Cost Accounting For Dummies. Kenneth W. Boyd

Learning to use a normal costing system

      

Applying indirect cost to the budgeting process

      Job costing is a costing methodology you use when your customers incur unique amounts of costs. Job costing assesses costs by the job and allows you to provide detailed price estimates based on the product constructed or service provided.

      By contrast, process costing (the topic of Chapter 16) assumes that individual product costs are nearly the same for every customer. For example, if you manufacture office chairs, each chair of a particular model has the same costs. You use the same amount of metal and material, and assemble the chair using the same amount of labor. If you calculate the cost for one chair, you know the cost for every chair of that model. In other words, the customer does not have the option to create his or her own unique product with unique costs.

Roofs (for example) aren’t like chairs. If your business puts roofs on houses, each client’s costs will be different. The amount of material depends on the type of roof and the square footage. Labor time varies, depending on the roof’s size, pitch, and unique angles. This is an example of job costing.

      When you’re deciding on which costing method to use, keep in mind how specific or unique your product or service is. Do the costs differ a great deal from one customer to another? If they do, your business should probably use job costing. Otherwise, use process costing.

      In this chapter, you see when job costing is the appropriate costing method to use. You also see how to apply both direct and indirect costs. (If you’re not sure about the definitions of direct and indirect costs, they’re covered later in this chapter.)

Understanding How Job Costing Works

      For some businesses, nearly every customer job has different costs, and that’s where job costing asserts its value. You need a job costing estimate in order to get the customer’s business, and you need to track costs accurately so you generate a reasonable profit.

      The different costs for different jobs will often be self-evident. Material costs, labor hours, mileage cost, and type of equipment used are likely to vary. For example, a tree trimming company would incur more costs to remove a 30-foot tree than to remove a small stump. The big tree takes more labor and different equipment.

      Some factors could lower costs and make a business more competitive in price (or improve its bottom line). For example, every few months I receive a flyer in the mail or a knock on my front door from a tree trimming company working on a job in my neighborhood. They offer me a free estimate while they are in my neighborhood. It’s a smart business move. If you’ve incurred the cost to locate your employees and equipment in a certain area, why not perform as much work as possible while you’re there? You can spread some costs (mileage, for example) over several jobs. As a result, your cost per job in that neighborhood is lower, and you increase your profit.

      The business lesson is that a little bit of flyer can go a long way.

      Cost objects: The sponges that absorb money

      A cost object is anything that causes you to incur costs. Think about a cost object as a sponge that absorbs your money. The object can be a customer, job, a product line, or a company division. Carefully identifying cost objects will help you cost your product or service accurately.

      Assume you manage a group of plumbers. You’re reviewing the month’s mileage expense (the equivalent of gasoline) for your staff and notice a 20 percent increase from the prior month. Why? You start asking questions. As it turns out, the customer demand for plumbing work required your staff to drive more miles. The average customer lived farther away.

      You grumble, “That driving ran up a lot of costs!” Yes, it did, and you do the driving to meet the needs of your customers. In this example, the cost object was the group of customers for the month. Without any customers, you wouldn’t have paid for all the gas. (Well, you wouldn’t have had any income either, but never mind that.) No cost object means no costs incurred.

      Direct costs are traced to the cost object, and indirect costs are allocated to the cost object.

      Indirect costs can be fixed or variable. Insurance costs on vehicles would be a fixed indirect cost. The premiums are fixed, and the cost is indirect to the job because you can’t trace the vehicle insurance cost directly to a specific job. Utility costs for the office (such as heating and cooling) are variable indirect costs. Costs vary with the weather, but as with the insurance premiums, you can’t trace them directly to any one job.

      

This list explains how fixed and variable costs are assigned to cost objects:

       Direct costsVariable direct costs, such as denim material, where denim jeans is a cost objectFixed direct costs, such as a supervisor salary at an auto plant, where an automobile produced is the cost object

       Indirect costsVariable indirect costs, such as utility costs for a television plant, where a television produced is the cost objectFixed indirect costs, such as insurance for a plumbing vehicle, where a plumbing job is a cost object

      Charging customers for direct and indirect costs

      To bill a customer and calculate a profit, you must add up all the costs for that customer, whether they are direct or indirect costs.

      If, for example, you manufacture kitchen countertops, you would want to include all direct and indirect costs of a custom countertop installation in order to bill the customer. A direct cost might be marble (for material). To find the total cost of material for the job, you’d compute direct material cost as (marble) × (quantity used).

      Indirect costs are different. If your kitchen countertop business makes lease payments on an office building, the cost is indirect. You can’t know the exact amount of indirect costs for the client. You also can’t trace the cost directly to a specific customer, but you can allocate it using a cost allocation base.

      

For job costs to be accurate, you need to collect information before you bill the client. You also need to consider the difference between your cost estimate and the final bill. Your client needs to understand how costs higher than the estimate will be handled. Should the customer expect to pay it, or will you absorb the cost (and lower your profit)? If this isn’t handled correctly, the customer may be upset. Unforeseen things happen, of course, and you should explain when you hand the customer the estimate that the final bill may be different. A customer would likely accept additional labor costs. That’s because the exact cost of labor is probably hard for you to predict.

      Think about allocating indirect costs this way: There’s a dollar amount of cost to allocate (say, $100). You spread that cost over a group of customers, a level of production, or some other activity level. In this section, you see how that might work.

      A carpenter owns trucks that require repair and maintenance expense. That cost can’t be traced to specific customers; instead, these indirect costs are allocated to a cost object. You find a “best” method to assign repair and maintenance expense to clients, perhaps labor hours worked for the customer.

      The logic is that if you worked more hours for a specific customer, you probably used your truck more. If you used the truck more, that customer should absorb more of your truck’s repair and maintenance cost.

      It’s virtually impossible to trace the repair and maintenance cost of the truck back to a specific customer.