Job order costing tracks costs for specific customer orders or batches. It follows the flow of costs through raw materials, work in process, and finished goods inventories, ultimately determining the cost of goods sold.
This system allocates costs to jobs using direct tracing and overhead allocation. It calculates the cost of goods manufactured and sold, providing crucial information for pricing decisions and profitability analysis in custom manufacturing environments.
Job Order Costing System
Flow of product costs
- Raw materials inventory
- Records the cost of materials purchased for use in production
- Materials requisitioned for a specific job are transferred out of this account into work in process inventory (flour, sugar, eggs for a bakery)
- Work in process inventory
- Accumulates costs transferred from raw materials inventory and other accounts such as labor and overhead (wages for bakers, electricity for ovens)
- Costs remain in this account until a job is completed (wedding cake order)
- Upon completion, job costs are transferred out of this account into finished goods inventory
- Finished goods inventory
- Holds the costs of completed jobs transferred from work in process inventory (decorated wedding cakes ready for pickup)
- Costs stay in this account until the goods are sold to customers
- When goods are sold, their costs are transferred out of this account into cost of goods sold (revenue is recognized)
Cost Allocation and Tracing
- Cost objects: The items or activities for which costs are measured and assigned (e.g., products, departments, projects)
- Cost pools: Groups of individual cost items accumulated before allocation to cost objects
- Cost tracing: The process of assigning costs directly to a cost object when economically feasible
- Cost drivers: Factors that cause changes in cost for an activity or cost object
- Overhead allocation rate: The rate used to assign overhead costs to products or services
- Often calculated as a predetermined overhead rate based on estimated costs and activity levels
Calculation of goods manufactured
- Cost of goods manufactured = Beginning work in process inventory + Current period production costs - Ending work in process inventory
- Beginning work in process inventory represents the cost of jobs that were started but not completed in the prior period (partially assembled products)
- Current period production costs include all manufacturing costs incurred during the current period such as direct materials, direct labor, and manufacturing overhead (raw materials used, wages paid, utilities consumed)
- Ending work in process inventory represents the cost of jobs that are still in progress at the end of the current period (unfinished products)
Determination of goods sold
- Cost of goods sold = Beginning finished goods inventory + Cost of goods manufactured - Ending finished goods inventory
- Beginning finished goods inventory is the cost of completed products on hand at the start of the period (unsold items from prior period)
- Cost of goods manufactured is the total cost of products completed during the current period, calculated using the formula in the previous section
- Ending finished goods inventory is the cost of completed products that remain unsold at the end of the current period (items awaiting future sales)
- Cost flows: The movement of costs through the manufacturing process, from raw materials to work in process to finished goods, and finally to cost of goods sold