Job Order Costing: What It Is And Examples

You’re going to need to calculate the cost of each product individually to know how much you need to charge your customer to make a profit. This process is called job order costing.

What Is Job Order Costing?

Job order costing is a system for determining the cost of each individual product a company provides for a customer, whether that product is a service or a physical item. This method considers the cost of the materials, labor, overhead, and other expenses that go into producing that product.

If your company sold the same product to every customer, you would only need to do this once since your costs would be the same for each item. Because your company provides a unique product or service to each customer, however, you need to complete this process for each order.

How To Calculate Job Order Costs

If you’ve started a business that provides custom or semi-custom products, chances are you’re going to need to start job order costing. While this process will look different for each company, there are some basic elements that you need to make sure you account for when you do this:

1. Materials. Every product requires materials of some kind, whether they’re construction materials for a remodeling project or ink and fabric for custom T-shirts. When you calculate the amount you’re spending on materials, make sure you include these obvious costs as well as the hidden expenses.

   For example, designers at a company that does kitchen remodel need paper, computer software, and samples to begin the process of remodeling a client’s kitchen. These costs are incurred long before the materials for the actual construction project are needed, but they are just as important to calculate.

   Also, if your company manufactures custom parts and your machines require coolant or some other material to run, include this in the cost of materials as well. Even though they won’t show up in the final product, these items play a vital role in making sure it’s completed.

2. Direct expenses. In addition to the materials you need to complete a project, you should also add any other directly related expenses required to make it happen.

   If your kitchen renovation company contracts with designers instead of hiring an in-house team, for instance, the amount you pay those contractors for the project is an example of a direct expense you’d need to account for.

   Similarly, you should include anything else you have to pay for in order to complete the project, whether that is purchasing tools, repairing equipment, or renting a truck.

3. Labor. Not only does each product your company produces require materials, but it also requires man-hours. Again, though, make sure you aren’t just calculating the obvious hours that went toward producing a product; be sure to note the work that went in behind the scenes as well.

   For a kitchen renovation company, this would include the designers, construction crew, managers, and delivery drivers.

   However, you likely wouldn’t include the customer service representatives’ cost, technicians in charge of maintaining the company’s vehicles, or the security guards in this calculation, as they are not directly involved with this specific project.

   Add these into your calculations for your overhead expenses, or talk to your accountant about the best way to account for them.

4. Overhead. This is often the most complicated cost category to accurately calculate since your overhead costs are more difficult to break down by project.

   This category includes expenses such as electricity, water, natural gas, trash collection, equipment depreciation, land depreciation, and property taxes.

   In order to calculate the cost of these elements for an individual project, you’ll need to start by estimating your total overhead for the year. Once you have that, you can divide it by your estimated number of machine or labor hours for the year.

   This will give you an hourly estimated rate that you can use to determine how much overhead a particular project will require.

   If, for example, you estimate that your annual overhead cost is $100,000 a year and that you’ll have 25,000 labor hours during that year, your hourly overhead rate will be $4.

   So, if a particular project requires 100 labor hours to complete, you’ll need to account for $400 in overhead.

Job Order Costing Example

To flesh out the steps above, here is an example of what job order costing would look like if you were running a custom t-shirt company.

These steps will look different for your company, and it’s always a good idea to talk to an accountant to make sure you’ve covered everything, especially as your business grows and you add expenses and employees, but this example will at least give you an idea of the basics to help you get started.

1. Calculate the cost of materials. If you needed to determine the cost of an order for 2,000 custom t-shirts, you’d start by adding together the cost of the blank t-shirts, the ink they’ll require, any items you’ll need to run the printing machines, and any packaging or shipping supplies. In this example, this adds up to $150.

2. Take into account any other direct expenses. Once you know how much the materials to make your product cost, it’s time to add in any other expenses that go toward completing it.

   One of these expenses in this example is the software your customers used to place their orders and create their t-shirt design. This costs you $5,000 a year to run, but you can’t charge one customer for that amount, so you need to break it down into a rate you can charge per order.

   If you estimate that you’ll have 3,500 customers for a year, you’ll divide $5,000 by 3,500 to get a rate of about $1.43 per order. You can add this amount to each customer’s bill to cover the costs of your platform.

   Another major expense in this category is delivery. If you aren’t charging separate shipping fees, you’ll need to include those as well, whether you choose to mail the product or deliver it on company trucks. In this case, these add up to $40.

3. Calculate any direct labor costs. It takes a team of people to complete an order, and you need to pay those workers, so it’s important to account for that in your order costing as well.

   While your customers create their designs on your t-shirt company website, you also have a team of designers who make sure the designs are optimized for printing, and you pay each one of them $30 an hour (including benefits). One designer can complete this particular project in an hour, so you’ll add $30 to the cost sheet.

   You also have a floor manager and technicians who handle the actual printing of the shirts. You pay the technicians $20 an hour, including benefits, and one of them can complete this order in an hour, so that adds another $20 to the total cost.

   You pay your floor manager $30 an hour, including benefits, and they cover an average of five orders each hour, so that adds $6 in expenses to this job.

   Your grand total for direct labor costs for this project is $56.

4. Account for overhead costs. Finally, you’re going to add in the overhead that this project requires.

   To calculate the hourly rate you’ll need to charge, start by finding your total overhead for the year by adding together your utility bills, machine, building, and land depreciation, repair, and upkeep costs, taxes, and anything else required to keep your machines running and your lights on.

   This may include computer programs, security guards, and janitorial staff, and supplies as well, but talk to your accountant about how you should calculate it all.

   Adding all of this together, in this example, you find that your overhead is $200,000 a year.

   You obviously can’t charge one customer for this amount, so you’ll need to break it down by machine hour or labor hour. This simply refers to the number of hours your company is actively producing something. So, if you have four machines running 40 hours a week, 52 weeks a year, you’ll have 8,320 machine hours.

   In this example, you have an average of 14 workers at a time running orders 40 hours a week, 52 weeks per year, which gives you 29,120 labor hours. Divide your $200,000 overhead by 29,120 labor hours, and you get an hourly overhead rate of about $6.90. So, if this order takes two hours total to complete, you’ll need to add $13.80 to the order for overhead costs.

5. Add it all together. With $150 in materials, $40 in shipping, a $1.43 software charge, $56 in labor, and $13.80 in overhead, the total costs for this job are $261.23. You can now use this number to inform how much you want to charge for the order so that you can cover your business expenses and still make a profit.

Author

Abby McCain

Abby is a writer who is passionate about the power of story. Whether it’s communicating complicated topics in a clear way or helping readers connect with another person or place from the comfort of their couch. Abby attended Oral Roberts University in Tulsa, Oklahoma, where she earned a degree in writing with concentrations in journalism and business.