What is Job Order Costing?

Job order costing is a costing method which is used to determine the cost of manufacturing each product. This costing method is usually adopted when the manufacturer produces a variety of products which are different from one another and needs to calculate the cost for doing an individual job. Job costing includes the direct labor, direct materials, and manufacturing overhead for that particular job.

Importance of job order costing

To determine the profitability of the job

Job order costing is useful for determining if a 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 to create quotes that are low enough to be competitive but still profitable for the company.

To make data-driven decisions

Over time, a job order costing system becomes a valuable database holding the details and costs of doing jobs. The information that is stored can be used as empirical data to help the company evaluate its own efficiency and reduce costs by changing its procedures, methods, or staffing.

To monitor 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 cost include all the different expenses which are incurred during the production of an item and should be included in its final price. These include:

1. Material cost

2. Direct labor cost

3. Direct expenses

4. 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 on their traceability to the product. They’re direct costs if 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, the oil and coolant used in the paper-making machinery to keep it running and cooled during the production process would be an indirect cost.

Direct labor

Direct labor is the cost of the employees who are directly involved in the product’s production process. It includes their wages and any other benefits they are offered while working on the product. For example, the person who collects wood pulp and 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 the COGS (Cost of Goods Sold) 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 expenses like the electricity bill, janitorial supplies, depreciation of the machines used, depreciation of the land where the manufacturing facility is located, and property 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 unique job which is being manufactured. Job order costing is calculated in six steps:

1. Identifying the job

2. Calculating the costs

3. Choosing the allocation base

4. Receiving the order

5. During manufacturing: Maintaining job cost sheets

6. 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 you decide on an estimate for the job that you will be undertaking. For example, when manufacturing paper, you need to know how many sheets of paper the customer needs, the number of trees that need to be cut down, the span of time required to produce this paper, the personnel who need to be assigned to this job, the capacity of your machines, and the electricity they consume.

Calculating the costs

The next step is to identify the costs associated with doing this job. This cost should be broken down into direct and indirect costs. For example, while manufacturing paper, your wood pulp, water, glue, bleaching agents, and directly involved factory personnel are direct material and labor costs. The security personnel deployed at the manufacturing unit, and the oil and coolants required to ensure the smooth functioning of the machines, are indirect material and labor costs. Adding all of these together will give you an idea of the total cost that 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 on previous examples. In other words, the cost for this job is assigned based on the costs incurred in the past while doing a similar job. They’re provided as an estimate, and should be adjusted in the final stages of production based on any additional indirect costs which add up during the production process. These costs include the cost of manufacturing equipment, the electricity used to run the equipment, utility bills, and depreciation of machines.

Receiving the order

Once the direct and indirect costs are calculated, they’re added together 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 job is assigned a unique production number and will be identified by this number until the job is completed.

Maintaining job cost sheets

While the job is being performed, you need to maintain a job cost sheet to track the actual 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 occurred so 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 them in 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.