Operating Costing Systems

Operation costing is an accounting method used to allocate costs of similar products that are manufactured in batches. It combines two other popular costing methods to get a more accurate picture of how a particular company's manufacturing process works. It simplifies the accounting process by only differentiating activities that cause a variation in cost between products. Similar items are allocated in batches that reflect the actual cost involved in creating that group. Here is a basic guide to the operation costing accounting method.

Operation costing: How it works

Operation costing is a combination of process costing and job-order costing. Process costing is an accounting method used for the creation of identical products. The costs are allocated to all products in a batch equally because they are all identical. Job-order costing is better suited for products that are different from each other. The products are separated into batches. The costs of each batch tracked separately and allocated only to the products contained in that batch.

Operation costing: What products are suitable

Operation costing works for products that have some similarities, but can still be separated out into batches. Some common products that use operation costing are electronic equipment or cosmetics. The manufacturing process is similar for all of the individual products, but there may be different costs involved. Using computer monitors as an example, each size of monitor may use the same manufacturing process, but will incur different levels of materials cost. The labor costs could then be allocated using a process costing system while the materials costs are allocated with a job-order costing system to account for the different sizes.

Operation costing: Procedures vary by company

Each company has its own specific operation costing procedures, but most of them will resemble both process costing and job-order costing. Direct materials costs are usually booked into work-in-process accounts in batches the way they would be under a job-order system. Most operation costing systems require the use of several work-in-process accounts to keep the batches separate. Conversion and labor costs are tracked in a lump sum that is later spread to all units produced during the accounting period.

Operation costing: How to determine the batches

The variation between products can be large or small, as long as it can be differentiated from another group of products. When deciding how to group products for operation costing, the difference in cost is the most important consideration. One product may have more features than another, but that only matters if it costs significantly more to produce that item. Each company must tailor its operating costing system to their specific products.