Job Order Costing

Job order costing is a cost accounting system in which costs are accumulated separately for each job, order, contract or batch. It is used by businesses whose output consists of distinct products or services that differ from one another, so that each one needs its own cost. Examples include custom home builders, furniture makers, print shops, machine shops, film producers, consulting and accounting firms, hospitals billing by case and repair workshops. It is often called simply job costing.

The alternative is process costing, used for large volumes of identical units, such as soft drinks, cement or chemicals, where costs are accumulated by department and averaged over all units produced. Some businesses use a hybrid known as operation costing. In all cases, the goal is to measure the full cost of products for inventory valuation, pricing and profitability analysis, following the rules of absorption costing for external reporting.

Each job is assigned a number and a job cost sheet that records its costs. Three kinds of cost are assigned:

• Direct materials are traced to jobs through materials requisitions, which record the materials issued from the storeroom and the job they are for.
• Direct labor is traced to jobs through time tickets or electronic timekeeping, which show how many hours each worker spent on each job.
• Manufacturing overhead is applied to jobs using a predetermined overhead rate, because indirect costs such as factory rent, utilities and supervision cannot be traced to individual jobs.

The predetermined rate is calculated at the start of the year:

Here $\text{Estimated annual overhead}$ is budgeted total manufacturing overhead and $\text{Estimated annual allocation base}$ is the budgeted total of the activity used to assign it, such as direct labor hours or machine hours.

A printing company budgets $480,000 of overhead and 16,000 direct labor hours for the year, giving a rate of $30 per hour. In March it works on three jobs. Job 101 uses $4,000 of materials and 100 labor hours at $25, Job 102 uses $9,000 of materials and 250 hours, and Job 103 uses $2,500 of materials and 60 hours.

• Job 101 costs $4,000 plus $2,500 of labor plus $3,000 of overhead, a total of $9,500.
• Job 102 costs $9,000 plus $6,250 plus $7,500, a total of $22,750.
• Job 103 costs $2,500 plus $1,500 plus $1,800, a total of $5,800, and is still in progress at month end.

Jobs 101 and 102 are completed and delivered. Their combined cost of $32,250 moves from work in process to finished goods and then to cost of goods sold. Job 103's $5,800 remains in work-in-process inventory on the balance sheet. Each step is recorded by journal entry, with the job cost sheets serving as the subsidiary records that support the work-in-process account.

Because overhead is applied using estimates, the overhead charged to jobs during the year rarely equals actual overhead. If the printing company actually incurs $495,000 of overhead but applies $486,000 because it worked 16,200 hours, overhead is underapplied by $9,000. At year end this difference is usually closed to cost of goods sold or, if large, allocated among work in process, finished goods and cost of goods sold. Persistent large differences suggest that the budget or the allocation base needs revision.

Job order costing gives managers detailed information for pricing bids, comparing actual and estimated costs, identifying unprofitable jobs and billing customers on cost-plus contracts. Its main drawbacks are the clerical effort needed to track materials and time for every job and the risk that a single plant-wide overhead rate misstates the cost of jobs that use resources differently. Many firms address the second problem with departmental rates or activity-based costing. Service firms apply the same approach, treating each client engagement as a job and charging professional time and an overhead rate to it, and the same principles underpin project costing for construction contracts. Accurate job costing depends on a clear understanding of direct costs and conversion costs, both central topics in cost accounting.