Job Costing Basics for Your Custom Product or Service
One of the most important things to keep track of as a business owner is your expenses. Whether you are a manufacturer or provide services, knowing how much it costs to provide the products and services your customers require is essential. This is known as job costing. In this article, we will discuss the basics of job costing and how to keep track of these expenses.
What Is Job Costing?
Job costing refers to the process of keeping track of all costs associated with a particular job or project.
For example, suppose you are a service based business owner that creates websites for clients. The basics of job costing for this project would be calculating all the labor, materials, and overhead that go into creating the website.
Let’s look at each of these categories in more detail.
Direct Labor
Direct labor costs refer to the costs of paying all the employees or contractors who work on the project, and are part of the basics of job costing. Service based companies typically record hours worked for hourly workers and combine this number with the amount of salary paid to employees who work on the project.
Service based business owners also often use a “job cost sheet” to keep track of costs as they are incurred, making the calculation of costs much easier.
Direct Materials
Direct materials refer to the actual materials directly used in the job. For example, if a manufacturing company agrees to create a custom table for a client, all the wood needed to create the table qualifies as direct materials. It is important to note that only materials that can be directly traced to the project qualify as direct materials.
In the above example, you are likely wondering where the costs of paint, glue, and similar materials are classified. Because it can be difficult to directly trace these materials, many companies classify paint, glue, and similar items as indirect materials.
Many service based business owners, such as attorneys or accountants have negligible amounts of direct materials in their job costing. Because these companies are much more labor intensive, their direct materials costs will be much less.
You May Also Like:
Manufacturing Overhead (Overhead)
Manufacturing overhead is probably the most complicated concept in job costing, but once understood, the basics of job costing for overhead become clear
Manufacturing overhead refers to items not directly related to materials or labor, but what a company needs to operate effectively. This includes items such as rent, utilities, internet, and similar expenses.
The easiest and most common way service based business owners add overhead costs to their job costing is by using a predetermined overhead rate, and multiplying this rate by direct labor hours worked.
For example, suppose your service based company uses a predetermined overhead rate of $5.00 of overhead for each direct labor hour worked on a project A. Completing project A required 10 labor hours, so the overhead applied to project A amounts to $50 ($5.00 x 10 hours).
It is important to note that the overhead applied is necessarily an estimate, as overhead costs are difficult to trace. The most important idea is to estimate these costs to ensure the cost of each job is as accurately calculated as possible.
Example
Let’s look at an example of a movie studio that is putting together a job cost analysis for a proposed film.
The direct labor hours involve calculating the hours of directors, actors, editors, and support staff that work on the movie. Their hours worked are then calculated by their pay rate to arrive at the labor cost for the movie.
In this case, assume the average labor rate is $50 per worker and the total hours worked equal 10,000. Therefore, the direct labor cost for this film is $500,000.
Next, let’s look at direct materials. These items include sets, props, wardrobe, and similar items. Because the company likely has receipts for all of these items, adding their total value should be a simple exercise. Let’s assume the total material costs equal $500,000 as well.
Finally, let’s calculate overhead. The company uses a predetermined overhead rate of $50 per labor hour worked, so the overhead cost of this film is $50*10,000 hours, or $500,000.
Now we simply add the direct labor, direct material, and overhead costs together to arrive at a total cost of $1,500,000 to produce this film.
Importance of Job Costing
Now that we understand the basics of job costing, why is it important? Simply put, if a service based or manufacturing company does not keep track of costs when providing their products or services, they run the real risk of letting costs get out of control and destroy profitability.
The more you utilize the basics of job costing in your projects, the more accurate your costs will be.
We hope you enjoyed this post about the basics of job costing. For more information on job costing and other services we provide, check out the rest of the Tatum Accounting website!
