Job costing system definition
/What is the Job Costing System?
A job costing system involves the process of accumulating information about the costs associated with a specific production or service job. This information may be required in order to submit the cost information to a customer under a contract where costs are reimbursed. The information is also useful for determining the accuracy of a company's estimating system, which should be able to quote prices that allow for a reasonable profit. The information can also be used to assign inventoriable costs to manufactured goods. A job costing system needs to accumulate the three types of information noted below.
Direct Materials
The job costing must be able to track the cost of materials that are used or scrapped during the course of the job. Thus, if a business is constructing a custom-made machine, the cost of the sheet metal used in the construction must be accumulated and charged to the job. The system can compile this cost through the manual tracking of materials on cost sheets, or the information can be charged by using on-line terminals in the warehouse and production area. Typically, materials are kitted for a job in the warehouse, and are charged to a specific job at that time. If any remainder materials are later returned to the warehouse, their cost is then subtracted from the job and they are returned to storage.
Direct Labor
The job costing system must track the cost of the labor used on a job. If a job is related to services, direct labor may comprise nearly all of the job cost. Direct labor is typically assigned to a job with a timecard (using a punch clock), timesheet (where hours worked are recorded manually), or with a networked time clock application on a computer. This information can also be recorded on a smart phone or through the Internet. In all cases, the user must correctly identify the job, so that the cost information can be applied to the correct job.
Overhead
The job costing system assigns overhead costs (such as depreciation on production equipment and building rent) to one or more cost pools. At the end of each accounting period, the total amount in each cost pool is assigned to the various open jobs based on some allocation methodology that is consistently applied.
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Understanding the Job Costing System
In practice, a job costing system may have to be tailored to the requirements of the customer. Some customers only allow certain costs to be charged to their jobs. This is most common in cost-reimbursement situations where the customer has contractually agreed to reimburse a company for all costs charged to a specific job. Consequently, a job costing system may contain a large number of specialized rules that are not broadly applicable to all jobs for which it is compiling information.
Once a job has been completed, a flag must be set in the job costing system to close down that job. Otherwise, there is a strong probability that employees will continue to charge time to it, and that it will continue to attract an allocated overhead charge at the end of each successive month.
As long as a job is under construction, the compiled cost is recorded as an inventory asset. Once the job is billed to the customer (or written off), the cost is shifted to the cost of goods sold account. This approach ensures that revenues are associated with expenses in the same time period. A company's auditors may attempt to verify how well the job costing system operates, to see if they can rely on its ability to compile costs for inventory items, as well as to charge costs to expense within the correct reporting period.
Why is Job Costing Important?
Job costing is a critical accounting function in a business that provides customized products, as well as in one that provides specialized services to customers (such as attorneys). In these situations, it is essential to compile costs by individual job, to determine whether you are generating a profit, or perhaps charging too little for your services. Conversely, a well-run job costing system can provide the foundational data needed to devise billings to customers, as well as to justify the amounts billed. This is especially important when the costs incurred can trigger the issuance of change orders to customers, thereby increasing your billings and profits.
Also, once job costs are being accurately compiled, it is much easier for managers to examine the goods and services being produced, and decide whether prices need to be changed, or perhaps whether some products should no longer be offered to customers.
Example of Job Costing
ABC Corporation starts up Job 1001. In the first month of operations, the job accumulates $10,000 of direct material costs, $4,500 of direct labor costs, and is allocated $2,000 of overhead expense. Thus, at month-end, the system has compiled a total of $16,500 for Job 1001. This cost is temporarily stored as an inventory asset. ABC then completes the job and bills the customer. At that time, the $16,500 is transferred out of inventory and into the cost of goods sold.
Job Costing Controls
The volume and flow of transactions in a job costing environment give rise to several problems that require the imposition of controls. The key problem areas are as follows:
Abnormal variance treatment. The default journal entry in job costing for any type of abnormal variance is to charge it to the cost of goods sold. This approach means that expense recognition tends to be accelerated into the current period. A profit-minded manager (perhaps one with a bonus riding on the outcome) may put pressure on the cost accountant to find a way to not treat these variances as abnormal, and thereby shift their recognition into a future period. The best control is to have an outside entity, such as the internal audit department, periodically investigate how these variances are recorded.
Allocation methodology. A manager may adopt whichever cost allocation methodology tends to shift overhead costs toward those jobs that are still open, and away from those about to be closed, thereby deferring expense recognition. This technique only works reliably when the allocation method constantly changes to whichever one yields the best results, so a prime indicator of this problem is a history of constantly altering the allocation method. Another control is to require senior management approval of any change in allocation methodology.
Cost shifting. Managers may shift costs among a variety of open jobs in order to defer their recognition for as long as possible. This is a particular problem for old jobs that remain open despite minimal activity, since no one is overseeing them. The best controls are to promptly close jobs as soon as they are completed, and to have the internal audit department periodically review the contents of the job accounts.
Designate direct labor as indirect labor. It is possible to defer the recognition of labor expenses by reclassifying direct labor as indirect labor and thereby moving it into an overhead cost pool. By doing so, some portion of this cost is apportioned to jobs that may not be charged to expense until a later time period. A good control is to lock in a direct labor or indirect labor designation for every person in the payroll, and track any designation changes over time.
Period expense treatment. A manager may attempt to record a current-period expense in an overhead cost pool, thereby deferring recognition of some portion of the expense until a later period. A current-period expense is one that is directly associated with the passage of time, rather than the production of inventory items, such as administrative expenses. A reasonable control is to conduct periodic reviews of the sources from which costs are pulled into the overhead cost pool. An indicator of a problem is a spike or increasing trend in the amount of this pool.
Variance recordation. A manager may attempt to report excessively high profits by incorrectly charging negative job cost variances to an inventory account, rather than to the cost of goods sold, which defers recognition to a later period. A possible control is for the internal audit staff to trace how these variances are calculated, and where they are recorded.
The primary reason for many of the preceding controls is that managers twist the results of the job costing system to defer expense recognition. Since managers are the ones most likely to be at fault, the only good control is to have an outside entity – such as the internal audit department – examine the results of the job costing system. Any other controls probably fall under the authority of the managers who are misusing the system, and so are useless.