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How Job Costing Works in Cost Accounting

In cost management, job costing is a method you use when your customers incur unique amounts of costs. Job costing assesses costs by the job and allows you to provide detailed price estimates based on the product constructed or service provided.

For some businesses, nearly every customer job has different costs, and that’s where job costing asserts its value. You need a job costing estimate in order to get the customer’s business, and you need to track costs accurately so you generate a reasonable profit.

The different costs for different jobs will often be self-evident. Material costs, labor hours, mileage cost, and type of equipment used are likely to vary. For example, a tree trimming company would incur more costs to remove a 30-foot tree than to remove a small stump. The big tree takes more labor and different equipment.

Some factors could lower costs and make a business more competitive in price (or improve its bottom line). Say you have a tree trimming company and have a job in a particular neighborhood. While you’re there, it makes sense to offer a free estimate to other homes in the neighborhood.

It’s a smart business move. If you’ve incurred the cost to locate your employees and equipment in a certain area, why not perform as much work as possible while you’re there? You can spread some costs (mileage, for example) over several jobs. As a result, your cost per job in that neighborhood is lower, and you increase your profit.

Here are a few examples of job costing. Look at three business sectors in the table.

Proper Use of Job Costing per Business Sector
Business Sector Job Costing
Service-sector businesses provide a service to clients Law firm, accounting practice, consulting businesses
Merchandising-sector businesses sell products as a retailer. (Think of a department store.)
Shipping expensive goods, customized product sales
Manufacturing-sector businesses make things Home builder or remodeler, swimming pool contractor

A cost object is anything that causes you to incur costs. Think about a cost object as a sponge that absorbs your money. The object can be a customer, job, a product line, or a company division. Carefully identifying cost objects will help you cost your product or service accurately.

Assume you manage a group of plumbers. You’re reviewing the month’s mileage expense (the equivalent of gasoline) for your staff and notice a 20 percent increase from the prior month. Why? You start asking questions. As it turns out, the customer demand for plumbing work required your staff to drive more miles. The average customer lived farther away.

You grumble, “That driving ran up a lot of costs!” Yes, it did, and you do the driving to meet the needs of your customers. In this example, the cost object was the group of customers for the month. Without any customers, you wouldn’t have paid for all of the gas. (Well, you wouldn’t have had any income either, but never mind that.) No cost object means no costs incurred.

Direct costs are traced to the cost object, and indirect costs are allocated to the cost object.

Indirect costs can be fixed or variable. Insurance costs on vehicles would be a fixed indirect cost. The premiums are fixed, and the cost is indirect to the job because you can’t trace the vehicle insurance cost directly to a specific job. Utility costs for the office (such as heating and cooling) are variable indirect costs. Costs vary with the weather and can’t be traced directly to any one job.

This list explains how fixed and variable costs are assigned to cost objects:

  • Direct costs

    • Variable direct costs, such as denim material, where denim jeans is a cost object

    • Fixed direct costs, such as a supervisor salary at an auto plant, where an automobile produced is the cost object

  • Indirect costs

    • Variable indirect costs, such as utility costs for a television plant, where a television produced is the cost object

    • Fixed indirect costs, such as insurance for a plumbing vehicle, where a plumbing job is a cost object

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