Question

As we move to a more service-based economy (and with the advent of ERP systems), job order costing has become more prevalent. Many service organizations use job costing (e.g., electricians, accounting firms, music studios, health-care providers...). How does job costing work in a service company setting? Give example(s).

Answer 1

Definition:

Job costing in service organizations is the same as in manufacturing organizations, except that service organizations tend to use fewer materials. There are also minor differences in the accounts that these types of organizations use,

Accounts Used in Service Organizations and Manufacturing Organizations

Manufacturing Organization Account Name	Service Organization Account Name	Financial Statement
Raw materials inventory	Parts inventory or supplies	Balance sheet (asset)
Work-in-process inventory	Work in process*	Balance sheet (asset)
Finished goods	(Not applicable)	Balance sheet (asset)
Cost of goods sold	Cost of services (or other expense accounts)	Income statement (expense)
Manufacturing overhead	Overhead (or service overhead)	None (clearing account)
*Some service companies do not use a work-in-process account but instead simply charge costs directly to expense accounts.

Many service organizations do not track direct materials for each job because the cost of the materials is negligible. For example, accountants and attorneys use low-cost materials, such as binders and paper. These materials, often called supplies, are included in overhead rather than tracked by job.

Some service organizations track direct materials for each job because the cost of the materials is significant. Consider auto mechanics, who track the parts needed to perform repairs for each job, or electricians, who track the materials needed to wire a new building. Materials may be requisitioned from parts inventory or supplies, similar to raw materials inventory in a manufacturing setting, or may be purchased directly from a supplier, depending on the nature of the business. The process of recording this information in the journal and job cost sheet is exactly the same as for a manufacturing company .

Direct labor tends to be the most significant cost for service organizations. The process of tracking labor using a timesheet and recording labor costs in the journal and job cost sheet is exactly the same as for a manufacturing company

Because overhead is typically driven by direct labor hours in a service organization, direct labor hours or direct labor cost is the most common allocation base. Again, the process of recording this information in the journal and job cost sheet is exactly the same as for a manufacturing company

Example:

Manufacturing company ABC uses a job costing system to allocate job order costs at their actual value and track costs accurately to generate a profit. In January 2015, the company’s project manager prepared a yearly plan, estimating approximately $625,000 in overhead costs. Moreover, the carrying balances from 2014 were raw materials $25,000, work in progress $95,000, and finished goods $31,000.