Operation costing uses a combination of process and job-order costing methods.
A type of costing system that is used in certain industries is called operation costing. Operation costing is a style of costing that is a hybrid of job-order and process costing. Operation costing uses the most appropriate method for costing that can be found in either process or job-order costing and combines them to determine the best way to cost items for a firm.
What Is Operation Costing?
Operation costing is a hybrid of job-order and process costing. Job-order costing is generally used for products that are differentiated and processed in batches. These batches are then treated as a group for costing purposes, separate from other batches of products. Process costing is used for homogenous (identical) products. In process costing, costs are spread out over all products in an equal manner because they are all undifferentiated.
Operation costing combines these two methods for products that are very similar, yet are somewhat differentiated in batches. An example of a product that may use operation costing would be clothes or electronics. These products are similar, yet can be differentiated.
For example, a manufacturer of LCD televisions may use essentially the same process for making all of their TV sets, but each size may require a different amount of raw materials. In this case, conversion costs could be set up in a way similar to process costing (since the process is the same regardless of the television size), but direct materials costs would be better distributed in a job-order costing manner (costs distributed to batches of televisions based on actual direct costs).
Operation Costing Procedures
Although operation costing procedures can vary by company or industry, most of the procedures and methods used will be borrowed from job-order and process costing. Generally, direct costs are recorded to work-in-process accounts in a batch format (similar to job-order costing), but conversion costs are handled in a way that is similar to process costing (all conversion costs divided by the total number of units). This type of costing generally involves many work-in-process accounts.
When Is Operation Costing Appropriate?
Operation costing is appropriate in businesses that have products that are very similar, yet differentiated in some form from each other. This difference can be in the finishing or in the actual functionality of the product. The specifics of how operation costing is used can vary by company and industry, as different procedures can be combined from job-order and process costing to make an operation costing methodology.
