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Job Order Costing

Definition of Job Order Costing

Job order costing links manufacturing costs to specific jobs, often using accumulated data from job cost sheets.

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.
Unit Cost=Total CostNumber of Products Produced for That Job{\text{Unit Cost}=\frac{\text{Total Cost}}{\text{Number of Products Produced for That Job}}}
Employees use a job cost sheet which is a document used to record the expenses of a product or service completed using job order costing. The accountant adds applied overhead to the job cost sheet. Job cost sheets can be either manual (paper) or part of a software program. This approach is known as normal costing, which is the calculation of the cost of a product by adding the actual direct materials cost, the actual direct labor, and overhead based on a predetermined overhead rate. Actual overhead is difficult to match directly with the production of a single unit. For this reason, accountants estimate overhead in order to determine total costs. A variety of software programs exist to support job order costing. Using a software program allows the company to collect and calculate information more quickly than is possible by hand. Many of these programs are integrated with payroll and other financial accounting areas and therefore help to reduce administrative costs. Whether the company collects data manually or uses a computer program, the basic data collected and information compiled to determine the cost of the product or job is the same.

Job Order Cost Sheet

In job order costing, the company uses a job order cost sheet to accumulate all costs for a specific job.