Accounting: The Language of Business - Vol. 1 (Part 113)

"Accounting noise: the current mess of confusing financial statements, created by a combination of excessive rules, and occasionally management manipulation." - Luke Johnson 

Introduction to Managerial Accounting and Job Order Cost Systems (Part F)

by

Charles Lamson

Job Order Costing for Decision Making

The job order cost system that was developed in previous posts can be used to evaluate an organization's cost performance. The unit costs for similar jobs can be compared over time to determine if costs are staying within expected ranges. If costs increase for some unexpected reason, the details in the job cost sheets can help discover the reasons.

To illustrate, Exhibit 12 shows the direct materials on the job cost sheets for Jobs 144 and 163 for a furniture company. Since both job cost sheets refer to the same type and number of chairs, the direct materials cost per unit should be about the same. However, the materials cost per share for Job 144 is $28, while for Job 163 it is $35. The materials costs have increased since the folding chairs were produced for Job 144.

EXHIBIT 12 Comparing Data from Job Cost Sheets

Job cost sheets can be used to investigate possible reasons for the increased cost. First, you should note that the rate for direct materials did not change. Thus, the cost increase is not related to increasing prices. What about the wood consumption? This tells us a different story. The quantity of wood used to produce 200 chairs in Job 144 is 1,600 board feet. However, Job 163 required 2,000 board feet for the same number of chairs. How can this be explained? Any one of the following explanations is possible and could be investigated further:

1. There was a new employee that was not adequately trained for cutting of the wood for chairs. As a result, the employee improperly cut and scrapped many pieces.

2.  The lumber was of poor quality. As a result, The cutting operator ended up using and scrapping additional pieces of lumber.

3. The cutting tools were in need of repair. As a result, The cutting operators miscut and scrapped many pieces of wood.

4. The operator was careless. As a result of poor work, many pieces of cut wood had to be scrapped.

5. The instructions attached to the job were incorrect. The operator cut wood according to the instructions but discovered that the pieces would not fit. As a result, many pieces had to be scrapped.

You should note that many of these explanations are not necessarily related to operator error. Poor cost performance may be the result of root causes that are outside the control of the operator.

Job Order Cost Systems for Professional Service Businesses

A job order cost accounting system may be useful to management of a professional service business in planning and controlling operations. For example, an advertising agency, an attorney, and a physician all share the common characteristic of providing services to individual customers, clients, or patients. In such cases, the customer, client, or patient can be viewed as an individual job for which costs are accumulated.

Since the "product" of a service business is service, management's focus is on direct labor and overhead costs. The cost of any materials or supplies used in rendering services for a client is usually small and is normally included as part of the overhead.

The direct labor and overhead costs of rendering services to clients are accumulated in a work in process account. This account is supported by a cost ledger. A job cost sheet is used to accumulate the costs for each client's job. When a job is completed and the client is billed, the costs are transferred to a cost of services account. This account is similar to the cost of merchandise sold account for a merchandising business or the cost of goods sold account for a manufacturing business. A finished goods account and related finished goods ledger are not necessary, since the revenues associated with the services are recorded after the services have been provided. The flow of costs through a service business using a job order cost accounting system is shown in Exhibit 13.

EXHIBIT 13 Flow of Costs Through a Service Business

In practice, additional accounting considerations unique to service businesses may need to be considered. For example, a service business may bill clients on a weekly or monthly basis rather than waiting until a job is completed. In these situations, a portion of the costs related to each billing should be transferred from the work in process account to the cost of services account. A service business may also have advance billings that would be accounted for as deferred revenue until the services have been completed. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 754-756*

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