Chapter 4: Job Costing

Summary

Product costing is the process of accumulating, classifying, and assigning direct materials, direct labor, and factory overhead costs to products or services. Product costing provides useful cost information for both manufacturing and nonmanufacturing firms for (1) product and service cost determination and inventory valuation, (2) management planning, cost control, and performance evaluation, and (3) managerial decisions.

Several different product costing systems are available and can be classified as the (1) cost accumulation method—job or processing costing systems, (2) cost measurement method—actual, normal, or standard costing systems, (3) overhead assignment method—traditional or activity-based costing systems. The choice of a particular sys-tem depends on the nature of the industry and the product or service; the firm’s strategy and its management information needs; and the costs and benefits to acquire, design, modify, and operate a particular system.

Job costing uses several general ledger accounts to control the product cost flows. Direct materials costs are debited to the Materials Inventory account at purchase time and debited to the Work-in-Process Inventory account when production requests materials. Direct labor costs are debited to the Work-in-Process Inventory account when they are incurred. Actual factory overhead costs are debited to the Factory Overhead account when they are incurred. Factory overhead applied using the predetermined factory overhead rate in normal costing is debited to the Work-in-Process Inventory ac-count and credited to the Factory Overhead Applied account. When a job is complete, the cost of goods manufactured is transferred from the Work-in-Process Inventory account to the Finished Goods Inventory account.

The predetermined factory overhead rate is an estimated factory overhead rate used to apply factory overhead cost to a specific job. The application of a predetermined overhead rate has four steps: (1) estimate factory overhead costs for an appropriate operating period, usually a year, (2) select the most appropriate cost drivers for charging the factory overhead costs, (3) estimate the total amount or activity level of the chosen cost drivers for the operating period, and (4) divide the budgeted factory overhead costs by the estimated activity level of the chosen cost drivers to obtain the predetermined factory overhead rates.

The difference between the actual factory overhead cost and the amount of the factory overhead applied is the overhead variance; it is either underapplied or overapplied. It can be disposed of in two ways: (1) adjust the Cost of Goods Sold account or (2) pro-rate the discrepancy among the Work-in-Process Inventory, the Finished Goods Inventory, and the Cost of Goods Sold accounts.

Job costing is used extensively in service industries such as advertising agencies, construction companies, hospitals, repair shops and consulting, architecture, accounting, and law firms.

Operation costing is used when most of the plant’s products have a similar conversion cycle, but materials costs may differ significantly. In this case, materials costs are traced to jobs, while conversion costs are traced to departments and then to jobs.