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2.4 Job Costing in Service Organizations

Learning Objective

  1. Apply job costing methods to service organizations.

Question: Although this chapter has focused on job costing in a manufacturing setting, many service organizations use job costing as well. Electricians, accountants, and auto mechanics are examples of service providers that use job costing. Electricians track costs by project (e.g., a new building or a kitchen remodel), accountants track costs by client (e.g., an individual or a corporation), and auto mechanics track costs by job (e.g., replacing a drive belt on a company truck). How does job costing work in a service company setting?

 

Answer: 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, as shown in Table 2.2 "Accounts Used in Service Organizations and Manufacturing Organizations".

Table 2.2 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.

Service organizations use a job cost sheet like the one discussed earlier to track direct materials, direct labor, and overhead.

Direct Materials

Question: How do service organizations track direct materials using job costing?

 

Answer: 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 (refer back to Figure 2.3 "Job Cost Sheet for Custom Furniture Company" for an example).

Direct Labor

Question: How do service organizations track direct labor using job costing?

 

Answer: 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 (refer back to Figure 2.4 "Timesheet for Custom Furniture Company" and Figure 2.5 "Direct Labor Costs for Custom Furniture Company’s Job 50" for examples).

Overhead

Question: Like manufacturing companies, service organizations often use a predetermined overhead rate to apply overhead. What allocation bases are most commonly used by service organizations to apply overhead costs to jobs?

 

Answer: 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 (refer back to Figure 2.6 "Overhead Applied for Custom Furniture Company’s Job 50" for an example).

Business in Action 2.2

Job Costing at Movie Studios

Studios that produce costly movies, such as 20th Century Fox, Universal Studios, and Warner Brothers, incur a variety of costs that are tracked using a job costing system. For example, the production of a Harry Potter movie requires direct labor in the form of actors, directors, editors, and the film crew. The direct materials category includes costumes, extensive sets, and props. Overhead costs include items such as depreciation of film production equipment, utilities in the editing studio, and executive salaries for those overseeing the production of several films concurrently.

Determining the production costs of movies and related profitability is important for this industry since actors, directors, and others involved in the film are often compensated based on a percentage of profits. Disagreements sometimes arise between studios and actors regarding the accuracy of costs for movies, particularly in the area of overhead. Some studios have been accused of allocating too much overhead to individual films to drive down the reported profitability of each film, thereby reducing the amount owed to those receiving a portion of the profits.

Key Takeaway

  • Job costing systems in service organizations are similar to those used by manufacturing companies. However, service organizations use fewer materials than manufacturing organizations, the account names they use are slightly different, and they often track costs by customer rather than by product.

Review Problem 2.4

Describe the similarities and differences in how service companies and manufacturing companies account for direct materials, direct labor, and overhead.

Solutions to Review Problem 2.4

The similarities and differences in how service companies and manufacturing companies account for direct materials, direct labor, and overhead are as follows:

  • Direct materials. The cost of direct materials for many service companies, such as accounting and law firms, is insignificant. These companies therefore do not track direct materials for each job. However, service companies that use costly materials, such as an auto repair shop, do track direct materials for each job. Because direct materials tend to be costly for manufacturing firms, these firms typically track direct materials for each job.
  • Direct labor. Because direct labor tends to be the most significant cost for service companies, these companies track costs by job using a timesheet and job cost sheet, just as manufacturing companies do.
  • Overhead. Service and manufacturing firms track overhead costs in a similar way. Both often use a predetermined overhead rate to charge overhead costs to jobs. Because overhead is typically driven by direct labor hours in a service company, direct labor hours are often used as the allocation base. The process of recording overhead costs in the journal and job cost sheet is the same for both types of firms.