Job Order Costing versus Process Costing
Job order costing is fundamental to managerial accounting. It differs from Process costing
in that the flow of costs is traced by job instead of by process. For instance, think of an assembly line making cookies. Job order costing would track how much material is placed in each cookie. Process costing tracks the amount of dough used, the baking time, and other aspects of the process of making cookies. Job costing is typically used for special orders or when the product made is unique. Process costing is used when the products are more homogeneous in nature.
Using Job Order Costing
In a job costing system, costs are accumulated by job. For a typical job, direct material and direct labor are tracked at their actual values. These are recorded and tracked until the job is completed. Overhead
is applied either by using a rate based on direct labor hours or by using an Activity Based Costing (ABC) cost driver
. In either case, once overhead is added, the total cost for the job can be determined. Upon completion, the costs are transferred out of Work in Process to Finished Goods
(Cost of Goods Sold
for service industries).
These examples will assume that overhead is allocated on the basis of Direct Labor Hours. Direct Material is abbreviated DM, Direct Labor as DL, and Overhead as OH.
XYZ corporation manufactures airplanes. 1 order was completed (#110), 2 received further work (#111, 112), and 1 new order was received (#113). Overhead is allocated at a rate of $100/DL Hour. All employees earn $20/hour. Beginning Work In Process Balances are as follows: #110, $25,000; #111, $10,000; #112, $12,000; #113 $0 (New Order). Below are the amounts of DM and DL used.
- #110 $2,000 DM, 25 DL hours. Therefore, $5,000 in new cost is added ($2,000 DM, $500 DL, $2,500 OH). The job had a total cost of $30,000. this amount is transferred out of Work in Process to Finished Goods or Cost of Goods Sold.
- #111 $3,000 DM, 30 DL hours. Therefore, $6,600 in new cost is added ($3,000 DM, $600 DL, $3,000 OH). The job has a new total cost of $16,600. This amount remains in Work in Process until completion.
- #112 $5,000 DM, 100 DL hours. Therefore, $17,000 in new cost is added ($5,000 DM, $2,000 DL, $10,000 OH). The job has a new total cost of $29,000. This amount remains in Work in Process until completion.
- #113 $1,000 DM, 10 DL hours. Therefore, $2,200 in new cost is added ($1,000 DM, $200 DL, $1000 OH). The job has a new total cost of $2,200. This amount remains in Work in Process until completion.
Caution: Remember, overhead is allocated on the basis of DL hours. While in this case, allocating overhead on the basis of DL cost ($5 of overhead for every $1 DL cost) would produce the same result, this may not always be the case. Since rates are developed based on a budget, if employees are actually paid a different rate from the budgeted rate, allocating at a $5 to $1 ratio would produce a different cost from the stated $100/DL hour allocation. Companies use slightly different overhead allocation methods.