Job order costing

Job order costing is the method that allows the company to allocate manufacturing expenses to the specific job under consideration.

It’s best to be used when a business does not produce standard units. It’s mostly used in service-based/professional organizations where the scope of services performed for each client is different.

As the mechanism of job order costing is based on the fact that each job is different and resources consumed in each of the jobs are different. So, the record for each job needs to be maintained separately.

However, the basic format of reporting for the cost sheet remains the same which is to report direct material, direct labor, and manufacturing overheads.

Cost order sheet

The cost order sheet is the main document that is used to extract the data for work in process account, finished goods account, and then cost of sales account. Hence, the accuracy of inputs in the job order costing directly impacts the financial statements.

If there are errors in the process to record to cost incurred in the job, it will not only impact the profitability of the job but the entire business. Depending on the materiality of error, it could even distort the decision of the financial statement users.

Examples

Businesses providing professional services

Professional service providers like chartered accountants, lawyers, private investment companies, and advisors can use job-order costing to keep a record of the work done/time spent on the job.

This helps to invoice the client based on the hours spent on the job and the extent of the resource usage.

These professional firms get details of the hours worked on specific jobs from employees by timesheets. This helps the firm to understand how many hours were consumed on the job and the firms already keep data about the cost of the resource.

Hence, they reach the actual cost consumed in the performance of the job for a specific client in the specific job.

For instance, the firm of chartered accountants audits different clients from small and medium companies to giant listed companies with operations in different jurisdictions. Hence, they charge differently based on the extent of work performed and the risk of engagement.

Businesses in manufacturing industries

The job order costing is only suitable for the companies that produce customized products for their customers. The job order costing helps the business to track usage of the direct material, direct labor, and overheads.

If there any variance in the job, the business can immediately identify as the span of the job is small compared to production for the whole business.

If the variance identified is un-controllable or due to macroeconomic factors, the business can negotiate the price with the customers based on inflation/changes in the variables.

Although, variance can be identified with process costing. However, it’s easy to allocate the variance for the specific job rather than allocating the variances to several processes/whole business.

Businesses performing medical services

Job order costing can be the best methodology of cost measurement for the medical services business. As the nature of the diseases is different for each patient and hospitals maintain a separate file for each patient admitted.

The patient file contains all the services performed for him/her including physician check-ups, diagnosis tests, medicines consumed and, all other aspects of the services consumed.

This patient file is a cost order sheet in the eyes of the accounting department of the hospital. They invoice patients based on the patient file which is different for each patient.

Hence, job order costing works best in the case of hospitals/medical services providers.

Objective of job order costing

  1. The main objective of the job order costing system is to ensure completeness and accuracy of the cost incurred performance of some specific job.
  2. This helps to quote price for a similar project, the becomes more informed in proposing terms of the job.
  3. Helps to identify variances for the specific job and a control mechanism can be activated if needed.
  4. Job order costing enables the business to easily identify gaps in profitability.

Steps to record job order cost

  1. Tracing and entering all the direct costs related to the job.
  2. Identification of the overheads and the basis of allocation.
  3. Absorbing overheads based on the expected use of activity.
  4. Finding the total cost for the job.
  5. Closing the job account and fluctuation of overheads in the cost of goods sold.
  6. Find the profitability of the job by comparing cost with the revenue.

Advantages of job order costing

There are several advantages of the job order costing that include but not limited to the following.

  1. It’s easy for a business to monitor the cost throughout the process of service performance/manufacturing.
  2. It’s an excellent tool to set the measure the performance of the employees working on the job. In other words, job order costing helps to set the benchmark to assess employee performance. For instance, an audit should be completed in 40 hours. Hence, the productivity of the employees can be measured. (to be used in the performance appraisals)
  3. The job order costing enables the business to accurately report profits for the individual operations.
  4. This method of costing is thoroughly effective irrespective of the scale of the business. In other words, the job order costing is equally effective irrespective of the size of the job.

Disadvantages of job order costing

The following disadvantage may be associated with the job order costing system.

  1. Fulfillment of the job order sheets can be time consuming and difficult task. There may be several items to be added to the cost order sheet and it can be difficult for the managers to track if they have accurately recorded the cost.
  2. If different activities are performed for the specific job at different places simultaneously, it may be difficult for the company to collaborate between different departments and it can actually be not feasible for the business to track all the expenses.
  3. The job order costing does not provide a mechanism to control the overhead cost. As the cost of overheads is estimated and costing does not help to control.