Reading Time: 5 minutes
Job order costing is a costing method which isused todetermine the cost of manufacturingeach product. This costing method is usually adopted when the manufacturer produces avariety of products which are different from one another andneeds to calculatethe cost for doingan individual job. Job costing includes the direct labor, direct materials, and manufacturing overhead for thatparticularjob.
Importance of job order costing
To determine the profitability of the job
Job order costing is usefulfor determining ifa job is profitable. It helps the company make estimates about the value of materials, labor, and overhead that will be spent while doing that particular job. Efficient job order costing helps companies tocreate quotes that are low enough to be competitivebut still profitable for the company.
Tomake data-driven decisions
Overtime, a job order costing system becomes a valuable databaseholding the details and costs of doing jobs. The information that is stored can be used as empirical datatohelp the companyevaluateits own efficiency and reduce costs bychanging its procedures,methods, or staffing.
Tomonitor machine usage
Job order costing helps companies see how much they’re using their fixed assets, such as manufacturing equipment. Since machine costs are distributed amongst different jobs, the identification of this cost is important to know the cost of the job. This helps determine the amount of overhead allocated to each asset and distribute it fairly between the company’s jobs.
What are the elements of cost?
The elements of costinclude all the differentexpenses which are incurred during the production ofanitem and should be included inits final price. These include:
Material cost
Direct labor cost
Direct expenses
Factory overhead
Material cost
The material cost is the cost incurred for purchasing materials that are essential for the manufacturing process. These costs are classified as direct or indirect costs based ontheir traceability to the product.They’re directcostsif the raw material used to manufacture the product is one of the essentials and is directly used in the product.For example, wood pulp is a direct cost for paper manufacturing, because it is the primary raw material used in the process. Indirect costs are any materials that are needed to supplement the production process. For example, theoiland coolantused inthepaper-makingmachinery to keep it runningand cooledduring the production processwould be an indirect cost.
Direct labor
Direct labor is the cost of the employees who are directly involved in theproduct’sproduction process. It includes their wages andanyother benefits they are offered while working on the product. For example, the person who collectswoodpulpand sends it for processing into paper, and the person who monitors the whole production process from start to finish are both considered direct labor.Whereas the guards or the janitors who are employed to supervise and assist during the production process are indirect laborers and are not included as a part of direct labor.
Direct expenses
Direct expenses are the costs that can be traced back to the spending of a specific department. These include expenses like design costs, tool maintenance and purchasing equipment that is directly used to manufacture the product.They’re listed under theCOGS (CostofGoodsSold) section in the income statement.
Factory overhead
Factory overhead is any other manufacturing cost, besides direct labor and materials, incurred during the manufacture of the product.It includes expenseslike the electricity bill, janitorial supplies, depreciation of the machines used, depreciation oftheland where the manufacturing facility islocated,andproperty taxes.Factory overheads are all added together is included in the cost sheet at the end and is charged to the finished items.
How to calculate job order costs
Job order costing is used to measure the revenue gained against the expenses incurred during the production process so that we can determine the profit for every uniquejobwhich is being manufactured.Job order costing is calculated insix steps:
Identifying the job
Calculating the costs
Choosing the allocation base
Receiving the order
During manufacturing: Maintaining job cost sheets
After manufacturing: Revising the cost sheets
Identifying the job
The first step is to identify the job and its requirements.This is done by analyzing the factors and outcomes which will be affected by taking up this job. This is a very essential step because it helps youdecide on anestimate for the jobthat you will be undertaking. For example, when manufacturing paper, you need to know how many sheets of paper the customer needs, the number of treesthat need to be cut down, the span of time required to produce this paper, the personnel who need to be assigned to this job, thecapacity of your machines, and theelectricitytheyconsume.
Calculating the costs
The next step is to identify the costs associated with doing this job. This cost should bebroken down into direct and indirect costs. For example, while manufacturing paper, your wood pulp, water, glue, bleaching agents, anddirectly involvedfactory personnelaredirect material and labor costs.The security personnel deployed at the manufacturing unit, and the oil and coolants required toensure the smooth functioning of the machines, areindirect material and laborcosts.Adding all of these together will give you anidea of the total costthat will you incur while performing this activity for your client.
Choosing the allocation base
The incurred indirect costs should be allocated to the job based onprevious examples. In other words, the costfor this jobis assigned based on thecosts incurredin the pastwhile doing a similar job. They’reprovided as an estimate, and should be adjusted in the final stagesof productionbased onany additional indirect costs which add up during the production process. These costs include the cost ofmanufacturing equipment,theelectricity used to run the equipment,utility bills,anddepreciation of machines.
Receiving the order
Once the direct and indirect costs are calculated, they’re addedtogether and submitted to the client to give a quote for the job.If the customer is satisfied with the quote they can place the order and the production can begin. During the manufacturing process, each jobis assigned a unique production number and will beidentified by this numberuntil the job is completed.
Maintaining job cost sheets
While the job is being performed, you need to maintain ajob cost sheet to tracktheactual material and labor being used. This sheet will help you evaluate if the actual cost of doing the job differs from your estimate. If they differ a lot,it means that either your estimation process or your manufacturing process can be improved. This can be due to incorrect estimation or inefficient implementation of the job. Since every cost incurred in this job can be tracked, it is easy to find out where the mistake or excessive consumption has occurredso that it can be rectified.
Revising the costs
Once the job is completed, you need to revise the actual cost by adding the additional costs which might be incurred while doing the job with respect to the estimate given to the customer. This helps to remove over or under applied costs and revise themin accordance with the completed job. This step will help identify the true cost of completing the job and arriving at its final cost.
Job order costing helps you calculate the entire cost of the job in a step by step. This method enables you to find out errors, decide if the job is profitable, finding areas for process improvement, monitoring fixed asset usage and creating more accurate quotes for future jobs. It is a highly efficient costing method for a manufacturer who produces a multitude of products different from one another.
