Conservatism Bias
In accounting and in finance, conservatism is generally considered to be a positive quality. However, studies in behavioral finance have shown that this may not be the case. This is because conservatism bias is one of the most profound biases which impact the investment decisions of an average investor. In this article, we will understand […]
Zillow Story – The Real Estate Marketplace
The real estate market tends to be a highly fragmented market in most parts of the world. Since the product being sold is not homogenous, there is very little information available about the trends in the real estate sector. For many years, participants in the real estate market have had to deal with this uncertainty. […]
Herd Mentality Bias
Human beings are social animals. For centuries, our brains have been wired to conform to the actions of the larger group. This is because, in the old times, a person’s probability of survival would be negatively impacted if they were not in a group. This herding mentality may have helped our forefathers survive in the […]
Types of Investment Banks
The investment banking industry is often referred to as if it were homogenous. However, this is not true at all. There are many different types of investment banks around the world. These different investment banks can also be categorized in different ways. However, these banks are most often categorized by the types of financial products […]
Reverse Factoring – Meaning and its Benefits
The purpose of commercial banking is to help corporations meet their funding needs in a better manner. Commercial banks help companies do this in several ways. One such way is related to the concept of reverse factoring. Reverse factoring is a solution that helps large corporations manage their supply chains better by helping optimize the […]
In earlier time, prices used to be driven by costs. This meant that the firms would consider the amount of money that they had spent in manufacturing a product. They would add a profit margin to it and then sell it at this “cost plus” price. This system had some issues. Even if the company was inefficient in its production, it could just pass on the costs to the consumer.
However with the advent of competition, pricing became a strategic issue. Companies could no longer charge on “cost-plus” basis. Rather they had to accept the price determined by the marketplace. Thus it became important to control costs and the job order costing system was amongst the first pricing system to be created.
A job order system is used by very specific type of companies. These companies do not manufacture standard products and stock them to sell to customers. Rather they take orders. This means that the product is custom built as per the requirements of the customers. This makes job order costing difficult since in a company that manufactures standard products, the production can be known in advance and overheads can be allocated amongst products. But in case of job order costing, determining what the overheads will be for the next accounting period is extremely subjective and prone to errors.
Companies that follow job order costing cannot determine the exact amount of costs that they will incur. Some of their overheads may be standard and required to run the business while some others may be dependent on the job being performed. Companies that perform these jobs cannot know the exact costs before the job is actually completed.
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-->One of the major problems in job order costing is the mismatch between when the quotation is made and when the costs actually become known. Prices need to be quoted before beginning production. However, the costs are known only after the job is completed.
Labour and material charges can be accurately known. However, overheads are an estimate. Hence the estimation needs to be spot on. If the overheads are not correctly known the company may quote too low and take a loss or the company may quote too high and lose customers to cheaper competitors.
Examples:
Not all types of companies follow job order costing. There are some businesses which are known to follow this technique since it is almost a pre-requisite for their business. Here are a couple of famous examples:
Builders usually do not produce standard units. Even if they do, the location, the logistics and many other factors are different. Thus the costs incurred are different too. Hence, job order costing iis very popular.
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