Job Costing and Batch Costing

A carpenter fitting out an office, an auditor reviewing a client’s books and a mechanic repairing a lorry all do work that is made to order. No two orders are the same, so the business has to work out what each one costs, both to quote a price in advance and to find out afterwards whether the work made money.

Job costing does this for single orders. Batch costing does it for groups of identical items made together.

This topic covers when each method is used, how the cost of a job or batch is built up, the documents and ledger accounts behind it, and how a price is set from the cost. It ends with practice questions modelled on the examination, including a job cost sheet and a batch cost per unit.

Specific order costing

Job and batch costing are together called specific order costing. They suit goods or services supplied to meet a particular requirement. In batch costing the “customer” may be inside the business, for example the stores department that will hold the finished goods. A costing system records total costs and spreads them into cost units. The method to use depends on the production system.

Job costing

Job costing is used when each cost unit is a single item, the time to complete a job is fairly short, and the business does many jobs in a year. Each job may involve similar work, but each is done to the customer’s own instructions.

The cost of a job

Actual costs of each job are recorded on a job cost card (job sheet), now usually a computer record. All documents for the job, such as stores issue notes and time sheets, must carry the job number. Every job has a unique number or code. Because every job is different, each is costed separately.

Two uses of job cost information:

• Before the work: an estimated cost is needed to quote a price.
• After the work: the actual cost is found, so that the profit or loss on the job is known.

A job costing system usually follows absorption costing, and adds a share of non-production overhead as well.

Direct expenses in job costing are more common than in other types of manufacturing. They include the hire of equipment for the job, work done by sub-contractors, and depreciation of equipment used only on that job. Production overhead may be absorbed per direct labour hour or on another suitable basis. Non-production overhead can be added as a percentage of the prime cost or of the production cost of the job.

Pricing from the cost

Most jobbing firms price by adding a profit to cost. Suppose Okoye Joinery adds a mark-up of 25% on total cost: price = ₦192,000 × 1.25 = ₦240,000, a profit of ₦48,000. If the firm worked instead to a margin of 20% of the selling price, the price would be ₦192,000 ÷ 0.80 = ₦240,000, which is the same here because a 25% mark-up on cost equals a 20% margin on price. Always read whether a percentage is on cost or on selling price.

Cost records and accounts for jobs

To cost each job there must be a way to charge direct costs to the right job, and to absorb overheads.

A job account is like a work-in-progress account for a single job. The costs go on the debit side. When the job is complete, the cost moves to cost of sales. For a firm that does mostly jobbing work, the work-in-progress control account is the total of all the individual job accounts. This is like a receivables control account supported by a ledger of customers.

A month of job costing

Nnewi Fabrication Ltd works on three jobs in March. A103 was started in February and had ₦40,000 of cost in opening work-in-progress. Labour costs ₦1,500 an hour and production overhead is absorbed at ₦1,000 per labour hour. Non-production overhead is added at 10% of production cost on completion.

A101 and A102 are finished. A103 is not. The two finished jobs go to cost of sales, with non-production overhead added: A101: 10% × ₦320,000 = ₦32,000, so total cost ₦352,000. A102: 10% × ₦252,000 = ₦25,200, so total cost ₦277,200. Contract prices are ₦450,000 and ₦340,000.

Double entry

The WIP control account shows: opening ₦40,000 + materials ₦275,000 − returns ₦5,000 + labour ₦255,000 + overhead ₦170,000 + hire ₦12,000 = ₦747,000. Transfer to cost of sales ₦572,000 leaves a closing balance of ₦175,000, which equals the cost of the unfinished job A103. ✓ If actual production overhead for the month was ₦178,000, the overhead is under-absorbed by ₦8,000 (₦178,000 − ₦170,000), which is charged to the income statement.

Information on a job cost sheet

• The job number, customer name and description of the work.
• Dates started and completed.
• Direct materials issued and returned, with quantities and costs.
• Direct labour hours and cost by grade or employee.
• Direct expenses.
• Production overhead absorbed and non-production overhead added.
• Total cost, selling price and profit or loss.

Batch costing

In batch costing, items are made in batches, also called production runs, rather than singly. Batch production is used when:

• the factory can make more than customers want, so it makes the product in occasional runs rather than continuously;
• the same machinery makes several products, so the machines switch between them, for example 100 tables, then 400 chairs, then 200 bookshelves; or
• it is impractical to make items except in groups, as with bread rolls baked several to a tray in the same oven.

The finished units go into finished goods inventory, and the product is not made again until stock runs down and another batch is needed.

Batch costing is like job costing, except that costs are attributed to a group of identical items, because it would not be cost-effective to treat each as a cost unit. The total cost of the batch is found, and divided by the number of units to give the cost per unit. It is less common to add non-production overhead to a batch, although it can be done.

Any set-up cost to prepare for the run can be charged directly to the batch.

Records follow the job pattern. Each batch has its own code. Materials requisition notes name the batch, and labour time is recorded on time sheets within each production cost centre. The batch account is debited with materials, labour, overhead and set-up cost, and credited with the transfer of finished units to inventory or cost of sales at cost per unit.

In ledger terms: debit the batch account and credit the materials, wages, overhead and set-up accounts as costs are incurred; then debit finished goods and credit the batch account.

