Job Order Costing System - Essay Example

Job Order Costing System Name: Professor Institution: Course Date Executive summary This paper is a report that shows how a cost analysis for a product or service is developed using the job order costing system. The report has shown that Data related to costs are readily available and the business is only required to understand the causes of costs. The report will show that costs information is very important to management for decision making. It will also be shown in the report that job order costing system is very suited in car repair business since each car requires different type of repair from the other hence the need for customizing each repair. Table of Contents Executive summary 2 This paper is a report that shows how a cost analysis for a product or service is developed using the job order costing system. The report has shown that Data related to costs are readily available and the business is only required to understand the causes of costs. The report will show that costs information is very important to management for decision making. It will also be shown in the report that job order costing system is very suited in car repair business since each car requires different type of repair from the other hence the need for customizing each repair. 2 Table of Contents 3 Section 1 4 Introduction 4 Description of the entity 4 Cost objects 5 Resources 5 Cost structure 5 Cost flow diagram 6 Appropriateness of job-order costing system 6 Section 2 7 Section 3 7 The strengths, effectiveness and importance of job order costing to management 7 Recommendation with respect to activity based system 8 Conclusion 10 References 11 Section 1 Introduction The report will use a real business owned by Smart Kims. The aim of any business is to make profit out of its activities in satisfying a need in the market. This means that for a SmartDrive Car Repair Shop to make profit it must get more benefit than the expenditures it has incurred in servicing a particular car. Therefore, Smart Kims must cost its car repair services prudently in order to ensure that it remains profitable. Cost refers to a resource which is foregone in order to attain a certain objective. Description of the entity The name of the business is SmartDrive Car Repair Shop. It is located in Sydney Australia, a place that is easily accessible since it is within the CBD. The business was started by Smart Kims in 2008. He had worked part time since he was 18 years in a local garage owned by his parents. By the time Kims graduated from university where he took a course in mechanical engineering, he had worked in his parents car garage and repaired different types of vehicles. This is to mean that Kims had a wealth of knowledge and experience in motor vehicle repair. Kims made his steps cautiously and conducted an extensive market research and made a good business plan before investing in the business. at first, he started with 3 employees but currently his business is an employer of over 16 people. This is without mentioning the many people who benefit from the business indirectly. The business is a sole proprietorship and is run by Kims as the manager. The business has been growing from year to year and its turnover is currently averaging at $100,000. The major customers for the business are private motor vehicle owners within Sydney and the main competitors are the repair garages located within the CBD. Cost objects The business mostly deals with motor vehicle repair and specialises in small cars. However, the business also retails motor vehicle spare parts for those who would buy and does the repair work elsewhere but for the business. This has been generating revenue than was anticipated and the management is thinking of expanding this line of business. This can be explained by the fact that most motor vehicle owners have the basic mechanical skills and would reduce the repair cost by buying the necessary spare parts and doing the repair work on their own. Resources The major resource used in this type of business is human labour. Actually this is a labour intensive business. There are machines employed in the business to ease the work of the mechanics. The cost of the spare parts is very significant in this business. Cost structure Costs in a business can be broadly categorised into fixed and variable costs. This is classification based on the behaviour of the cost in question. Fixed costs are the costs that remain fixed irrespective of the level of activity in the business. Such costs include operating licenses and manager’s salary. On the other hand, variable costs are the costs that vary depending on the level of activity in the business. Such costs include payments made to the mechanics and the costs of spare parts. The most prudent way of understanding how costs are incurred in a business like SmartDrive car repair shop is to analyse them as part of the value chain of the business. This is a set of related processes and activities that create value in a service. This includes both the primary activities and the supporting services. The primary activities may include research and development, design, supply, operations, marketing, distribution and customer services. On the other hand, supporting services include human resources, financial accounting, general management and information system among others. Cost incurrence is said to occur whenever a resource such as labour is used up or sacrificed. Cost flow diagram Costs are first identified and assigned to either direct or indirect costs. The indirect costs are then allocated to a job using an appropriate allocation bases. The final stage is adding the allocated cost to the direct cost in order to determine the cost of a particular job. Appropriateness of job-order costing system There are several techniques for costing a product or service but this paper focuses on job order costing system. Job order costing system requires costs to be recorded only when incurred. A job order costing system is appropriate for SmartDrive car repair shop since it makes an approximation of the cost of a job which may be services labour, material