In: Accounting
Manufacturers and service organizations often use job order costing to track direct labor costs.
Job order costing is a system companies use when they can trace costs to a specific product or service. It allows managers to accumulate costs by jobs instead of departments. A job could refer to a service performed or a customer. Job order costing gives companies in all industries the ability to evaluate costs accurately and price services correctly.
At a manufacturing facility, direct materials—the raw materials that workers use to create products—are likely to be expensive and require highly specific tracking and inventory. But in a service business, such as an accounting or legal firm, direct materials may not be significant expenses. Most materials that the accountants or lawyers and their support staff use will have insignificant cost that an accountant would allocate to the job as overhead. This is not true in all service firms, though. An auto repair shop is a service business, since it is providing a service rather than producing a product. While a significant cost for an auto repair shop is labor, the costs of parts can also be significant. So the accountant for an auto repair shop would include direct materials in job costing.
A service firm uses a job cost sheet to accumulate all costs related to a specific job. In a white-collar firm where labor may be the only direct cost, employees would fill out a time sheet as the costing document. A time sheet, or time ticket, is a paper form or spreadsheet that employees use to record the amount of time they spent working on a job. Members of a CPA firm would use a time sheet to indicate start and stop times where they worked on projects for clients. CPA firms classify employees into groups, such as partner, auditor, senior accountant, and junior accountant. The firm's cost accountant would calculate the costs associated with each employee based on the employee's classification. The cost accountant would apply overhead based on the allocation base and rate. Most service organizations use direct labor as the allocation base.
The challenge in a service organization occurs when trying to determine how to bill for 100% of an employee's cost. While employees do not work 100% of the time on a job, the company needs to cover 100% of the cost of the employee in its billing. The time that employees are paid for work not directly related to a customer or job needs to be considered in determining the rate of pay associated with the work performed. The challenges in this area differ based on the type of service organization.
All organizations need to determine a reasonable percentage of employees' time that is spent as direct labor. In an accounting firm, where most of the labor costs are fixed, staffing must align customer demand and capacity. For situations in which customer demand and capacity do not align, the company will have to pay employees their salaries even though there is little or no work available for them to perform.
Service organizations do not always use salaried employees to perform direct labor. Employees doing direct labor work in service companies can be paid hourly. Some examples of service industry workers who are hourly are those who work for cleaning businesses and repair services. Also, social service agencies often pay social workers and other caseworkers on an hourly basis. When service workers are hourly, management can align hours worked versus the hours on a job by the workers' schedule. If demand decreases, then the person works fewer hours and earns less.