Why are Pension Funds Important?
Individual investors are well aware of the existence of pension funds. Retail investors who earn their income in the form of a salary are likely to have invested in these funds. Other retail investors may also have invested in these funds. Almost everyone has heard about pension funds in the news. However, very few people […]
The Silicon Valley Bank Collapse: Why Is It Important?
In the second week of March 2023, the Silicon Valley Bank, which is headquartered in Santa Clara California collapsed in spectacular fashion. The shares of the bank fell by over 60% in one day. There was a classic run on the bank which led to a collapse almost overnight! This created a panic-like situation across […]
Pension Funds and Fiduciary Duty
Whenever investors pool their resources together in order to create a fund that then invests in other assets, the concept of fiduciary duty comes into play. The average investor considers fiduciary duty to be a complex legal subject and hence tries to avoid delving into the details. However, the subject is not very complex. Also, […]
Macro-Economic Factors and their Effect on Personal Finance
Personal finance is defined in such a way that it is supposed to be linked with the financial decisions of an individual or their family. Any decision which is taken at a higher level is not considered to be a part of the personal-finance domain. However, it is important to realize that decisions related to […]
The Merger Modeling
The Three statement financial models and discounted cash flow models are considered to be basic from a financial modeling point of view. On the other hand, financial modeling for mergers and acquisitions is said to require a lot of skill. Merger modeling is extremely complex. This is also the reason why investment banks across 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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