1 Compiled by: Chhaya Sehgal

The Winning Edge

JOB ORDER COSTING

INTRODUCTION

1. In order to be successful and survive, businesses need to track the cost of making a product or
furnishing a service. They therefore employ some type of product costing system. Costing literally
means a process of ascertaining of costs. In accounting however, costing is a formal mechanism by
which costs are ascertained and analysed. It includes the whole set up for collecting and analyzing
expenditure according to the elements of cost and to determine the cost for each for each for each
cost centre or cost unit.
Management needs to cost products for a number of reasons including the following:

a. To prepare the financial statements management needs a Cost of Goods Sold figure on the
Income Statement and an Inventory figure on the Balance Sheet.

b. For internal needs management needs product cost information to establish prices, to
compare actual with budgeted figures, to properly decide to ―make or buy‖, etc.

c. Often outsiders such as insurance companies or government agencies have a need for product
cost information.

2. Every enterprise is in some way different from the other. As such, there are numerous
methods devised in terms of production activity and cost collection. There are two broad systems of
assigning cost to products. These are: Process Costing and Job Order Costing.
3. Process costing treats all units of output produced in a period alike by accumulating and
averaging costs over the units produced. It is used in industries where there is mass production of
similar or identical products—food products, chemicals, cement, etc. Since each product is
identical, product cost can be determined by dividing total manufacturing costs by total units
produced. This average cost applies equally to all units produced.
4. Job Order Costing is used by companies where products are identifiable by individual units or
batches—auto repair, case in an attorney’s office, ship construction, etc. The costs attributable to a
particular job are assigned directly to it. For the purpose of this paper however, only Job-order
costing would be discussed.

JOB-ORDER COSTING

5. Job Order Costing is one method of allocating the costs of manufacturing to the product.
Treats individual jobs as units of output and traces or allocates costs of resources used to each job. In
Job order costing, the manufacturing costs are allocated to the product by batch.
6. Job order costing is appropriate when the firm makes products in small batches, and each
batch consumes different amounts of direct labor, direct materials, and processing time/energy.
7. A survey in ―Cost and Management Accounting Practices..‖ in the Management
Accounting Research Centre indicates that job order costing is the primary method of costing in
the following industries:
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-Electronics
-Machinery
-Computers
-Furniture and fixtures

JOB ORDER COSTING IN COMMERCIAL FIRMS

7. When a service is rendered the customer is given an invoice detailing the material and labour
costs. In a manufacturing environment, costs are accumulated on a Job Cost Sheet.

8. The direct material cost comes from material requisition forms and the direct labour costs
from employee time tickets.

APPLICATION OF MANUFACTURING OVERHEADS

9. Since manufacturing overhead consists of numerous costs some of which are not immediately
available, Manufacturing Overhead is charged on an applied basis.

10. At the beginning of the year the company calculates a predetermined overhead rate by
dividing estimated total manufacturing overhead cost by estimated total units of allocation base.
Overhead is charged to an individual job by multiplying the predetermined overhead rate by the
number of units of allocation base charged to the particular job as shown in the formula below:

Applied Overhead = POHR × Actual Direct Labour Hours

Estimated total manufacturing

overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

EXAMPLE OF JOB –ORDER COSTING

Direct materials – Rs 200

Direct labor hours 10 at Rs 15 per hour.
Estimated total overhead for the year was Rs 760,000 and estimated direct labor hours were
20,000.
What would be recorded as the cost of job?

Direct Material $200

Direct Labour 15 x 10 $150
Mfg O/H 38 x 10 $380
Total Cost $730

11. Since a company uses estimates to calculate the predetermined overhead rate there will
typically be a balance remaining in Manufacturing Overhead at the end of the period. It must be
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noted that Manufacturing Overhead is a temporary account and must be closed out at end of the year.
The difference between the overhead cost applied to Work in Process and the actual overhead costs
of the period is called either under-applied or over-applied overhead.

TREATMENT OF OVERPAID/UNDERPAID OH

12. When overhead is under-applied, manufacturing costs have been understated and when
overhead is over-applied, overhead costs have been overstated. In the Manufacturing Overhead
Account actual costs are recorded on the debit side and applied costs are recorded on the credit side.
The remaining balance in the Manufacturing Overhead Account can be closed out to Cost of Goods
Sold or proportionately to Work in Progress, Cost of Goods Sold and Finished Goods below.

