Description of job costing in accounting
January 11, 2014
The process of tracking production costs is critical for the information needs and reporting requirements of manufacturers. In this article, we’ll discuss a method of cost distribution called job costing. After describing the theory behind job costing, we’ll walk through an example - a manufacturer of drag race engines.
As far as recordkeeping related to inventory costing goes, retail accounting may be less complex than factory accounting. When a retail company buys merchandise from a supplier, the amount recorded in the Inventory account is the price paid by the retailer plus other incidental costs related to the merchandise. That cost flows from the balance sheet to the income statement when the merchandise is resold. For a manufacturer, however, the full cost of inventory for sale is not immediately clear. The materials used to manufacture a product are an obvious part of the cost, but what about salaries of the factory employees or factory’s electric bills?
U.S. GAAP requires full absorption cost accounting for manufacturing companies. What this means is that direct materials, direct labor, and factory overhead are all included as product costs – essentially all costs that are directly or indirectly related to factory production. Overhead includes cost items like factory utilities, machine maintenance, and foremen salaries. Costs that are not allocated to inventory include selling expenses, such as advertising, and corporate administration expenses, such as officer salaries.
Manufacturers generally have three different procedures to choose from when allocating costs to specific products - job costing, process costing, or activity-based costing. Job costing is most appropriate for service corporations and the production of special-order inventory. For instance, an accounting firm or a manufacturer of unique high-end yachts would likely use job costing for reporting and pricing purposes. Under this method, direct materials and labor are allocated to each specific product being manufactured, and overhead costs are added to the projects in a predetermined manner. A common allocation basis for overhead is the number of labor hours spent on the project. Let’s dig deeper with a full example.