What Is the Cost-Accounting System Used for Manufacturing Operations?
Small-business manufacturing companies are subject to the same accounting rules as merchandisers. However, in addition to these rules, manufacturers must determine the costs of products manufactured. There is some leeway in which system to choose. Knowing some of the common cost-accounting systems used in manufacturing can help you choose the right system for your small business.
The most common cost-accounting system used by small-business manufacturers is job-order costing. Job-order costing assigns costs to products based upon production batches. For example, if your clothing manufacturing business produces socks, jeans and shirts, you might produce a batch of jeans, then a batch of socks, then some shirts. Each production run of clothing is considered a batch or job. Under job-order costing, you would account for the actual materials and labor used during the job and assign these costs to products. You would then allocate a portion of overhead costs, those manufacturing costs not included as materials or labor, to each batch as well. If your company produces different products via production batches, job-order costing is probably the best choice for your company.
If your small business produces products where individual units of product are indistinguishable from one another, then process costing will probably be the best choice for your business. Products manufactured under a process-costing system include orange juice, ball bearings, petroleum products and milk. The process costing system assigns costs to products based upon the department in which the costs occur. For example, if your company produces orange juice, you may have washing, peeling, juicing, pasteurizing and bottling departments. Under process costing, you would allocate any materials and labor related to washing the oranges in the washing department. In addition, you would allocate any overhead costs related to the products in this department. Once the product moves onto peeling, the costs move on as well. In peeling, the same process occurs, with materials, labor and overhead costs being added to the product cost. This process repeats until the product is completed.
Many small-business manufacturers use standard costing systems. These systems start with the establishment of a standard cost. The standard cost of a product is the estimated cost of production, provided normal operations and a reasonably minimal amount of waste, defect and spoilage. At the end of each period, you compare the amount of materials, labor and overhead costs used in production to the standard. If management deems the difference between the actual and standard to be significant, the company will investigate the differenceand attempt to correct operations to eliminate the difference in the future. If not, the company accepts the difference and does not change the process.
Companies use activity-based costing systems to obtain more-detailed cost information. Because these systems are not allowed for external financial reporting, activity-based costing is done in addition to process or job-order costing. In an activity-based costing system, you accumulate costs by activities that may include both manufacturing and non-manufacturing costs. For example, if your company produces custom riding saddles, you may incur costs during the ordering, machinery setup, production, packing and post-sale customer service processes. In an activity-based costing system, you assign ordering costs, such as the costs of telephone operators and ordering system computers, to products. Once the ordering process is complete, you add costs of setup to the product's cost, and so on, until the product is completed.