PRODUCTION ORDER COST SYSTEM: CHARACTERISTICS - DUDAS - 2025

The production order cost system is a system for allocating and accumulating manufacturing costs for an individual unit of production. It is used when the various items produced are sufficiently different from each other and each has a significantly different cost.

When the production of a company consists of a continuous flow of identical, low-cost units, it is more appropriate to use the cost per process system.

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But when there is significant differentiation between manufactured items, the production order costing system requires a separate record of the production cost for each item, or for each order.

The order cost record will report direct labor and direct materials that were actually used for each item, plus an allocated amount of manufacturing overhead.

The order cost record also serves as documentation for the cost of work-in-process inventory, finished goods inventory, and cost of merchandise sold.

characteristics

- Most commonly used for small batches, especially when the products within each batch are different from the products created in other batches.

- The production is generally against the client's request, not for stock.

- Each job has its own characteristics and needs special treatment.

- There is no uniformity in the production flow from one department to another. The nature of the job determines the departments through which the job must be processed. Production is intermittent and not continuous.

- Each job is treated as a unit of cost.

- Each job is uniquely identified by a production order throughout the production stage.

- The production cost of each job is determined after its completion.

- Jobs in process differ from period to period, depending on the number of those available.

Information sources

The elements used to obtain information on the cost of manufactured products can vary greatly, even within the same company. Next we will see the most common ones.

Supplier invoices

From which only the items corresponding to that job should be loaded to order.

Payroll records

From which the hours worked on that specific job are charged to order, possibly also including payroll taxes, overtime, and shift differentials.

Material costs

Where inventory items are released from stock and loaded onto an order, as they are used.

Allocation of overhead

It is derived from a set of costs and is charged to each order based on some form of use, such as labor hours or machine hours used.

Advantage

Cost analysis

It provides a detailed analysis of the cost of materials, salaries and general expenses of the different departments and production units based on their nature and functions.

This makes it possible to determine the operational efficiency of the different production factors, production centers and functional units.

Detailed cost records from recent years can be used for statistical purposes to determine cost trends for different types of jobs and their relative efficiency.

Costs control

Keeps an accurate record of the costs of different departments and units. It helps to compare the actual costs with the estimated costs, facilitating the control of expenses.

Profitability per job

It helps to know the profitability of each job separately, identifying the most profitable. This allows you to better determine whether it is desirable to look for a specific job or assignment in the future.

Cost estimate

Helps estimate the cost of work similar to those already done by providing details of past expenses. Therefore, it helps in future production planning.

Adequate evaluation

It helps to evaluate the performance, efficiency and profitability of different jobs separately, helping to identify the most favorable or unfavorable.

Disadvantages

Complex system

The cost of the production order consumes more time and procedures to be able to maintain detailed information about the job.

It also requires more office work to record material costs, labor costs, and overhead. Therefore, it is a complex cost calculation method.

As an example, you can consider a construction contractor. To use this system, you would need to keep track of all screws, nails, paint, electrical accessories, wood, and other items used in your work, as well as track employees' lunch breaks and hours worked.

Expensive system

It is a laborious system due to several jobs and procedures that are required to be performed on paper to maintain the records of the different production orders.

In addition, it involves a lot of administrative work to record the cost of issued materials, wages spent, and overheads applied to each production order on a daily basis, adding to the cost of cost accounting.

Strict supervision

Strict supervision is required to practice the cost system for production orders, due to the lack of standardization of the works.

The probability of making mistakes is high, as the cost of a job can be wrongly recorded.

Example

Manufacturing overheads are allocated to in-process orders using a predetermined overhead rate.

This rate is determined during the annual budget process by estimating factory overhead and dividing by total direct labor hours or total direct labor cost.

Suppose a company uses direct labor cost for its overhead allocation. He estimated his total overhead to be $ 300,000, and his total direct labor cost $ 250,000.

Then the company's default overhead rate for allocating overhead to in-process orders will be 120% direct labor.

Costs of the month

If the direct labor costs for the month are $ 20,000, the overhead will be $ 24,000 ($ 20,000 × 120%), which will be allocated to work-in-process inventory.

Factory overhead will be allocated to each order, based on the portion of the direct labor cost of $ 20,000 to be allocated to each job.

If order number 45 had $ 9,000 in direct labor costs for the month, factory overhead costs of $ 10,800 ($ 9,000 x 120%) will also be assigned to this order.

Upon order completion, the total costs assigned to the job are transferred from the work-in-process inventory to the finished goods inventory.

After the job is sold, the order costs are carried over from finished goods inventory to cost of goods sold.

References

1. Harold Averkamp (2019). What is job order costing? Accounting Coach. Taken from: accountingcoach.com.
2. Steven Bragg (2018). Job order costing system. Accounting Tools. Taken from: accountingtools.com.
3. Cliffs Notes (2019). Job Order Cost System. Taken from: cliffsnotes.com.
4. David Ingram (2019). Advantages & Disadvantages of Job Order Costing & Process Costing. Small Business-Chron. Taken from: smallbusiness.chron.com.
5. Accounting-Management (2019). Advantages And Disadvantages Of Job Order Costing. Taken from: accountlearning.blogspot.com.
6. Ashish Lodha (2019). Job Order Costing: Features, Advantages and Disadvantages. Your Article Library. Taken from: yourarticlelibrary.com.