Learning Outcomes
- Calculate job costs for a service business
Before we dive into using job costing for a manufacturing firm, let’s look at a simpler example: a service business.
Job order costing can be used for service businesses where the service and costs are unique to each customer, such as those of an attorney, accountant, physician, or event planner. Each customer, client, or patient is a separate job or project. Clients, customers, and patients incur direct costs, direct labor, and applied overhead costs. And while there are no materials related to inventory for a service business, there may be expenditures associated directly with a particular project, such as travel or supplies.
Creative Compton, Inc. is an advertising agency that designs web sites and promotional materials for medium-sized businesses. For each client project, Creative Compton (CC) accumulates the direct labor costs of its professional designers at an hourly rate of $140. The company allocates overhead costs to jobs at a rate of 35% of total direct labor cost incurred.
Let’s keep it really simple and assume that CC has only two clients, and the marketing manager sent them the following proposals based on her best estimate of the amount of time each job would take, applying a rate of $200 per hour to come up with the amount she would charge each client:
IceBurg Drive-in Burgers: $44,000 (220 hours of work at $200/hour)
Laney’s Fashions: $18,000 (90 hours of work at $200/hour)
The companies accepted the bids, and the work was passed on to staff.
The data for each project as completed is as follows:
| IceBurg Drive-in Burgers | Laney’s Fashions | |
|---|---|---|
| Actual Direct Labor | 200 hours | 100 hours |
| Software Licensing | $500 | $2,000 |
| Travel | $160 | $0 |
What is the total calculated cost of each job?
| IceBurg Drive-in Burgers | Laney’s Fashions | |
|---|---|---|
| Direct costs | 200 labor hours * $140/hour = $28,000
Licenses and travel = $660 Total direct costs = $28,660 |
100 labor hours * $140/hour = $14,000
Licenses and travel = $2,000 Total direct costs = $16,000 |
| Indirect costs @35% of DL$ | $28,000 * 0.35 = $9,800 | $14,000 * 0.35 = $4,900 |
| Total costs, direct and indirect | $38,460 | $20,900 |
Did the company make or lose money on these jobs?
| IceBurg Drive-in Burgers | Laney’s Fashions | |
|---|---|---|
| Revenue | $44,000 | $18,000 |
| Costs, direct and indirect | $38,460 | $20,900 |
| Made/(Lost) | $5,540 | ($2,900) |
Although the contract for Laney’s of $18,000 covered the $16,000 direct costs, it did not contribute sufficiently to overhead, and so the company lost money on that bid.
Management will have to determine what action to take, if any, but this illustrates the power of full absorption costing and job costing to help determine the actual cost of a project.
Before we apply these basic job costing concepts to a manufacturing environment, check your understanding of job costing with regard to a service company.
