Job Order Costing and Process Costing

A job order costing system is used when a job or batch is significantly different from other jobs or batches. Cost accounting is usually fairly simple in these systems. Labor and materials are entered on a job ticket. Overhead is usually added to the amount the customer will be charged for labor and materials.

If you go to an auto repair shop, they will start a job ticket just for the work to be done on your car. Your job ticket will show charges for labor and materials, just for your job. Let’s say they charge you $35 per hour for labor. That charge includes the mechanic’s payroll cost. But it also includes an overhead charge – which is generally not stated separately. The overhead charge covers the costs of operating the garage – tools and equipment, rent, insurance, maintenance, utilities, etc. It is a way to allocate overhead (discussed below), and build it in to the amount charged to customers.

The garage will also make a gross profit on the parts they use to repair your car. This gross profit covers the cost of buying and maintaining a parts inventory, including department employee wages, insurance and warehousing costs.

Job Costing involves the calculation of costs involved in a construction “job” or the manufacturing of goods done in discrete batches. These costs are recorded in ledger accounts throughout the life of the job or batch and are then summarized in the final trial balance before the preparing of the job cost or batch manufacturing statement. Job costing (known by some as job order costing) is fundamental to managerial accounting. It differs from Process costing in that the flow of costs is tracked by job or batch instead of by process.

The distinction between job costing and process costing hinges on the nature of the product and, therefore, on the type of production process:

  •     Process costing is used when the products are more homogeneous in nature. Conversely, job costing systems assign costs to distinct production jobs that are significantly different. An average cost per unit of product is then calculated for each job.
  •     Process costing systems assign costs to one or more production processes. Because all units are identical or very similar, average costs for each unit of product are calculated by dividing the process costs by the number of units produced.
  •     Many businesses produce products with some unique features and some common processes. These businesses use costing systems that have both job and process costing features. job order costing system is used in situations where many different products are produced each period. For example clothing factory would typically made many different types of jeans for both men and women during a month. In a  job order costing system, costs are traced to the jobs and then the costs of the job are divided by the number of units in the job to arrive at an average cost per unit.

The details here deal with a manufacturing firm, the same concept and procedures are used by many service organizations.

The record keeping and cost assignment problems are more complex in a job order costing system when a company sells many different products and services than when it has only a single product or service. Since the products are different, the costs are typically different. Consequently, cost records must be maintained for each distinct product or job. For example an attorney in a large criminal law practice would ordinarily keep separate records of the costs of advising and defending each of her clients. And a clothing factory would keep separate track of the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing system requires more effort than a process costing system. Companies classify manufacturing costs into three broad categories:(1) direct materials, (2) direct labor, (3) manufacturing overhead. (See manufacturing and non-manufacturing costs page) As we study the operation of a job costing system, we will see how each of these three types of costs is recorded and accumulated.

1:Measuring Direct Materials Cost in Job Order Costing System:

At the beginning of production process  a document known as bill of materials is used for standard products. “A bill of materials is a document that lists the type and quantity of each item of materials needed to complete a unit of standard product”.

2: Measuring Direct Labor Cost in Job Order Costing System:

Direct labor cost is handled in much the same way as direct materials cost. Direct labor consists of labor charges that are easily traced to a particular job. Labor charges that cannot be easily traced directly to any job are treated as part of manufacturing overhead.

3: Application of Manufacturing Overhead:

Manufacturing overhead must be included with direct labor on the job cost sheet since manufacturing overhead is also a product cost. However, assigning manufacturing overhead to units of product can be a difficult task.

4: Job Order Costing in Services Companies:

Job order costing is also used in service organizations such as law firms, movie studios, hospitals, and repair shops, as well as manufacturing companies.

5: Use of Information Technology in Job Order Costing:

Bar code technology can be used to record labor time–reducing the drudgery in that task and increasing accuracy. Bar codes also have many other uses. In a company with a well-developed bar code system, the manufacturing cycle begins with the receipt of a customer’s order in electronic form.

