JOB ORDER COSTING

In any company, understanding the cost of the product being sold is critical to the company's continued success. If you do not undertand how much your product costs, you could potentially set a price that is too low which could result in you not making any profit or you could set a price that is too high, resulting in your company pricing its product out of the market. Either one of these scenarios would be devastating to the company. In a manufacturing environment the determination of cost is more challenging(see previous posting) than in a merchandising company, but it must still be done.

Job Order Costing is one of the two methods that are used to account for costs in a manufacturing environment (the other is Process costing which I will cover in another post).
In a job cost environment as costs are incurred for ongoing production, the costs are charged to Work-in-process (WIP) where they are accumulated and aggregated for each 'job' that is worked on. When that job is complete, then the total cost of the job is moved out of WIP and transferred to Finished Goods inventory. Then, when the job is sold (i.e. the customer comes to pick it up), the cost is moved from Finished Goods inventory to Cost of Goods Sold (COGS). [COGS is an expense, subtracted from Sales on the income statement to determine Gross Profit.]

The WIP account in the general ledger becomes a control account (similar to Accounts Receivable). There is a corresponding sub-ledger comprised of job accounts - one account for each job in process. As costs (Labor, Materials, Overhead) are incurred they need to be identified as to which job they belong, so that they can be posted to the appropriate job account in the sub-ledger, allowing the total cost of the job to be accumulated. It should go without saying that total of the balances in each job account in the sub-ledger MUST equal the balance in the WIP control account in the general ledger.

A job cost system is appropriate in the following circumstances;

• There is a definable start and stop to the production process for a unit of production ( i.e. a 'job')
• Each 'job' has identifiable charactersitics that distinguish it from other jobs

These characteristics make it possible to effectively identify the costs that belong specifically to each job - making it easier to accumulate those costs by job.

Reviewing costs after a job is completd can provide valuable insights into the company's production process. Once the job is complete and the accumulated cost of a job has been transferred to Finished Goods inventory, the data about the job's cost can be used in a variety of ways;

• Allow the company to set a price that covers the cost of the job and ensures a fair profit.
• Allow the company to review the costs charged to the job to see if they were correct and to see if there are ways to reduce costs in the future.
• If the price was 'fixed' prior to starting the job, then understanding the cost of the job will allow management to see if the price charged was adequate and to review their pricing for future jobs, if necessary.

A job cost system is not only able to be used in a manufacturing environment. In the motion picture industry each movie is different with a definite start and stop; the costs associated with a movie are easy to identify and accumulate. Similarly, technicians for a company like Geek Squad will maintain time and materials separately for each computer that they work on, so that customer can be billed appropriately. Each of these is an example where a job cost system is being used in a non-manufacturing situation.

Manufacturing Costs

Manufacturing Costs

Like any other kind of company, a manufacturing company is in business to make money. It wants to generate revenues and in order to do that it will incur costs. What makes a MANUFACTURING company different from a MERCHANDISING company is HOW it views and records the costs that it incurs.
A MERCHANDISING company buys inventory for the purpose of re-selling it at a profit - A MANUFACTURING company on the other hand, MAKES the product it intends to sell. This distinction is at the root of the challenge a manufacturing company has as it records the costs it incurs. Costs incurred to make the product are considered maufacturing costs.


So - what is important to take away from a discussion of manufacturing costs......

The SIMILARITIES to a MERCHANDISING company

• Costs incurred are for the most part very similar to the costs a merchandising company incurs - salaries, wages, utilities, rent, depreciation, insurance, etc.
• Costs are recorded in the journal and posted to the ledger.
• Costs are recorded with DEBITs and CREDITs.
• If payment is with cash - Credit is to CASH
• If purchase is on account - Credit is to Accounts Payable

The DIFFERENCES......

• Inventory for a manufacturing company is not purchased - it is MADE
• Costs incurred for wages, salaries, depreciation etc. which are incurred as part of the production process (i.e. manufacturing costs) are NOT recorded as EXPENSES
• So, before recording a cost, a determination has to be made regarding the REASON the cost was incurred. If the cost was incurred as part of the process to manufacture the product then the cost is not an expense - instead it is included in account treated as part of INVENTORY cost (an asset).
• This means that the Chart of Accounts for a Manufacturing company is quite a bit expanded when compared to a merchandising company- for example, there may be multiple accounts for 'depreciation' - one depreciation account in the Chart of Accounts may be classified as expense, another may be part of inventory. Either account is subject to be DEBIT-ed when a depreciation charge is incurred - which account gets Debit-ed depends on why the cost was incurred.
• If the depreciation is related to the Factory where the product is made - then the charge is related to the manufacturing process and is debit-ed to the depreciation account in Inventory.
• If, however, the charge is related to the headquarters office building then the charge is not part of the manufacturing process - it is therefore treated as an expense and is debit-ed to depreciation expense.

Manufacturing Cost Categories

Manufacturing Costs can be categorized as Labor, Materials or Overhead costs. All manufacturing costs incurred can be slotted into one of these three categories.

Direct Labor - Costs incurred for the employees directly involved with creating the product

Direct Materials - Costs of materials used directly in each unit created in the production process

Overhead - Costs incurred in the manufacturing process which cannot be directly assocuated with or attributed to specific units of production. Overhead costs include costs such as depreciation, insurance, utilities - as long as these costs were incurred for a production-related facility.

Also included in Overhead are Indirect Labor and Indirect Materials

• Indirect Labor - Costs incurred for the employees who are part of the manufacturing process but who are not directly making the product (e.g. Factory supervisor)
• Indirect Materials - Materials used out of inventory which were were used in the production process, but cannot be associated with a specific unit of production.