Chapter 12: Job order costing

A manufacturer must know what each product costs, to set prices, decide what to produce and value inventory and cost of goods sold. This chapter explains job order costing, the system for companies that make unique products or batches: how materials, labour and overhead are traced or allocated to jobs, how a predetermined overhead allocation rate works, how completed and sold jobs are recorded and how over- or underallocated overhead is corrected. It closes with job costing in a service firm.

Job order costing versus process costing

A cost accounting system measures, records and reports product costs. Knowing unit costs helps managers decide which products to make and how many, set profitable prices, and compute cost of goods sold and inventory.

	Job order costing	Process costing
Product type	Unique products or batches, specialised services	Similar or identical products through uniform steps
Production	Customised, low volume	Repetitive, high volume
Costs accumulated	By job	By process (department)
Work-in-process	One general ledger account, with a job cost record per job	A separate WIP account for each process
Record keeping	Job cost record	Production cost report
Cost transfers	When each job is completed	At the end of the period
Examples	Tax returns, custom homes, music recordings, hospital patient care, superyachts	Soft drinks, paint, cleaning chemicals, packaged food, steel

A job is the production of a unique product or service, one unit or a batch. Each job has a job cost record that collects its direct materials, direct labour and allocated overhead.

Materials and labour

Smart Touch Learning (now making tablets) illustrates the flow. Materials purchased are stored first: purchases of $367,000 on account: Dr Raw materials inventory 367,000, Cr Accounts payable 367,000. A materials requisition moves materials to the production floor. Direct materials are charged to the specific job; indirect materials go to the Manufacturing overhead account:

Account	Debit	Credit
Work-in-process inventory	355,000
Manufacturing overhead	17,000
Raw materials inventory		372,000

Labour is tracked with time records. Of total labour of $197,000, $169,000 is direct labour (charged to jobs) and $28,000 indirect (to overhead): Dr WIP 169,000, Dr Manufacturing overhead 28,000, Cr Wages payable 197,000.

Overhead: actual and allocated

Other actual overhead costs are also debited to Manufacturing overhead: plant depreciation $20,000, utilities $7,000, insurance $6,000 and property taxes $5,000. Actual overhead for the year: 17,000 + 28,000 + 20,000 + 7,000 + 6,000 + 5,000 = $83,000.

But actual overhead is only known at the end of the year, while managers need job costs during the year. So overhead is allocated with a predetermined overhead allocation rate, computed before the period from estimates:

Predetermined overhead allocation rate = \frac{Total estimated overhead costs}{Total estimated quantity of the allocation base}

Allocated overhead = Rate \times Actual quantity of the allocation base used

The allocation base links overhead to jobs; ideally it is the primary cost driver, the factor that causes overhead to rise or fall. Common bases are direct labour hours or direct labour cost (labour-intensive production) and machine hours (machine-intensive production).

Smart Touch Learning estimated overhead of $68,000 and direct labour cost of $170,000: rate = 68,000 / 170,000 = 40% of direct labour cost. Job 27 (15 tablets) has direct labour of $1,250, so it receives 1,250 × 40% = $500 of overhead. For the whole year actual direct labour was $169,000, so allocated overhead is 169,000 × 40% = $67,600: Dr WIP 67,600, Cr Manufacturing overhead 67,600.

Completing and selling jobs

When jobs are finished their cost moves to finished goods: the year's cost of goods manufactured is $644,600 (Dr Finished goods inventory, Cr WIP). Jobs sold for $1,200,000 with a cost of $584,600: Dr Accounts receivable 1,200,000, Cr Sales revenue 1,200,000, and Dr Cost of goods sold 584,600, Cr Finished goods inventory 584,600.

Over- and underallocated overhead

Manufacturing overhead is debited for actual costs and credited for allocated costs. At year end it rarely balances:

Underallocated overhead: actual > allocated (debit balance). Jobs were undercosted; cost of goods sold must be increased: Dr Cost of goods sold, Cr Manufacturing overhead.
Overallocated overhead: actual < allocated (credit balance). Jobs were overcosted; cost of goods sold is decreased: Dr Manufacturing overhead, Cr Cost of goods sold.

Smart Touch Learning: actual 83,000 − allocated 67,600 = $15,400 underallocated. The entry credits Manufacturing overhead for 15,400 (bringing it to zero) and debits cost of goods sold.

Worked exercises from the solutions

Omari Print: estimated overhead $115,000 and estimated direct labour cost $71,875: rate = 160%. Actual direct labour $73,000, so allocated = 73,000 × 1.6 = $116,800. Actual overhead $119,000: underallocated $2,200.
Mischa Company (base: machine hours): estimated overhead consists of maintenance labour 16,000, plant supervisor 46,000, screws and glue 23,000, plant utilities 42,000 and plant depreciation 83,000 = $210,000. Freight out and advertising are period costs and are left out. Rate = 210,000 / 28,000 = $7.50 per machine hour. Actual hours 32,400 give allocated overhead of $243,000; actual overhead is 26,500 + 47,000 + 46,000 + 93,850 + 82,000 = $295,350, so overhead is underallocated by $52,350 (Dr Cost of goods sold).
Ritik Chassis: WIP starts at 20,000; DM 31,000, DL 33,000 and overhead 13,000 are added; jobs of 38,000 and 36,000 are completed. Ending WIP = 20,000 + 77,000 − 74,000 = 23,000. Job 143 sold for 46,000 gives a gross profit of 46,000 − 36,000 = 10,000.
Exercise session: estimated overhead $100,000 and 20,000 direct labour hours give $5 per hour; a 50-hour job receives $250.

Why not simply use the actual rate? Because actual overhead is not known until the end of the period, and managers need cost information during the period for pricing and decisions.

Job costing in a service company

Service firms have no inventory, but they trace direct labour to clients (jobs) and allocate indirect costs in the same way, then use the result for pricing. A law firm pays an attorney $100,000 a year for 2,000 hours (40 hours × 50 weeks): direct labour costs $50 per hour. Indirect costs of $300,000 are allocated over 10,000 estimated direct labour hours: $30 per hour. A client job of 14 hours receives 14 × 30 = $420 of indirect costs. Total cost is $80 per hour; with a desired markup of 75% of cost, the price is 80 + 0.75 × 80 = $140 per hour.

For the exam

Rate = estimated overhead / estimated base; allocated = rate × actual base.
Only manufacturing costs are overhead: leave out selling costs such as freight out and advertising.
Underallocated (actual > allocated): increase cost of goods sold. Overallocated: decrease it.
Indirect materials and indirect labour go to Manufacturing overhead, not directly to WIP.

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