Job costing involves a series of transactions that accumulate the cost of materials, labor, and overhead (of which there are two different calculations) to a specific job. For each of these costing categories, costs are accumulated through a series of transactions before they are finally charged to a specific job. In this section, we will trace the journal entries used for all of these costs.
The basic flow of journal entries required for direct materials is noted in the first exhibit, which itemizes the general format of each sequential transaction. When raw materials are purchased, they are rarely charged to a particular job upon receipt. Instead, they are stored in the warehouse, so there is a debit to the raw materials inventory and a credit to accounts payable. Once production is scheduled, the raw materials will be sent to the production floor, which triggers another transaction, to be created by the warehouse staff – a debit to the work-in-process inventory account and a credit to the raw materials inventory account.
During the production process, it is quite likely that some portion of the materials will be destroyed as part of the normal production process; if so, another entry will be required that creates a debit to the overhead cost pool, and a credit to remove the cost from the work-in-process inventory account. This normal amount of scrap will then be allocated through the overhead cost pool back to product costs – we will deal with this issue shortly, when we talk about the cost flow for overhead costs. If there are excessive amounts of scrap, then these will instead be charged directly to the cost of goods sold with a debit, while the work-in-process account is reduced with a credit.
Once the production process has been completed (which may be a few moments for simple products, and months for complex ones), it is shifted back to the warehouse in the form of finished goods. To record this transaction, we use a debit to the finished goods inventory account and a credit to work-in-process inventory. Once the goods are sold from stock, a final entry relieves the finished goods inventory account with a credit, and charges the cost to the cost of goods sold with a debit.
One of the numerous benefits of a just-in-time system is that materials are in the production process for such a short period of time that there is no point in creating transactions that move their cost in and out of work-in-process inventory. Instead, a single transaction shifts raw material costs from the raw materials inventory account to cost of goods sold (though there may be an extra entry to record the cost in finished goods inventory if completed products are not immediately sold). This greatly reduces the number of potential problems that can arise with the recording of transactions.
The recording of labor costs follows a slightly different path than what is typically seen for material costs. Instead of taking a direct route into the work-in-process inventory account, labor costs can either be charged at once to the overhead cost pool or go into work-in-process inventory. The charge to an overhead cost pool is done if there is no direct relationship between the incurrence of the labor cost and the creation of a product – this results in a debit to the overhead cost pool and a credit to the wages expense account. However, if there is a direct tie between the incurrence of labor costs and the production of specific products, then the debit is instead to the work-in-process inventory (or a separate labor) account. These cost flows are shown in the next exhibit.
If the wages have flowed into an overhead cost pool, these costs will be summarized at the end of the accounting period and charged to specific products based on any number of allocation methodologies. The allocation calculation will result in another transaction that shifts the overhead costs to product costs, which can occur both at the work-in-process and finished goods stages of production. Meanwhile, labor costs that have been charged directly to work-in-process inventory will then be shifted to finished goods inventory and later to the cost of goods sold in the same manner as for materials costs.
As was the case for material costs, there are a large number of labor transactions that are required to track the flow of labor costs through the production process under the job costing methodology. There is a high risk that transactional errors will arise, just because of the large number of transactions, so control systems must be created that keep errors from occurring, and verify that completed transactions are correct.
The final job costing process under the job costing system is the allocation of costs to products. There are two ways to do this – either with the actual costs incurred during the production process, or else with standard costs that are later adjusted to match actual costing experience. The first of these approaches is called actual cost overhead allocation, while the later is called normal cost overhead allocation. We will address the actual cost overhead allocation first.
Under actual costing, there are several sources of costs that will flow into an overhead cost pool. As shown in the next exhibit, all production supplies that cannot be traced to a specific product will be debited to the overhead account and credited to accounts payable (the credit may also be charged to raw materials inventory or supplies expense, if supplies were first charged to either of these accounts). As already noted, some labor costs will also be charged to the overhead account. Also, and as previously noted under the materials costing flow, normal amounts of production scrap and spoilage will be charge to overhead. Indirect wages and other indirect costs will also flow into the overhead cost pool. At the end of the accounting period, the cost pool is charged out to various products based on a variety of possible allocation calculations. Once overhead costs have been assigned to specific products, they follow the usual pattern of being moved to the finished goods inventory while their associated completed products are held in storage, and from there to the cost of goods sold upon sale of the product.
The allocation of costs to specific jobs can be delayed for some time under the actual cost overhead allocation method, because some costs can only be compiled at the end of the month, or perhaps not until several weeks thereafter. This is a problem for those companies that want more immediate costing information. We use normal overhead cost allocations to resolve this problem. Normal costing means that a company charges out costs in the short-term using a historical average for its overhead costs, rather than actual costs. This process is shown in the following exhibit. This allows costs to be charged to jobs at once. To ensure that the historical average being used for allocations does not stray too far from actual results, it is periodically compared to actual costs (which must still be accumulated), and adjusted as necessary.
When actual and normal costs are compared, there should be a small variance, which can be disposed of in several ways. One approach is to charge off the entire variance to the cost of goods sold, though this can create an unusually high or low cost of goods sold. Another approach is to spread the variance among the cost of goods sold, work-in-process inventory, and finished goods inventory, based on the total balances remaining in each account at the end of the reporting period. A final approach is to retroactively charge the variance to every job. These three options require an increasing amount of work to accomplish, in the order described. For that reason, the first option is the most commonly used, while allocation to individual jobs is a rarity.
The very large number of transactions required in a job costing system makes it a very inefficient costing methodology from the perspective of the accounting department, which must verify that all of the transactions entered are correct. It can also call for the purchase of large quantities of data collection equipment, such as automated time clocks and bar code scanners, which can be quite expensive. Furthermore, this system requires some participation by production personnel in the data collection process, which detracts from their primary mission of manufacturing products. However, given the need for job costing information, a company may find that there is no reasonable alternative to using this system. If so, the cost accountant should carefully review the need for each type of data that can potentially be produced by the system, and only collect those that will result in valuable information – this will create a more efficient data collection environment that only focuses on the key cost elements.