Job order costing system definition
/What is a Job Order Costing System?
A job order costing system accumulates the costs associated with a specific batch of products. This system is used for small batch sizes, and especially when the products within each batch are different from the products created in other batches. In these situations, management wants to ensure that the costs incurred are reasonable when compared to the prices charged to customers. For example, the system could be used to track the costs of custom-made machinery. Without a job order system, it is likely that a business would quote the prices of some batches too low, thereby incurring losses.
An accountant using a job order costing system may track job-specific information on a job cost sheet, or this information may be coded into a job order database, where each job is assigned a unique identifying number.
Advantages of a Job Order Costing System
There are several advantages associated with a job order costing system, including the following:
To determine profitability. A job order costing system allows you to accumulate all of the costs specifically associated with a job, which can then be paired with the billed revenue for that job to arrive at a profit figure.
To monitor equipment usage. If specific machine usage is coded into the system, then it is possible to accumulate the total hours of machine usage across all jobs. This is useful for tracking when to maintain or replace production equipment.
To monitor labor levels. If specific positions or persons are coded into the system, it is possible to track hours worked, which can be used to allocate employees and plan for future staffing levels.
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Information Tracked by a Job Order Costing System
A job order costing system can be quite complex. It must track information from multiple sources, including the following:
Supplier invoices, from which only those line items pertaining to a job should be charged to that job.
Payroll records, from which the hours worked on a specific job are charged to that job, possibly also including payroll taxes, overtime, and shift differentials.
Material costs, where inventory items are relieved from stock and charged to a job as used.
An overhead allocation, which is derived from a cost pool and charged to each job based on some form of usage, such as labor hours incurred or machine hours used.
The number of sources of information and the volume of detail that may be associated with a job means that the underlying records could contain any number of errors. To mitigate the risk of errors, job order records must be scrutinized with great care. This is especially important when job costs will then be summarized and billed to customers under cost plus billing arrangements.
Job Order Costing vs. Process Costing
Job order costing and process costing are two different methods used to assign costs to products, depending on the production process. Job order costing is used when products are made based on specific customer orders or in small, distinct batches, where each job or order can have different materials, labor, and overhead costs. It is common in industries like custom manufacturing, construction, or printing, where each project is unique. Process costing, on the other hand, is used when identical or similar products are mass-produced in a continuous flow, and costs are averaged over all units produced during a period. This method is common in industries such as food processing, chemicals, and oil refining, where it is difficult to trace costs to individual units since they are produced in large, homogeneous quantities.