Most companies create a variety of goods or services that cost varying amounts to produce. Job order costing, sometimes shortened to job costing, is a system companies use when they can trace costs to a specific product or service. Often this type of costing is related to operations that produce custom products in which the customer designs the specifications.
An accountant uses job order costing to pinpoint and keep track of the following costs:
- direct materials used in the production process that can easily be traced to a product, such as the fabric and thread needed to make clothes
- direct labor, which means the hours spent producing a product or providing a service that can easily be traced to the product or service, such as the hourly wages of the people who use the sewing machines
- manufacturing overhead, which means indirect, factory-related production costs that come from making an item; for example, the salaries of production supervisors and the rent and utility bills for the factory
Because the products produced or services provided are unique to that customer, the manufacturer will need to calculate the total cost based on the direct material, direct labor, and manufacturing overhead it uses in each product.
The process of accumulating costs for job order costing is similar to process costing, which is a method managers use when large quantities of similar products are manufactured and expenses are applied to a series of actions instead of an individual product. A company uses process costing if it is manufacturing large amounts of similar products. In this case, the accountant keeps track of direct material, direct labor, and overhead to determine what creating the product or service cost the company. In some cases, such as creating a custom car based on customer requirements, the costs are applied to a single item.
When a customer orders a custom car, the company gives the car a unique job number. The accountant gathers all costs to produce that car under the assigned job number. For example, a car manufacturer's "Build Your Own" site shows the different costs associated with the various available options. The site shows the visitor the difference in price to the customer for each change to the car.
Significant differences in price can occur based on custom requirements. The price that the car maker's site provides for each option includes direct material, direct labor, and manufacturing overhead. The amount shown also includes selling and administrative costs and desired profit to arrive at a final selling price.
In other cases—such as when a customer orders 1,000 marketing pamphlets for a trade show—the costs for a batch of items are accumulated under a single unique job. While all 1,000 pamphlets are identical, the batch is different from other jobs that the company manufacturers. The 1,000 brochures become one job, and the accountant applies costs using job order costing.When a company creates a unique job for a group of like products, it determines the unit cost—in other words, the amount the company must spend to create one pamphlet (or one T-shirt or one tire) in a batch. The accountant calculates the unit cost of each product by dividing the total cost by the number of products produced for that unique job.