Definition: Operation Costing is a system of costing adopted when the firm manufactures many variants of a final product by using different raw materials but with the same conversion process. In other words, the process through which the product passes is the same. But the materials used to produce them differs. Due to this characteristic, we call it Hybrid product costing. This is because it combines two costing methods – Job Costing and Process Costing.
And so, accumulation of material takes place by way of job order or batch-wise. However, conversion costs like labour and overheads are accumulated through process costing.
The two scenarios in which we adopt operation costing are:
- When at the initial stage the manufacturing of the product requires the use of different raw materials. After that, completion of the product takes place using a common process, which is similar for a group of products.
- When at the initial stage product undergoes an identical process that the firm uses for a group of products. Thereafter, its completion requires a product-specific process.
Hence, in both scenarios, implementation of both job and process costing takes place to produce the product.
Points to Note
- It involves the ascertainment of unit operation costs by each operation.
- The expenses in operation costing are recurring.
- It is useful when product units are identical and the firm produces more than one type of product.
What is an Operation?
Operation is nothing but a sub-division of a manufacturing process into many parts. So, a process is a bigger activity that comprises many operations. Each operation has all the characteristics of the process. Therefore, for more accuracy in the cost of product and detailed control, ascertainment of costs is on the basis of operations. Hence, the cost of the process is nothing but the total of cost of constituent operations.
Calculation of Cost per unit
To compute the cost per unit at each stage of production, we will divide the total cost of each production by the normal output of that operation. In this way, averaging of costs over the units produced during a certain period takes place.
Use of Operation Costing
- Industries that involve repetitive manufacturing often use this costing method. For example, Jewelry, Readymade garments and shoe making enterprises are some common examples of such industries. In these industries large production runs of common processes and materials take place.
- Industries where the manufacturing process comprises several operations. For example Toy Making, Car Manufacturing, Timberworks, Machine tools, Leather tanneries, etc.
Suppose a company produces two products – Product A and Product B. While product A is a regular product, product B is a premium product. The two products undergo a similar conversion process. But the quality and quantity of the raw material used in production are different.
So, on the basis of job or batches cost of raw material is accumulated. But because both products go through similar conversion activities, the cost of conversion should not be identified with the product. Thus, the cost of conversion is accumulated on the basis of processes.
When operation costing is suitable?
Operation costing is suitable for those industries where products are similar but, they differ from each other to some extent. The difference in the product can be:
- In their finishing
- In their functioning
We prefer this costing method when the product passes through multiple operations consecutively before the final product gets ready. One must note that the occurrence of wastage is quite common in each operation.
A word from Business Jargons
So, it is that costing method that ascertains the unit cost of the product by each operation, that forms part of the production process. This type of costing differs from process costing in a manner that each operation is regarded as a separate cost centre.
Hence, all direct material, labour and expenses are accumulated for each operation by way of direct measurement. Whereas overhead is equally apportioned among various operations.