully
justifiable.
Clearly, one must weigh the pros and cons of
using a job order costing system to see if the benefits outweigh the costs.
This system is a complex one that is prone to error, but it does yield good
information about production-specific costs.
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