6: Advantages and Disadvantages of Job Order Costing System:

One of the primary advantages of job order costing system is that the management team has ready access to all the costs incurred for each job being completed. This allows the team to examine each cost incurred, finding out why it happened, and determine how it can be controlled better in the future, thereby contributing to better ongoing levels of profitability

Shows the use of several major types of cost accounting systems. All companies have to accumulate and allocate costs. Each company has to decide how it is going to do that. Companies pick a method that works well for them, and is cost effective.

Accounting isn’t hard; students just like to make it seem that way. Accounting is simply a way to organize information, and make it useful for the people who have to manage a business, and make decisions. Managerial accounting reports don’t have to follow GAAP because they are prepared for managers, not outside investors or creditors.

A well designed accounting system should generate reports for a large variety of uses. Of course, it must provide the necessary information for annual financial statements; and it should also help in the preparation of special reports, like sales tax and  payroll reports. It should help managers track and manage inventories, open orders, accounts receivable and accounts payable.

Managers must make decisions on a daily basis. Annual financial statements are prepared well after the end of the year, and are useless for managing a businesses daily affairs. Managers must look forward to the near future, usually the coming week, month and year. Annual financials look backwards in time.

The basic concepts and terms you learned in Chapter 16 will carry over through this chapter and the remainder of the course. Businesses use these concepts to prepare managerial reports, and analyze their business activities.

There are two main types of cost accounting systems. Companies select a method that best matches the flow of work in their business. These methods are used to allocate all production costs: labor, materials and overhead.

Job order costing – work is broken into jobs; each job is tracked separately auto mechanics, carpenters, painters, print shops, computer repair

Process costing – a large quantity of identical or similar products are mass produced           auto assembly plants, hot dog manufacturing, any large mechanized production facility

Allocating Overhead

Overhead is a large mixed group of costs that can’t be directly traced to products. There are several methods of allocating overhead costs in a cost accounting system. ABC costing is one method. We will learn other, simpler methods as well.

Activity-based costing (ABC) – overhead costs are tracked activities that consume resources         used primarily for allocating overhead that is hard to track to specific products or departments

Cost flow in an accounting system

We say that costs flow through an accounting system. That is because they accumulate as the product progresses through the various stages of production. Let’s look at a typical product.

Before a product is started, no costs have been incurred. Workers stand ready to make the product, inventory waits patiently in the warehouse, and the manufacturing plant contains all the resources necessary to perform the manufacturing operation.

We first add materials into production, from the inventory. At the same time the accounting department transfers the cost of inventory items to the Work in Process account, and the product or job now has a value.

Next the workers start to convert the raw inventory into a product. As labor is added, the accounting department transfers payroll costs to the Work in Process account, increasing the value of the product or job.

Overhead costs are allocated to the product or job, based on the costing method used. As work progresses on the product or job, it accumulates labor, materials and overhead costs. Finally, the total finished product or job cost is transferred to Finished Goods, and when it is sold the cost is transferred to Cost of Goods Sold.

Accounting Overhead Costs

Overhead is allocated to products or jobs using a reasonable allocation method. We try to find some part of the manufacturing process that is regular and predictable. We call this a cost driver.

Labor hours used is the most popular allocation method. The number of labor hours in a year are fairly predictable. Differences in employees pay rates are not relevant when using hours. The information is readily available from existing payroll records. There is usually a direct correlation between labor and the production process.

Labor dollars is the second most popular allocation method. It is used by very large companies, with large work forces operating under labor contracts. The labor costs are fairly predictable, and are closely linked to production. Because of the large number of employees, labor dollars tends to be a very stable and predictable measure of the progress of production.

Other overhead methods include:

number of units produced,

machine hours use (jet engines, diesel locomotives),

square footage of floor space (heating, cooling & janitorial costs),

miles (taxis, trucking)

Some companies use a sophisticated method involving service departments such as maintenance and computer processing. These departments provide services to other departments. Service departments are widely used in hospital accounting.

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