What is the Job Order Costing System?
Job order costing is a system of assigning the cost of production to a specific manufacturing job; this system is used when each output is different from others. This system is mainly used by those organizations that are providing customer-specific jobs; it means others cannot use the same product—for example, Manufacturing of machinery & equipment as per the specification provided by the customer. Service provided by professionals like Doctor, Lawyer, and Chartered Accountants are client-specific; therefore, determining the cost of these services is calculating by the job order costing method.
Types of Costs Involved in Job Order Costing
In Job order costing different – different type of costs are involved which are mainly divided into below three categories:
- Direct Material – Direct materials are the major contributor to job order costing. Raw materials which are directly consumed for completion of specific job or manufacturing of finished goods come under direct material. These costs are entirely dependent on the quality and quantity of finished goods.
- Direct Labor – In Job order costing cost of laborCost Of LaborCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. used in a specific job is identified and added to the cost of production. Direct labor cost is calculated based on no. of manpower and no. of hours worked. If the specific job is related to providing service, then direct labor cost is comprised of almost 80% – 90% of the total cost.
- Overhead – Overhead costsOverhead CostsOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc. are those cost which is incurred in the manufacturing of a product or providing service other than the direct labor and direct material like Rent, Electricity, Depreciation, Legal Fees and any other. Some overhead costs are variable, and some are fixed.
Features of Job Order Costing System
- In job order, each job has its characteristics.
- In this type of cost, each job has done against customer orders only, not as a regular production.
- In this method of costing, each job is treated as a cost centerCost CenterCost center refers to the company's departments that don't contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments..
Example of Job Order Costing
Let’s take the example of a job order costing system.
Notebook Inc is a printing & stationery company that has received an order of 5000 copies of invoices from one of its customers. According to the specification provided by the customer as on 1st aug’19, notebook inc has to give delivery on or before 20th aug’19. As per the company, they can finish the work within ten days. Therefore, they have started on 5th aug’19 and assigned this work as a job no. 10/2019. In completion of this job below cost has been incurred by the company.
Direct Materials: In Production of one copy of the invoice, two units of raw material are required; therefore, for production of 5000 copies, 10000 units of raw material will be consumed which company has procured at different – different dates as per requirement. Initially, the cost of Raw material was $ 10 per unit. However, from 13th aug’19, it has increased by $ 1 because of a shortage of raw material in the market. The total cost of raw material consumed is $ 10500.
Direct Labor: In the production of one copy of the invoice, one manpower hour is required, and the cost of one manpower hour is $ 5. For completion of job 5000 manpower hours have consumed which company has taken at different – different days according to the availability of raw material. The total cost of direct laborCost Of Direct LaborDirect labor costs refer to the total cost incurred by the company for paying the wages and other benefits to its employees against the task performed by them, which are straight away related to the manufacturing of the products or provision of the services. is $ 25000.
Manufacturing Overhead: Cost incurred by the company is $ 20000, which includes depreciation of plant and machinery, factory and office rent and other overheads consumed in the production of these 5000 copies of invoices.
Advantages of Job Order Costing
The following are the advantages of job order costing.
- It helps management in the analysis of the material, labor & overhead cost that is incurred in production or completion of the job.
- It helps in the identification of the efficiency of machines and manpower.
- The job order costing method helps in cost controlCost ControlCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies. and better utilization of resources.
- With the help of the job order costing method, management can ascertain which job is profitable, which is not.
- It helps in comparison with a similar job will be done in the future and become the basis of future jobs also.
- They also identified the scrap and defective arises in the production or completion of the job, and accordingly, steps can be taken to minimize this.
Disadvantages of Job Order Costing
The following are the disadvantages of job order costing.
- It is a time-consuming and costly affair because of a recording of material, labor, and overhead daily and specific job-wise recording.
- A cost comparison is difficult because, in this method, the cost sheet is prepared for each job separately according to the specification.
- If two or jobs are going simultaneously, then there is a chance of mistake as the cost of one job may be posted in another job.
- In job order costing, overhead costs are based on estimates because it is challenging to know the overhead cost, which is directly linked with the specific job because most of the overhead facilities are used for more than one job. Therefore, there is a chance of excess/shortage allocation of cost.
- They mainly depend on the expertise of the production manager. Therefore, a person who is allocating cost to a specific job must have knowledge; otherwise, a small mistake can change the cost of the product.
Job order costing is useful only for those organizations which are work based on customer requirements, and one job is different from another so that cost of each job can be calculated. Still, it is vital to identify all the cost which is incurred in the completion of a job otherwise it will be lost to the company because the cost of one job cannot be assigned to another job. It is a costly affair because it requires skills and knowledge for identifications of cost, analysis, and controls the cost.
This article has been a guide to what is job order costing and its definition. Here we discuss features, types, and examples of a job order costing system along with advantages and disadvantages. You can learn more from the following articles –