Job Costing is a technique from management accounting. It is a part of the internal accounting process to facilitate strategic planning and data-driven decisions.
Management accounting goes down to the business’s basic units to understand profitability and help evaluate how successful management is in running the company.
One of the most critical decisions for businesses is how to set prices and quote prospective customers.
Job Costing helps us track costs on a per-project basis to analyze our pricing and profitability better.
We have two types of costs to consider:
- Direct — the business incurs these while working on a specific identifiable client project;
- Indirect — these are the overhead costs not directly linked to a project.
Overheads are the costs to run the business. They have no direct link to generating income and are placed below Gross Profit on the Income Statement. Most commonly, these are selling and general and administrative expenses.
What is Job Costing?
It’s an accounting tool allowing businesses to track costs and income per project. Also known as Project-based costing, the technique looks at each project in detail, breaking costs down to materials, labor, and overheads.
It requires fewer assumptions than other costing methods and helps track expenses and analyze cost-saving potentials for similar future jobs.
Job Costing is the process of accumulating costs of materials, labor, and overheads for a specific job or project. It’s a handy tool in tracing particular costs to individual jobs and evaluating them for potential cost-saving in similar future projects.
We can also use job Costing to identify excess costs that we can try to recover from the customer.
The method is useful for appropriating costs to small unit levels. For example, a construction company can treat each building as a separate job, and software development businesses can treat individual pieces of software as jobs.
Job Costing is well suited for businesses where we produce goods or provide services based on a particular customer order. The technique works well when each job is unique.
Manufacturing companies employing Job Costing usually produce against specific customer requirements and specifications and not for stock.
It is also beneficial in companies providing services, where the bulk of the cost comes from the time employees spend on a job. Job Costing can help in situations where:
- There’s limited skilled human capital;
- Markets are highly competitive with a lower barrier to enter;
- We have tight deadlines;
- It is increasingly important to plan and budget for volatility.
Join our Newsletter for a FREE Excel Benchmark Analysis Template
The Job Costing Process
Under this costing approach, we accumulate three accounting categories.
- Materials — we track costs of components and raw materials and allocate them to projects;
- Labor — employees allocate time spent on projects or specific tasks, which we then assign to jobs/projects;
- Overheads — we use so-called ‘cost pools’ to accumulate all costs which we cannot directly attribute to a project and later allocate them proportionally to all jobs.
When we finalize the job, we charge the total costs towards the Cost of Goods Sold (for businesses rendering services) or transfer it to Finished Goods if it’s a physical product. Later, when we sell it to the client, we will charge the Cost of Goods Sold account with the total cost.
Realizing the accumulated Job Cost through the cost line in our Income Statement happens when we recognize the job’s revenue.
In a Job Costing setup, we take components and materials from storage and put them into a project.
If there’s wastage, normal amounts can go into an overheads cost pool, and we can later assign them proportionally. On the other hand, abnormal amounts are usually charged directly to Cost of Goods Sold.
We track the consumption of materials with materials requisition forms that evidence the inventory flow from storage to a particular project.
We can allocate labor costs directly to a project if they are traceable to the particular project. This represents the direct labor cost for the project. We charge all other labor costs to a cost pool which we then allocate to all jobs. This is also known as indirect labor.
The most popular way to track labor allocation is to implement timesheets, where our employees mark how they spend their time. Such timesheets will often show hours doing administrative tasks that we cannot attribute to a specific project. These can be separated and pooled together with other non-direct labor costs as part of the company’s overheads.
We accumulate all costs that we cannot attribute to a particular project in different cost pools. Then these are allocated to projects or jobs based on some measure of cost usage.
The key is to be consistent in our allocation approach from period to period to facilitate proper reporting and analysis.
Accumulating and allocating all actual costs into overhead pools can become tedious and time-consuming, and it may have adverse effects on the annual and monthly closing process.
