Different Accounting Systems for Different Businesses
Updated: Dec 6, 2018
There is a common erroneous thought that accounting is accounting; that is, accounting practices are standard across businesses. Whilst there are standards for accounting and best practice, different types of businesses will indeed use different accounting systems. For example, let's look at a couple of accounting systems, job-order costing and process order costing. The former is a system for assigning manufacturing costs to an individual product or batches of products (typically products that are sufficiently different from each other). For the latter, process order costing, there is collection and assignation of manufacturing costs to the units produced (which are near identical). Another accounting method that can be commonly found is activity-based costing, which identifies activities in a company and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. Sometimes, different departments may utilize different methods if the company is sufficiently large and diverse enough. Let's look at a couple of examples to highlight these accounting methods.
Job-order costing accounting company:
I chose Boeing for an example of a company that uses job-order costing accounting. I chose Boeing due to my investment interest in the company and more importantly, since typically, aircraft manufacturers (an industry Boeing falls into) utilize job-order costing accounting. This accounting method is frequently utilized by companies that focus on the manufacturing of various products to individual client needs. Given that Boeing makes a variety of different aircraft models for a global client base (each with slightly different needs) and since they bid for contracts it makes sense they would use an accounting system whereby costings is covered in a job-ordered fashion. In these instances, due to the relatively unique nature of each product manufactured, the costings must fall under a ‘per job basis’. So in order to calculate the per unit cost the below formula would be used by Boeing management and accounting staff:
Per unit cost = Total cost applicable to job / Number of units in the job
Process costing company:
For an example of a company that would use process costing, I selected Sigma-Aldrich, a company owned by Merck KgaA. I chose Sigma-Aldrich since it is a supplier in the research and fine chemicals market (one I have had an extensive career in), and since chemical manufacturers/suppliers typically use process costing. The reason that process costing accounting is used by companies such as Sigma-Aldrich is due to the batch production nature of identical products that customers can select from (usually via a catalogue of some sort). This is of course partially different to a company that does this type of activity in addition to others (such as Merck KgaA, which will engage also in R&D, a more varied activity with far greater variables). Process costing accounting methodology will separate costs into various cost categories according to when the costs are added into the process. Generally speaking, only direct materials and conversion costs are required. The direct materials will get typically added at the start or the end of the process (for example, the precursor chemicals for producing a given product). All conversion costs (that is, direct labour and overhead costs) are added at around the same time, but in a different pattern to the direct materials costs. Conversion costs will be added throughout the process due to them varying in their time required.
Activity-based costing company:
As alluded to above, Merck KgaA is an example of a company that engages in a variety of services for its customers and its continued growth; from chemical production (via its acquisition of Sigma-Aldrich), to R&D activities and healthcare with respect to clinical trials of new drugs. Additionally, Merck KgaA also engages in custom client research solutions which also followed its acquisition of Sigma-Aldrich to combine it with Merck Millipore, turning this business venture into what is now known as MilliporeSigma. MilliporeSigma therefore has clients in the in biotech, pharma, diagnostics, food safety, academia, and environmental sectors. Due to the extremely diverse nature of Merck KgaA with respect to their client base and activities, they would require a managerial accounting system that can differentially deal with this. Activity-based costing accounting perfectly would serve this function since this accounting method allows for the vastly different services a company may employ, and as such, allocates fixed overheads and administrative costs to activities (both of which are cost-incurring events). Cause and effect relationships are deducted in order to assign costs. So for example, when deciding on allocation of budgets for various departments (such as R&D and clinical trials), activities that are dynamic in nature need to be identified; these could be the different levels of patient follow up following a drug side-effect, or at what point a new product in development is exceeding the costs of its very development (also the different timescales required for the development of different drug types).
As the above examples should demonstrate, each of the companies can have quite diverse needs with respect to accounting; all of which are the result from the different styles of business and different needs of their customer base. A simple chemicals manufacturer like Sigma-Aldrich for example, does not need to worry as much about differing costs to either a custom manufacturer (like Boeing) or a large multinational pharmaceutical/biotechnology company that is engaged in a broad array of differentiated services (i.e. Merck KgaA). And of course, Boeing, whilst having some degree of complexity due to custom client needs, does not have quite the same degree of custom client needs that Merck KgaA has since the former remains focused purely on aircraft manufacturing (this would be different if they also engaged in a lot of consulting and spread out into other sectors). In fact, since Boeing will be required to produce the same product in batches (changing for each client), they could utilize process costing in a per-client basis. However, from a top-down approach, it makes more sense to use job-order costing. Likewise, Merck KgaA could use either job-order costing and process costing for each of its different departments, but for simplicity it makes more sense to stick to one type of accounting method, deviating only when absolutely required (for example in its consulting business).