Operation costing is a mix of job costing and process costing, and is used in either of the following situations:
- A product initially uses different raw materials, and is then finished using a common process that is the same for a group of products; or
- A product initially has identical processing for a group of products, and is then finished using more product-specific procedures.
In both cases, you use a mix of job costing and process costing to compile the cost of a product; this mixed costing environment is called operation costing. The job costing element is based on the concept that you can assign costs to specific products, which is the case when something is produced in units of one or in very small quantities. The process costing element is based on the concept that you allocate the cost of producing a large group of products equally to all the products in that group, since they are manufactured in an identical manner.
In short, operation costing is most applicable to the more complex manufacturing environments that require a mix of different types of production processes in order to create goods.
Examples of Operation Costing
A company manufactures watches in lots of 1,000. The watch casings and workings for all 1,000 units are identical, so the company simply adds up the cost of the production run and divides by 1,000 units to arrive at the per-unit cost. In addition, watch bands are custom-made for the wrist size of the customer, and use a variety of unique materials. These costs are compiled for each individual watch. Thus, we have process costing for one portion of the production process (the watch casings and workings) and job costing for another portion (the watch bands). When combined, this is operational costing.
An example of the reverse situation is when a product initially has unique raw materials, but is then finished using a common process. For example, a company builds unique, custom-designed race cars. It uses job costing to compile the cost of each car. However, all cars are then run through a paint shop, which is essentially a fixed cost. The cost of the paint booth is allocated equally to all of the cars run through it, which is process costing. Thus, we use job costing for the first part of the production process and process costing for the second part. Again, this is an example of operation costing.
Operation costing is a form of hybrid costing system.