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What Is Job Order Costing In Managerial Accounting? Explanation of the Management of a Cost Based Accounting System

Updated on September 18, 2012

Cost Accounting Systems: The Difference Between Job Order Cost Systems and Process Costing

Cost accounting systems are an important managerial accounting tool for measuring and reporting accurate product costs. Explaining these costs is critical because managers utilize them in contexts such as price setting, financial reporting, and operations control.

A job order cost system differs significantly from a process cost system. What is a job order cost system, and what is a process cost system?

The definition of a job order cost system is an accounting system that counts costs for units of product manufactured – batches or quantities of units sent through manufacturing are called “jobs.” A specific job might involve manufacturing twelve guitar fretboards, or perhaps seventeen microprocessors for a computer. Job costing is generally used by manufacturers that produce products in discrete batches – clothing manufacturers, electronics producers, etc.

Process costing, on the other hand, measures costs for departmental processes. This is useful when the company does not produce discrete, quantifiable objects – think of a refinery processing oil.

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A Summary of Job Order Cost Systems Accounting for Manufacturers: Business Principles

Summarizing job order costing is relatively simple when viewed from the business perspective. The general principle of a manufacturing enterprise is that items flow from materials through WIP/production into finished goods that are subsequently sold. Thus, reports are divided up based on the stage of production they’re covering.

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Materials Cost Accounting

Materials, for example, are maintained in separate accounting entries called materials ledgers. When receiving reports signal the business has received and approved purchased materials, a debit is made to the account based on the invoice. When materials requisitions signal that materials have been taken out of the warehouse and used for production, a credit is made to the account with a note on what specific “job” utilized the materials.

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Job Cost Sheets

Job cost sheets cover costs and expenses incurred by a specific job – for example, direct materials cost, direct labor cost, and general administrative and factory overhead expenses.

Job-Based Labor Cost Accounting

When cost accounting is done in a job order system, labor hours are reported on a per-hour basis. Therefore, the cost of the specific job (say, Job 15) only takes into account the labor hours utilized by Job 15. So if John is an employee responsible for painting finished chairs, and John works for 12 hours on the chairs produced in Job 23, and another 18 hours on the chairs produced in Job 15, the costing for Job 15 will ONLY include the 18 hours he spent on that specific job. His other labor hours would be costed under Job 23.

The total job labor cost is the sum of all labor costs utilized by a specific job.

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Job costing for overhead is slightly more complicated. All period costs that aren’t classified under labor or materials are grouped under the “overhead” umbrella. For example, utility period costs, depreciation, rent, indirect materials, and indirect labor.

Once these costs are totaled up for the given month, year, etc, they are assigned to specific jobs using a concept called cost allocation. The costs are allocated using an activity base – which varies depending on the job.

The predetermined factory overhead rate is a way of calculated how much of the overhead should be assigned to a specific job – that is, how is overhead divided among jobs? The POHR formula is as follows:

Predetermined Factory Overhead Rate = (Estimated) Total Factory Overhead Costs divided by Estimated Total Activity Base

Or: Overhead/Activity Base

For example, if a certain plant has an overhead of $20,000 a month, and the chosen activity base is “direct labor hours,” then if the plant uses 1,000 direct labor hours that month, the POHR is 20,000/1,000 = $20 per direct labor hour. So if Job 30 uses 200 labor hours, then 200 * $20 = $4,000 of overhead will be assigned (allocated) to the job cost sheet for Job 30. Note that the amount of overhead assigned to each individual job will vary depending on WHICH activity base is used.

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Overused and Underused Overhead As A Result of Job Order Costing

Remember that the POHR uses estimates, and actual overhead may end up being either higher or lower than the estimate. Therefore, in the process of job costing for overhead, managerial accountants might incorrectly report the overhead costs, which poses a problem for management. The solution is to use something called underapplied/underabsorbed factory overhead and overapplied/overabsorbed factory overhead. Essentially, at the end of the period (year, month, quarter) the actual overhead costs are compared with those reported in job costing. If the actual costs are less than the estimated (applied) costs, then the factory overhead account will have a credit balance called overapplied factory overhead. If actual costs are higher than estimated costs, then the factory overhead account will have a debit balance called underapplied overhead.

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Determining Cost Of Goods Sold from Job Cost Sheets

Under a job costing accounting system, calculating the cost of goods sold is relatively easy. The job cost is divided by the quantity of products or goods produced to calculate the individual unit cost. For example, if Job 5 produced 10 sofas, and Job 5 has a total cost of $2,000, then the cost of an individual sofa is $200.

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