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Job Order Costing

 

In job order costing, product costs are accumulated for each job. In other words, you will have Direct Materials, Direct Labor and Manufacturing Overhead for each job. The direct costs are actual costs that should be easy to track to the appropriate cost object: the job. Manufacturing Overhead (MOH), on the other hand, cannot be known with precision until the end of the period, so it must be estimated by computing a predetermined overhead rate and applied to the job upon completion or at the end of any interim period like a month.

As manufacturing overhead costs are incurred, the MOH account is debited. Because manufacturing overhead is an indirect cost, a cost driver must be used to allocate the overhead to production. The company may use one cost driver for the company or multiple cost-drivers that differ by production department. Because manufacturing overhead is needed to price products and bid on jobs, choosing the allocation base is extremely important. If production is highly dependent on manual labor, then a typical allocation base is direct labor hours. If the manufacturing process is highly automated, then the logical allocation base might be machine hours.

Once a company selects the proper allocation base, a predetermined overhead rate must be computed using the budgeted level of manufacturing overhead cost and the amount of the allocation base expected to be incurred for the next year. (Please note this is the only time budget numbers are used in product costing; the budget is never actually booked.) For example, if a company budgets its annual manufacturing overhead at $1,687,500 and expects to incur 75,000 direct labor hours, then the predetermined overhead rate would be 1,687,500/75,000 = 22.50 per direct labor hour. (Specify all overhead rates as an amount per unit of the allocation base.) In other words, this company would "apply" or add $22.50 to Work in Process (WIP) for every direct labor hour worked during the period, whether those direct labor hours were used to complete units of product or to partially complete units of product or jobs.

To continue this example, assume that the following direct costs were incurred on job 500.

Direct Labor Hours

250

Direct Labor Cost

$ 2,500

Direct Material Cost

$ 3,985

A total of $5,625 in Manufacturing Overhead would be applied to this job (250 x 22.50 = 5,625), and the total cost of the job would be $12,110 as computed below. This total is the amount that would be transferred from Work in Process to Finished Goods when the job was completed and to Cost of Goods Sold when the job is sold.

Direct Labor

$ 2,500

Direct Materials

$ 3,985

Manufacturing Overhead Applied

$ 5,625

    Total Cost of Job #500

$ 12,110