What Is Job Order Costing and When Should You Use It?
Explore job order costing, the accounting method for accurately tracking expenses of unique products and services. Gain insight into custom project finance.
Job order costing is a cost accounting system that focuses on accumulating costs for distinct production units.
What is Job Order Costing
Job order costing is an accounting method used to determine the manufacturing costs of unique, identifiable products or services. This system accumulates all costs associated with a specific project, order, or activity. Each individual job is treated as a distinct cost object.
The purpose of job order costing is to assign direct materials, direct labor, and manufacturing overhead costs directly to specific jobs. This allows businesses to understand the profitability of individual projects. It is particularly suitable when products or services are customized to meet specific customer requirements, rather than being mass-produced. The system aids in accurate pricing.
When Job Order Costing is Used
Job order costing is appropriate for businesses that produce unique goods or provide specialized services. This method suits situations where each product or service differs significantly from others and has a substantial cost. Companies producing custom-made items or working on distinct projects find this system useful.
Examples of industries that commonly use job order costing include custom home builders, advertising agencies, auto repair shops, and shipbuilders. Specialized manufacturers like bespoke furniture makers, printing companies, and film production studios also use this method. Professional services, such as accounting and law firms, utilize job order costing to track expenses for each client’s unique case.
Components of Job Costs
The total cost of any job under a job order costing system comprises three main components: direct materials, direct labor, and manufacturing overhead. These elements are tracked to determine the full cost of each unique product or service.
Direct materials are raw materials or components directly used in the production process. For instance, the wood for a custom cabinet or fabric for a tailored suit are direct materials. These costs are recorded when materials are issued or purchased for a job.
Direct labor refers to compensation paid to employees who directly work on the product or provide the service. This includes the time spent by a carpenter assembling a cabinet or a tailor sewing a garment. Direct labor costs are measured based on hours worked and wage rates.
Manufacturing overhead encompasses all indirect costs incurred during the production process that cannot be traced to a specific job. Examples include factory rent, utilities, depreciation on factory equipment, indirect materials like lubricants and cleaning supplies, and salaries of factory supervisors or maintenance workers. Since these costs cannot be directly assigned, they are allocated to jobs using a predetermined overhead rate. This rate is calculated at the beginning of an accounting period by dividing estimated total manufacturing overhead by an estimated allocation base, such as direct labor hours or machine hours.
Tracking Costs in Job Order Costing
Tracking costs in job order costing centers around the job cost sheet. This sheet serves as the record for accumulating all costs assigned to a specific job. It provides a detailed breakdown of expenses, allowing for cost control and profitability analysis.
As a job progresses, direct materials, direct labor, and applied manufacturing overhead are recorded on the job cost sheet. Material requisition forms document direct materials, while time tickets or labor tracking systems capture direct labor hours. The predetermined overhead rate is then applied to the actual activity consumed by the job (e.g., actual direct labor hours) to allocate manufacturing overhead.
The job cost sheet includes a unique job number, a description of the job, and the start and estimated completion dates. As costs are incurred, they are entered into the categories on the sheet. Once the job is complete, all recorded costs are totaled on the job cost sheet to determine the final cost of the job. This record helps management compare actual costs against estimates, assess profitability, and make informed decisions for future projects and pricing.