The ideas in more depth

Why batch size matters

Set-up costs are fixed for each run, so the larger the batch, the lower the set-up cost per unit. In the example above, a set-up cost of ₦45,000 is ₦18 per unit on a batch of 2,500 and ₦9 per unit on a batch of 5,000. But bigger batches mean more stock and higher holding costs. This is the same trade-off that the economic order quantity addresses for purchases.

Job, batch and process costing compared

Strengths and weaknesses of job costing

• It gives the cost and profit of each job, which helps pricing and control, but it needs good records and discipline in writing the job number on every document.
• Estimates may differ from actual costs, so jobs should be compared with the estimate to improve future quotes.
• Overhead absorbed by labour hours depends on accurate time recording.

Job accounts and the ledger

A firm that does mostly jobbing work does not keep a separate WIP account for the whole factory. The WIP control account in the general ledger is supported by a subsidiary job ledger, in the same way that the receivables control account is supported by the customer ledger. At any time the control account balance must equal the total of the open job accounts.

Worked example: a job cost sheet and a price

1. Direct labour.
   (40 × ₦1,800) + (20 × ₦1,000) = ₦72,000 + ₦20,000 = ₦92,000.
2. Prime cost.
   ₦150,000 + ₦92,000 + ₦30,000 = ₦272,000.
3. Production overhead.
   60 hours × ₦700 = ₦42,000.
4. Production cost.
   ₦272,000 + ₦42,000 = ₦314,000.
5. Non-production overhead.
   15% × ₦314,000 = ₦47,100.
6. Total job cost.
   ₦314,000 + ₦47,100 = ₦361,100.
7. Price.
   ₦361,100 × 1.30 = ₦469,430.
   Profit = ₦469,430 − ₦361,100 = ₦108,330.

Overhead absorption in job costing with several departments

Where a job passes through departments that use different resources, each department has its own absorption rate. Job 305 spends 40 hours in the machining department, which absorbs overhead at ₦300 per machine hour, and 30 hours in finishing, which absorbs it at ₦250 per labour hour.

A single blanket rate would ignore the fact that machining has heavy equipment costs and finishing has little. Departmental rates give a fairer job cost.

Comparing an estimate with the actual cost

After the job is finished, the actual cost is compared with the estimate used in the quotation, so that estimating can improve. A furniture job was quoted at ₦480,000 and actually cost ₦526,000.

The biggest overrun is in materials (a price rise or wastage). If this recurs on several jobs, the estimator should revise the material allowances. A job price of ₦600,000 would have given a profit of ₦120,000 on the estimate (25% on cost) but only ₦74,000 on the actual cost.

Valuing unfinished jobs at the period end

At the end of a period, jobs not yet finished are in work-in-progress at the cost recorded so far. If a firm has three open jobs with costs to date of ₦175,000, ₦90,000 and ₦145,000, the work-in-progress in the statement of financial position is ₦410,000. Completed jobs not yet delivered are finished goods at cost. Jobs delivered are in cost of sales.

Because each job is recorded on its own account, valuing work-in-progress needs no estimate of the stage of completion, which is a strength of job costing compared with process costing.

Spoilage and rework in jobs

When work has to be redone, the treatment depends on the cause:

• Specific to the job (for example, the customer changed the specification, or the spoilage was unusually high on a difficult job): the rework cost is charged to that job.
• Normal and general to the business (some rework is unavoidable): the cost is a production overhead, spread over all jobs through the absorption rate.
• Abnormal (a careless mistake): written off as a loss in the income statement and not charged to the customer’s job.

If ₦12,000 is spent redoing a job because the customer altered the design, the ₦12,000 is part of that job’s cost and should be recovered in the price.

The most economical batch size

Batch size involves a trade-off. Larger batches spread the set-up cost over more units but increase stock and holding costs. The economic batch quantity uses the same formula as the economic order quantity: EBQ = √(2 × set-up cost × annual demand ÷ holding cost per unit per year). With a set-up cost of ₦45,000, annual demand of 20,000 units and holding costs of ₦90 per unit a year:

EBQ = √(2 × 45,000 × 20,000 ÷ 90) = √20,000,000 = 4,472 units. That means about 4.5 batches a year (20,000 ÷ 4,472). Annual set-up cost = 4.47 × ₦45,000 = ₦201,246, and annual holding cost = (4,472 ÷ 2) × ₦90 = ₦201,240, which are equal at the optimum, as in the economic order quantity (EOQ) model.

Which method fits which business?

Common mistakes in the exam

• Applying the production overhead rate to the wrong base, for example using total hours when the rate is per direct labour hour of one grade only.
• Leaving direct expenses out of prime cost.
• Applying non-production overhead to prime cost when the question says production cost, or the reverse.
• Confusing mark-up on cost with margin on selling price.
• Forgetting opening work-in-progress when a job is carried forward from a previous period.
• Forgetting to credit the job for materials returned to stores.
• Dividing a batch’s cost by planned units instead of units actually produced.
• Omitting set-up costs from a batch.

Quick revision

• Job costing: single, customer-specific orders. Job number on every document. Job cost card or account.
• Job cost = prime cost + production overhead absorbed + non-production overhead. Price = cost + profit.
• Job account is like a WIP account for one job. WIP control = total of open jobs. Completed jobs go to cost of sales.
• Batch costing: groups of identical items. Cost per unit = total batch cost ÷ units. Set-up costs charged to the batch.
• Batch used when capacity exceeds demand, when machines switch between products, or when items must be made together.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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