Job order costing is a costing method that is used for determining the production cost of each product. If a business or company produces different and unique products for customers then the business might need a job order costing system to properly manage each product and order.
A job order costing system helps to ensure the time and resources used in manufacturing products or services that will be profitable for the business.
Creating an effective job order system requires multiple components to make sure all the calculations are up to the point. Job costing order is all about the direct labor, direct materials, and manufacturing overhead for that particular job.
In this article, we will discuss the Job Order Costing System and explain how it actually works. We are also going to check out some of its different aspects including its objective, importance, examples, etc.
Definition of Job Order Costing:
In simple words, job order costing is a costing system that helps in determining the cost of each individual product and also makes sure that the cost of each product is reasonable for the customers to buy them but it also allows the company to make profits out of it.
Job order costing becomes crucial when customers place orders for different products or services from a particular company or business.
Since there is a significant difference between produced goods and services, the job order costing system needs a different job cost record for each item. Those records will report each product’s direct material cost and labor cost that was used in manufacturing the products.
A job order costing system can help you gain control over your financial assets such as invoices, material costs, payroll, etc. It helps your accountant to calculate the data or track any important information using those assets.
They usually use the database to help you track the production cost of each item or service. Later you can use that information to make changes to the production cost that eventually leads to profit.
Importance of Job Order Costing:
A job order costing system is the best method for businesses or companies to calculate the required cost for labor, overhead, and materials before producing any items or services.
Getting accurate information about the manufacturing costs will allow you to understand the potential profits and help you decide how much you have increased or decreased the production cost to meet your goals.
Besides this advantage, job order costing comes with many other benefits. Here are some of the benefits of job order costing apart from the production costing:
1. Helps You Determine the Profitability:
Job order costing is a very efficient method of determining profitability. It helps businesses and companies to estimate the material, labor, and overhead costs that will be spent on the particular manufacturing process.
An efficient job order costing system helps businesses to create rates that are competitive and also offer profits after being sold.
2. Offers Accessibility:
Job order costing provides access to the cost of each job even during the manufacturing process. It offers businesses the opportunity to verify the costs one by one and identify the included products.
Most importantly, it helps you find the gaps and opportunities to determine whether you need to reduce or increase the production cost. Depending on your understanding of the situation you can develop strategies that allow you to control the costs.
3. Helps You Make Decisions Depending on the Database:
Eventually, you are going to notice that the job order costing system has become an important database that contains details and costs for each job.
You will be able to use the stored information to help your business in estimating its own effectiveness and decreasing the costs by making changes in the production system, methods, labor, and materials.
4. Helps to Improve the Performance of Your Employees:
A job order costing system also helps you to evaluate the performance of your employees. It not only helps you determine the production cost but also helps in determining the productivity and performance level of an individual employee.
With the help of job order costing, you will be able to identify employees who fail to meet the required performance and productivity. Now you can develop a training course to make them perform better and it will eventually increase the performance of your business.
5. Helps You Monitor the Fixed Assets:
The job order costing system also helps businesses to gain control over their machineries such as manufacturing equipment and other electronic tools.
Since machines play a major role in the manufacturing process, they can not be taken for granted. Keeping an eye on the machinery will help businesses to increase their productions. Replacing the old ones and repairing them can not be ignored as well.
How does Job Order Costing Work?
The job order costing is the process that measures the cost of materials, labor, and overhead on a specific job:
1) Calculate the Material Costs:
First of all, start calculating the cost of all materials used on a particular job. For example, if you own a construction company, this will include materials such as bricks, woods, cement, wiring, etc. You can also choose margins for these materials to cover other costs including delivery or clearing costs.
2) Calculate the Labor Cost:
Calculate how much your business has to spend on staff members who are going to work on your project each day. Now multiply the payroll day rate with the amount of time you need to complete the project plus the number of staff.
3) Calculate the Overheads:
Calculating the overhead cost is the most difficult part because you will have to rely on an estimation instead of an exact figure.
You have to estimate the total overhead costs that consist of your office rent, equipment costs, and administrative costs.
Documents that you need for Job Order Costing:
The job order costing system allocates costs to each job. In order to calculate accurately, we will need materials, direct labor, and factory overhead costs.
Direct Materials: This document allows businesses for producing a specific amount of products that constitute the job.
Direct Labor Cost: This document helps businesses to determine how much time the employees have spent on each job. And also what will be the payroll day rate.
Factory Overhead: Factory overhead costs are not allocated based on the actual cost of each job. They are allocated based on estimation. This document helps businesses with the estimation and cost allocation.
Job Order Costing Objectives:
Here are the main objectives of job order costing:
- It helps to find the manufacturing cost of each project to determine whether it is making profits or going into loss. This basically works in favor of the business to decide whether they have to make changes or not.
- It helps the business or company to execute more accurate estimations for similar projects in the future based on their past reports.
- It helps businesses to provide a valuation of the work-in-progress.
Example of Job Order Costing:
- Calculating the Material Costs: If you had an order of making 1,000 custom t-shirts, you had to start by adding the cost of blank t-shirts, colors, printing machine maintenance costs, etc. Let’s assume all those things add up to $75
- Add up the other direct expenses: Other direct expenses include the delivery costs, website or application costs, etc. Let’s assume that the shipping cost would be around $40 and the website or application costs would be $2,000 a year. So if you have a customer base of 1,500, you have to add $1.30 to each customer.
- Calculate the labor cost: Your buyers can design their t-shirts on the website or app but you still have to physically design those t-shirts. So you hired a team of designers. Now each designer charges $30 per hour and creates a t-shirt in an hour. You also have a floor manager and technicians who handle the printing of the shirts. You pay them $20 an hour including a percentage of the profit. So, let’s assume your grand total is $56 including the profit.
- Overhead Costs: Here comes the hard part. Now you have to start by finding your total overhead for the year by adding together your utility bills, rents, machinery, etc. Adding those all together you found out the cost is around $100,000 a year. Now you have to divide the $100,000 by the labor hours. So let’s imagine, you have an average of 14 designers working on 4 machines and they work 40 hours a week. We have 52 weeks in a year so you will have a total of 29,120 working hours and get an average hourly overhead rate of $6.50.
- Add those all up: $150 in materials, $40 in delivery, $56 in labor, $1.30 on the website, and $6.50 in overhead, the total cost will be $252.50. Now you know how much you should charge to complete this project and still make a profit.
Job order costing allows you to calculate the whole cost of a particular project in an extremely efficient manner. It helps you find mistakes, gaps for improvement, determine profitability, etc.
It helps you create more accurate rates for future projects by monitoring your assets and past decisions. This is a very efficient method for businesses and companies that produce different and unique products.