Consequences of Incorrect Job Order Costing
Causes of Failure of Job Order Costing: The following is the list of the most probable causes that would cause the job order costing system of the company to fail: Adequate System Not In Place: Job order costing requires an elaborate system in place. In earlier times this was done with the help of paperwork…
Constraints and Contribution Margin Analysis
Hidden Assumption: The cost volume profit analysis has a rogue assumption. This rogue assumption believes that the cost volume profit analysis is completely scalable. We know that this is not the case. We operate in a finite world and have finite resources. We show this in our analysis when we write down the relevant range…
Allocating Overheads in Job Order Costing
Tracking direct labor and materials that have been used in a job can be done with a fair degree of precision. That is not the real problem when it comes to costing. The real problem is with allocation of overheads. Usually, they have very little correlation to any specific activity. They are the result of…
Job order costing systems have a massive paper trail. They function on the basis of this paperwork. This creates a lot of complications. Companies have to employ a lot of clerical staff to sift through this paperwork and that adds to the overheads that job order costing is trying to minimize.
For every job, there are several documents like quotation, invoice, sales order, materials receipt, labour tickets and so on. They need to be classified and maintained. Of late, information technology has helped in this regard. ERP systems have the option of job order costing inbuilt in them. This helps companies manage their paperwork faster.
Job order costing is a very powerful concept in theory. But in practice, it is very complicated to implement. These difficulties are multiplied if the organization works out of multiple locations and conducts a wide variety of jobs.
In practice, it becomes difficult to measure the costs that are associated with a particular job. Information technology has helped in this regard too. With barcodes and RFID chips these difficulties can be negated. But these IT systems are expensive to purchase and maintain and add to overheads.
Job order costing allocates overheads based on an allocation base. This allocation base then leads to an allocation rate which results in overhead costs being allocated to different jobs. Many times companies do not choose the best allocation base. Rather politically powerful managers in the organization choose allocation bases in such a way that it suits their department. Because of the incorrect costing, there is wide-spread conflict and discontent amongst the other departments which end up being charged. Since choosing an allocation base is so subjective, it ends up creating political problems in the organization itself and hampers productivity.
One of the major disadvantages of job order costing is that overheads are based on estimates. At the beginning of a job, overheads are not accurately known. This system, therefore relies on the experience and expertise of certain professionals and on empirical data. Neither of these is a reliable measure.
Past overheads cannot be considered to be a measure of future overheads because prices keep changing. True, that the prices are adjusted to show the effect of inflation and deflation but empirics itself will show that empirical data is far from accurate. Instead, firms can work on more effective ways to find their overhead cost information by studying the current trends in the external marketplace.
Also, job order costing does not provide an effective way of controlling overhead costs. Estimates are usually for quotation purposes only. The management is aware that these quotations are seldom accurate and hence they cannot be used as a base for controlling overheads. There are other costing techniques which provide better control over the costs being incurred.
Your email address will not be published. Required fields are marked *
