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20.2 Describe and Identify the Three Major Components of Product Costs under Job Order Costing

Product Costs in Job Order Costing​

Under job order costing, product costs consist of three major components:

  1. Direct Materials
  2. Direct Labor
  3. Manufacturing Overhead

These three components together make up the total cost of a job.

Direct Materials​

Direct materials are raw materials that become an integral part of the finished product and can be easily traced to specific jobs.

Characteristics:

  • Physically become part of the product
  • Can be easily traced to specific jobs
  • Significant cost
  • Examples: Wood for furniture, fabric for clothing, ingredients for custom cakes

Example: For Marie's catering job:

  • Direct materials: Food ingredients (€200), beverages (€150), packaging (€50)
  • Total direct materials: €400
  • These can be directly traced to the specific catering job

Accounting:

  • Recorded on job cost sheet
  • Debited to Work in Process
  • Credited to Raw Materials Inventory

Direct Labor​

Direct labor is the labor cost of employees who work directly on the product or service being produced.

Characteristics:

  • Work directly on the product/service
  • Can be easily traced to specific jobs
  • Significant cost
  • Examples: Carpenter building furniture, chef preparing custom meal, consultant working on client project

Example: For Marie's catering job:

  • Chef time: 8 hours × €25/hour = €200
  • Server time: 6 hours × €15/hour = €90
  • Total direct labor: €290
  • These hours can be directly traced to the specific job

Accounting:

  • Recorded on job cost sheet
  • Debited to Work in Process
  • Credited to Salaries/Wages Payable

Manufacturing Overhead​

Manufacturing overhead (also called factory overhead or indirect costs) includes all manufacturing costs that cannot be easily traced to specific jobs.

Characteristics:

  • Cannot be easily traced to specific jobs
  • Indirect costs
  • Applied to jobs using allocation
  • Examples: Rent, utilities, indirect labor, depreciation, insurance

Types of Overhead:

  • Indirect Materials: Materials used but not directly traceable (glue, screws, cleaning supplies)
  • Indirect Labor: Labor not directly working on products (supervisors, maintenance, security)
  • Other Overhead: Rent, utilities, depreciation, insurance, property taxes

Example: For Marie's restaurant (catering operation):

  • Kitchen rent (allocated): €500
  • Utilities (allocated): €200
  • Equipment depreciation: €150
  • Insurance: €100
  • Total overhead: €950
  • Cannot be directly traced to one job (shared across all jobs)

Accounting:

  • Accumulated in Manufacturing Overhead account
  • Applied to jobs using predetermined rate
  • Debited to Work in Process (when applied)
  • Credited to Manufacturing Overhead (when applied)

Total Job Cost​

Formula: Total Job Cost = Direct Materials + Direct Labor + Applied Manufacturing Overhead

Example: Marie's catering job:

  • Direct materials: €400
  • Direct labor: €290
  • Applied overhead: €200 (calculated using overhead rate)
  • Total job cost: €890

Cost Classification Summary​

Product Costs (Inventoriable):

  • Direct materials
  • Direct labor
  • Manufacturing overhead
  • Become part of inventory until sold

Period Costs (Expensed Immediately):

  • Selling expenses
  • Administrative expenses
  • Not part of product cost
  • Expensed in period incurred

Service Companies​

For service companies, the three components are similar but may be called:

  • Direct Materials: Supplies used for specific clients
  • Direct Labor: Time spent on specific clients
  • Overhead: Indirect costs allocated to clients

Example: Consulting firm:

  • Direct materials: Travel, supplies for client
  • Direct labor: Consultant hours on client project
  • Overhead: Office rent, utilities, support staff

Luxembourg Compliance Note​

In Luxembourg:

  • Product costs must be properly classified
  • PCN accounts support cost tracking
  • Direct costs should be directly traceable
  • Overhead allocation must be reasonable
  • Cost records support tax compliance
  • Consider VAT in cost analysis (exclude recoverable VAT from costs)

Think It Through​

Why is it important to distinguish between direct and indirect costs? How does this distinction affect job costing accuracy?