Job Costing Fundamentals

• Costing accumulates, classifies, and assigns direct materials, direct labor, and factory overhead expenses to products, services, or projects.
• Management accountants choose a costing system based on:
  • Cost accumulation method (job or process costing)
  • Cost measurement method (actual, normal, or standard costing)
  • Overhead application method (volume-based or activity-based)

Cost Accumulation: Job Costing

• Jobs consist of individual or batches of products/services
• Appropriate when most costs are easily identified with a specific product, batch, order, contract, or project.
• Companies include construction, printing, manufacturing, shipbuilding, custom furniture, professional, medical, and advertising.
• Job costing can involve a single product or multiple products in a batch
• A batch might be 20 units for warehouse distribution or a quantity ordered by a customer
  • The "push" method fills the warehouse
  • The "pull" method is based on direct customer demand.

Cost Accumulation: Process Costing

• Used by firms producing homogenous products/services (easily substituted, no unique characteristics)
• Firms use continuous mass production
• It is economically impractical to trace most costs to individual products
• Industries include chemical, bottling, plastics, food and paper.

Cost Measurement: Actual Costing

• Actual costs incurred for direct materials, direct labor, and factory overhead are used.

Cost Measurement: Normal Costing

• Actual costs for direct materials and direct labor with normal costs for factory overhead are used
• Normal costs involve estimating a portion of overhead assigned to each product during production
• Provides a timely cost estimate per product or job.

Cost Measurement: Standard Costing

• Standard costs and quantities are used for direct materials, direct labor, and factory overhead
• Standard costs are expected costs a firm should attain
• Systems provide a basis for cost control, performance evaluation, and process improvement.

Overhead Application: Volume-Based Product Costing

• Overhead is allocated to products/jobs using volume-based cost drivers like units produced
• Assumes each product uses the same overhead amount
• Some argue overhead should be proportional to direct labor hours, as more labor time increases equipment, supervision, and facilities costs
• Allocation using direct labor hours, may not accurately capture differences in overhead consumption.

Overhead Application: Activity-Based Costing (ABC)

• Factory overhead costs are allocated to products using cause-and-effect criteria with multiple cost drivers
• Systems use volume-based and non-volume-based cost drivers
• Accurately allocate factory overhead costs to products based on resource consumption during activities.

The Strategic Role of Costing

• Accurate cost information is needed, regardless of strategy, especially for cost leadership firms focused on efficiency and quality
• Effective cost management requires timely and accurate information
• Firms should choose a cost system matching their competitive strategy
• Cost leadership firms producing commodity products in process industries should use process costing systems
• These firms are likely to use activity-based costing for accurate costs and standard costing for cost targets and reports
• Commodity/cost leadership firms may use a combination of process, activity-based, and standard costing.

Job Costing: The Cost Flows

• Job costing gathers costs and assigns them to specific jobs, customers, projects, or contracts
• The job cost sheet is the main document in electronic form that records and summarizes costs of direct materials, direct labor, and factory overhead for jobs
• Job costing is typically done by a database software system that collects relevant data and prepares reports, financial statements, and tax returns
• Database software systems are used due to the large amounts of data that manufacturing firms maintain
• Job cost sheets include all cost elements and detailed data
• Job cost sheets track products through production, with all costs recorded as materials and labor are added
• Overhead is added upon completion using a peso amount per labor hour

Direct and Indirect Materials Costs

• ABC Furniture purchases direct materials (lumber, fabric) and indirect materials (glue, nails)
• An example purchase of P2,400
  • Materials Inventory Dr 2,400
  • Accounts Payable Cr 2,400
• Materials requisition is a document used by the production department to request materials, indicating the job charged
• Department A uses P1,500 in direct materials for Job 351
  • Work-in-Process Inventory Dr 1,500
  • Materials Inventory Cr 1,500
• Indirect materials are part of factory overhead costs. Example
  • Factory Overhead Dr 50
  • Materials Inventory Cr 50