Therefore, we use historical costs to estimate standard costs. These are never the same as actual costs, but they usually even out over time. Plus, it’s much easier to calculate our monthly statements with standard costs.
We use historical cost data to calculate an average standard overheads rate per unit. We can then multiply the actual total units by the standard rate and compare them to the actual costs within the particular overhead pool. This will inevitably give us a variance.
There are three approaches to deal with this variance.
- We can charge the whole variance to Cost of Goods Sold, which is the simplest way;
- Allocate it proportionally to WIP (work-in-progress), Finished Goods, and Cost of Goods Sold in the Income Statement, which is more in line with GAAP;
- Allocate the variance to the active projects during the period, which is closest to actual costing.
It is important to remember that the allocation of overheads is inherently flawed, as it covers costs that we can’t link directly to any job or project. Therefore, it’s usually best to use an approach that takes less time.
We calculate total costs for a job or project by accumulating the costs of materials, labor, and overheads.
- Calculate all materials consumed in the project, including delivery and shipping costs and normal wastage;
- Calculate payroll expenses, including any subcontractors working on the project;
- Calculating the overheads is more challenging as we need to rely on estimation techniques.
- DM is the Direct Materials cost;
- DL is the Direct Labor cost;
- OH is the Allocated Overhead.
Companies often use a predefined overheads absorption rate. We can use our annual budgets to get an approximate overhead rate.
The basis for assigning overheads should be something comparable, representing how costs are absorbed in projects.
The most common activity we use is labor hours.
Job Costing and Analysis
Job Costing shows distinctly the costs associated with projects which makes them highly auditable. If a job runs for a long time, we can compare its cost bucket to its budget periodically and have an early warning if a job is about to overrun its budget.
We can try to bring down some of the costs or negotiate to transfer a portion of them to the customer.
In a ‘cost plus’ contract, where we invoice incurred costs plus profit, Job Costing can be very helpful because of its details-rich nature. However, this also makes it a system that’s harder to maintain. Job Costing requires much precision, especially if we share project cost details with the client.
Job Costing allows profitability reporting on a more granular job level. A job can be a project, a single product, or a batch of similar products that are produced together.
Once we have the direct materials and labor and the allocated overheads, we can prepare a Job Cost Sheet. This is a job profitability report representing a Profit & Loss statement but only limited to the particular project. Software for Job Costing usually offers this functionality.
Such software solutions help us improve cost control, reduce risk, and ensure proper analysis. Having those supports a data-driven decision-making process and leads to better project management and improved profitability.
Advantages of Job Costing
The Job Costing approach has some advantages over other costing methods.
- Provides us with a straightforward way to determine individual profitability of projects;
- We have a detailed cost analysis for each job;
- Helps in the preparation of estimates for prospective customers;
- We can compare estimates to actual costs and calculate variances;
- It helps us identify unprofitable jobs.
Disadvantages of Job Costing
The technique is popular amongst accountants, but it still has some inherent limitations.
- It’s costly as it requires more administrative work and supervision;
- Due to higher requirements for the level of detail to track, the method is more prone to human error;
- It requires historical data for useful estimation and standard cost calculation.
Job Costing is a management accounting method under which we determine the cost for each project or job separately.
It became more popular as software advancements made it more achievable and cost-effective.
Job Costing answers some of the essential questions for each project within the company:
- Is the job profitable, or are we making any money?
- Who are the most profitable clients of the company?
- Who are the most productive teams within the business?
- Where should we focus our sales and marketing efforts?
Thank you for reading this article. Please show your support by sharing it with colleagues and friends.
You can also take a look at:
The Absorption Costing Method In Management Accounting - Magnimetrics
Today we take a look at the Absorption Costing Method and how it is used to allocate cost to produced goods. Do not…
Disclaimer: The information in this article is for educational purposes only and should not be treated as professional advice.
Originally posted on https://magnimetrics.com/ on 19 February 2021.