Overapplied and Underapplied

Manufacturing Overhead

may be allocated closed directly to

to these accounts. cost of goods sold.
OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold

13. Job order costing for a service organization such as a law or accounting firm is somewhat
simpler in that materials and supplies may not an important cost element and these costs will be
included in Overhead. Thus computation of the job cost in a service organization may take this form:

Labor Costs + Overhead Costs = Total Job Cost

EFFECT OF UNDER AND OVERAPPLIED OVERHEAD ON NET OPERATING INCOME

14. If overhead is under-applied, less overhead has been applied to inventory than has actually
been incurred. Enough overhead must be added to Cost of Goods Sold (and perhaps ending
inventories) to eliminate this discrepancy. Since Cost of Goods Sold is increased, under-applied
overhead reduces net income.
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15. If overhead is over-applied, more overhead has been applied to inventory than has actually
been incurred. Enough overhead must be removed from Cost of Goods Sold (and perhaps ending
inventories) to eliminate this discrepancy. Since Cost of Goods Sold is decreased, over-applied
overhead increases net operating income.

IMPORTANCE OF JOB-ORDER COSTING

16. The importance of Job-Order Costing can be summarized as follows:

a. Cost control.
b. Re-negotiation incase of change
c. Made by customer
d. Price determination
e, Decision making
f. Bidding
g. Using a predetermined rate makes it possible to estimate total job costs sooner.
h. Actual overhead for the period is not known until the end of the period.

ADVANTAGES OF JOB ORDER COSTING

17. Following are the advantages of job order cost accounting:

a. It provides a detailed analysis of cost of materials, wages, and overheads classified by

functions, departments and nature of expenses which enable manage determine the operating
efficiency of the different factors of production, production and the functional units.
b. It records costs more accurately and facilitates cost control by comparing with estimates.
c. It enables the management to ascertain which of the jobs are more profitable than the others,
which are less profitable and which are incurring losses.
d. It provides a basis for estimating the cost of similar jobs taken up in future and thus helps in
future production planning.
e. Determination of predetermined overhead rates in job costing necessitates application of a
system of budgetary control of overheads with all its advantages.
f. Identification of spoilage and defectives with the respective production company and
departments may enable’ the management to take effective steps in reducing these to the
minimum.

CONCLUSION

18. The job order costing definitely carries a lot of importance due to the very advantages that it
provides. This concept will go a long way in providing the perfect solutions to dilemma such as
Make or Buy.
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Solved problem

The information given below has been taken from the costing records of an Engineering Works in
respect of Job no 303
Materials – Rs 4010
Wages: Dept. A 60 hours @ Rs 3 p.h.
B 40 hours @ Rs 2 p.h.
C 20 hours @ Rs 5 p.h.
Overhead expenses for these departments were estimated as follows:
Variable overheads: Dept. A Rs 5000 for 5,000 labour hours
B Rs 3000 for 1,500 labour hours
C Rs 2,000 for 500 labour hours
Fixed overheads: Estimated at Rs 20,000 for 10,000 normal working hours.
You are required to calculate the cost of Job 303 and calculate the price to give profit of 25% on
selling price.

Solution
Working notes
1) Calculation of variable Overhead Rate Per Labour Hour
Department A = Rs 5,000/5000 labour hours = Re 1
B = Rs 3,000/1,500 labour hours = Rs 2
C = Rs 2,000/500 labour hours = Rs 4
2) Calculation of Fixed Overhead rate per hour = Rs 20,000/10,000 = Rs 2

Cost Sheet of Job No.303

Materials 4010
Wages
Dept. A (60hrs * Rs 3) 180
Dept. B (40 hrs * Rs 2) 80
Dept. C (20 hrs * Rs 5) 100 360
Overheads:
Variable Overheads
Dept. A (60 hrs * Re 1) 60
Dept. B (40 hrs * Rs 2) 80
Dept. C (20 hrs * Rs 4) 80 220
Fixed overheads (120 hrs * Rs 2) 240
Total cost 4830
Profit (25% on selling price or 331/3 % on cost) 1610
Sales 6440