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.
You may also be interested in other useful articles from “job order costing system” chapter:
- Measuring Direct Materials Cost in Job Order Costing System
- Measuring Direct Labor Cost in Job Order Costing System
- Application of Manufacturing Overhead
- Job Order Costing System – The Flow of Costs
- Multiple Predetermined Overhead Rates
- Under-applied overhead and over-applied overhead calculation
- Disposition of any balance remaining in the manufacturing overhead account at the end of a period
- Predetermined Overhead Rate and Capacity
- Recording Non-manufacturing Costs
- Recording Cost of Goods Manufactured and Sold
- Job Order Costing in Services Companies
- Use of Information Technology in Job Order Costing
- Advantages and Disadvantages of Job Order Costing System
- Job Order Costing Discussion Questions and Answers
- Job Order Costing Exercises
- Case Studies
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