Direct and Indirect Labor Costs

• Direct labor costs are recorded on the job cost sheet using time tickets
• Time Tickets show employee time on each job, pay rate, and the total direct labor cost for each job
• Analysis of the tickets assigns direct labor costs to individual jobs
• Total direct labor P1,000
  • Work-in-Process Inventory Dr 1,000
  • Accrued Payroll Cr 1,000
• Indirect labor is part of factory overhead cost. Example
  • Factory Overhead Dr 100
  • Accrued Payroll Cr 100

Factory Overhead Costs

• Overhead application is the allocation of factory overhead costs to cost objects (jobs)
• Allocation is necessary because overhead costs cannot be traced to individual jobs
• Actual and normal costing are the two approaches to allocating overhead costs.

Actual Costing

• Actual factory overhead costs incurred monthly
• Costs include indirect materials, indirect labor, factory rent, insurance, property tax, depreciation, repairs, power, light, heat, and payroll taxes
• Terms include manufacturing overhead, indirect manufacturing cost, production overhead, or overhead
• Steele Machine Tools Inc. Example
  • Monthly fixed factory overhead: P60,000
  • Variable manufacturing costs: P10/unit
  • 50,000 units in January at P11.20
  • 10,000 units in February at P16.00
• Unit cost fluctuations arise because total fixed costs don't change, so unit costs change with volume
• Not desirable for cost estimation, budgeting, pricing, or product profitability analysis
• In actual costing, all job costs are recorded at the end of the accounting period
• Revenues and actual expenses calculate overall profitability
• The company doesn't know the cost/profitability of each job until the end of the period

Normal Costing

• Actual costs for direct materials and direct labor with estimated factory overhead applied
• Avoids cost per unit fluctuations from volume/overhead cost changes
• predetermined annual factory overhead rate normalizes overhead cost fluctuations. Formula:
  • Predetermined Overhead Rate = (Estimated Annual Factory Overhead) / (Estimated Total Amount of Cost Driver)
• ABC Furniture Inc. Example
  • Budgeted overhead cost is P200,070
  • Labor hours: 34,200
  • Job 351 labor hours: 300
• Formula
  • (P200,070) / (34,200) = P5.85 per direct labor hour
• Calculation
  • P1,755 = 300 hours × P5.85
  • Work-in-Process Inventory Dr 1,755
  • Factory Overhead Cr 1,755

Job Costing in Service Industries

• Job costing is used in advertising, hospitals, repair shops, consulting, architecture, accounting, and law firms

• Terms used: client, project, case, or contract

• Project costing tracks the costs and progress of non-recurring tasks: marketing plan development or strategic direction

• Service industries use similar recording procedures as illustrated earlier, except for direct materials

• Focus is on direct labor with overhead costs applied based on direct labor cost

• Law firm L&P provides legal services. The firm uses 2 main costs

  • Compensation for professional staff
  • All other costs

• Professional staff costs are direct while other costs are overhead

• An overhead rate for client billing is based on professional staff hours used, P150 per hour, time billed at P250 per hour

• L&P Examples

  • Estimated professional staff cost: P6,000,000 (40,000 hours)
  • Estimated overhead: P5,000,000
  • Total estimated costs: P11,000,000

• Abby Johnson Examples:

  • 100 hours of professional staff time
  • The cost to be billed to Abby is determined in three steps

• Determine the overhead rate:

  • P5,000,000 / 40,000 = P125/hour

• Determine applied overhead for the job Example

  • 100 hours × P125 = P12,500

• Determine the total billing for the job. Example

  • Total billing for professional staff (P250 per hour × 100) = P25,000
  • Total overhead applied to the job (P125 per hour × 100) = 12,500
  • Total billing for the Abby Johnson job = P37,500

• Job cost of the Abby Johnson job is determined by replacing the billing rate (P250) with the staff compensation cost (P150). Example

  • Total billing for professional staff (P150 per hour × 100) = P15,000
  • Total overhead applied to the job (P125 per hour × 100) = 12,500
  • Total cost for the Abby Johnson job = P27,500

• The profit on the Abby Johnson job = P37,500 − P27,500 = P10,000