usage, and specific and general expenses. This is done in two stages. The first stage accumulates the cost by collecting data related to cost in an organised manner through an accounting system. This is ensured through classification of cost data into cost pools such as materials, labour and general expenses among others. The second stage is cost assignment which involves assigning costs to jobs (Steven, Roby and Gregory, 2008). The purpose of a costing system at this point is to trace accumulated direct costs to a job and allocate the accumulated indirect costs to a job. Section 2 Cost analysis. See the excel workbook attached. Section 3 The strengths, effectiveness and importance of job order costing to management The job order costing system has an advantage over other costing methods in that it treats each job as a separate item different from the other activities of the business. This helps the management to customize an order since a customer will be charged based on his requirements and not the standard rate. Therefore, the problem of over or under costing a service does not arise under this system. However, the management should take appropriate actions to increase the value of services and increase cost efficiencies. In order to achieve this goal they must have a clear understanding of the real causes of costs. Job order costing system requires cost and revenue information but emphasis is placed on costs. There is no business (SmartDrive Car Repair Shop included) that does not incur costs hence the need to plan and control the costs. However, the costs of obtaining this information should not outweigh the benefit derived from the utilisation of cost information. The management usually requires the information generated from the job order costing system for decision making. Specific ways of using this information include: Determination of the areas of business or certain jobs that is most profitable for the business. This helps SmartDrive Car Repair Shop to focus on those orders that will maximize its profit. Cost control: knowledge of the exact cost incurred in a particular job will help the management to control the cost of that job (Stolowym & Lebas, 2006). For example, if the actual amount incurred in a particular job is more than was budgeted then the management will put measures to control the costs in that job. Determination of costs will help the management of SmartDrive Car Repair Shop to decide on whether to outsource a particular function. For instance, the management can evaluate its labour costs and compare it with the contract price from an outsourcing vendor. If the fee from outsourcing is less than the labour wages paid by the SmartDrive Car Repair Shop then the management should consider outsourcing its human labour from another firm. Determination of costs aids in pricing decisions. In order for the company to continue growing it must make profit. The profit will be determined by the difference between its selling price for its products and the cost incurred in producing that product. Therefore, SmartDrive Car Repair Shop should first determine the cost of completing a specific job order before deciding on the customer price (selling price). The customer price will be determined by adding a profit margin on the cost incurred in completing the job. Recommendation with respect to activity based system In an ABC system, the organisational processes are broken down into activities. An activity can be any event which causes a cost to be incurred. SmartDrive Car Repair Shop can break its process of servicing a car into maintenance, process setups, wiring, panel bitting, and handling materials activities. The costs assigned to these activities are then allocated to services on the basis of cost drivers appropriate to these activities. For instance, the best cost driver for panel biting activity is the number of hours taken the staffs to get the job done. The steps applied are outlined below: 1. Identify major activities. 2. Identify appropriate cost drivers 3. Collect costs into pools based upon the activities. 4. Charge costs to units of production based on cost driver volume. Fess and Warren (2004) explains that ABC first categorizes indirect costs according to discrete business activities that are responsible for consuming resources and then uses cost drivers to estimate the resources attributable to the cost objects. Product cost differences between job order costing system and ABC system arise because of the manner of treating the indirect costs. Hilton (2004) observes that the objective of ABC is not to attempt to allocate all indirect costs. Rather, the objective is to accurately allocate indirect costs where it is relevant. Some costs will have no relevant or applicable basis to allocate to cost objects. Conclusion This report has shown that the main aim of a business is to make profit. The profit is attainable if SmartDrive Car Repair Shop business can sell its service at a margin. The cost of accomplishing a repair is important since it will guide the management in deciding how much to price its services. These costs may be fixed while others may be variable. These costs are rarely similar from one business to another. Therefore, SmartDrive Car Repair Shop should price its car repair services independently of other repair shops. Direct labour is a major cost for repairing a car but these costs varies because human labour is dynamic and is priced differently from different operators. Pricing decisions can be a competitive tool for a business. If SmartDrive Car Repair Shop is cost efficient then it can reduce the repair cost hence can price its services competitively. References Fess, E. and Warren, C., 2004. Accounting principles. Canada: Southwestern Company. Hilton, R. W., 2004. Managerial Accounting: Creating Value in a Dynamic Business Environment. New Delhi: McGraw-Hill Publisher. Steven, R. J., Roby B. S., and Gregory, J., 2008. Managerial Accounting: A Focus on Ethical Decision Making. New Jersey: Cengage Learning. Stolowym, H. & Lebas, M., 2006. Financial Accounting and Reporting – a global perspective (2nd ed.). London: Thomson. Read More