Are you tired of going over budget on projects and wondering what to do about it? An important part of a chief financial officer's job is managing projects through job costing. Accountants in industries like construction, marketing, and manufacturing need to be experts in job costing in order to price their products and services properly.

In this essential guide to job costing, you'll learn about types of job costing, why job costing is important for medium-sized businesses, and challenges and tips for managing job costing effectively.

We'll also explore how QuickBooks Online Advanced can help streamline the entire process — so you can focus on your business, not cost overruns. 

Table of Contents

• What is job costing?
• Common job costing challenges
• What is process costing?
• What are the benefits of proper job costing?
• How to calculate job costs
• Job costing best practices for mid-sized businesses
• FAQ

What is job costing?

Job costing is an accounting technique used to track the expenses of a specific project or job. Allocating costs to jobs or projects allows finance managers to determine the profitability of those jobs.

Three key elements are required to calculate job costing effectively: direct materials, direct labour, and overhead.

If a construction company in the business of building new homes wants to make sure each home is profitable, they can use job costing to track the direct materials, direct labour, and overhead costs associated with each new build.

Costs in each category might include:

• Direct materials: lumber, concrete, paint
• Direct labour: employee wages, subcontractors, site management
• Overhead: administrative wages, equipment costs, insurance, permits, safety gear and equipment

What types of businesses use job costing?

All types of businesses, both service-based and product-based, use job costing. Any business interested in learning about the profitability of their projects can use job costing.

Here are some types of businesses that most commonly use job costing:

• Service-based: marketing agencies, consulting firms
• Product-based: construction, manufacturing, custom production (such as handmade furniture)

Growing businesses should consider adopting job costing because it helps monitor operational efficiency and profitability.

Why is job costing important for mid-sized businesses?

As a business grows, it can be easy to lose sight of the true costs associated with individual projects. This can occur due to a number of reasons, including not having enough accounting staff to keep up with project demand and not having a proper system for tracking costs.

If job costing is forgotten because there are more pressing issues in the business, this can lead to budgeting issues, missed financial targets, and difficulty making informed decisions.

An effective job costing system is important for:

• Financial control
• Scalability
• Decision-making
• Compliance
• Stakeholder communication

Financial control helps track profitability per job. This becomes more important the more diverse the projects are. As a business scales up, job costing helps with efficient resource allocation.

Pricing and cost management are key when it comes to financial decision-making, and job costing helps guide both. Clear cost tracking is also important when it comes time to communicate project value to stakeholders.

Common job costing challenges

As companies scale and handle more complex projects, job costing can become challenging. Some difficulties include data accuracy and consistency, overhead allocations, and scalability of costing methods.

Data accuracy and consistency

The larger a business becomes, the more data there is to record. Add to this the fact that mid-sized businesses are working on multiple projects at one time, and it becomes easy for employees to accidentally record costs inconsistently. A variety of tools are often used to manage operations, leading to manual data transfers between systems. This type of data entry can lead to inaccurate job cost reports and poor financial decisions.

To maintain data accuracy and consistency, implement standard data entry procedures and train staff on job costing best practices.

Overhead allocations

Overhead costs such as rent, equipment maintenance, administrative salaries, and insurance aren't directly tied to a single project but still impact profitability. If these costs are incorrectly attributed to projects, profitability per job can end up distorted.

Clear guidelines for how overhead costs are to be allocated will help ensure more precise job costing.

Scalability of costing methods

As a business grows, solutions or software that used to work to keep track of job costing may no longer be adequate.

For many mid-market businesses, manual or basic job costing methods aren't efficient. Automated systems and scalable solutions like QuickBooks Online Advanced can help improve job costing efficiency as a business grows.

If mistakes are made during job costing calculations, it will be difficult to manage the budget and make informed financial decisions.

Some of the most common errors that lead to inaccuracies in job costing include:

• Inconsistent data entry
• Incorrect overhead allocation
• Overlooking small expenses
• Failing to update job cost data regularly

What is process costing?

Process costing is an accounting method used to allocate costs across continuous production processes. For example, a mid-sized company produces large batches of the same product in a continuous flow, such as 10,000 bottles of orange juice in one production run. Because there is no customization in this production run, job costing isn't the best choice for analyzing costs in this situation.

For an industry like beverage manufacturing, process costing is more efficient because it averages the total production costs across all identical units.

Job costing vs. process costing

The main difference between job costing and process costing is that job costing is used to track costs for unique jobs or projects and process costing is used to track costs for mass production of identical items.

• Here are some characteristics to help you know when to use each:

What are the benefits of proper job costing?

1. Job costing can help financial managers understand which jobs bring in the most value by comparing the costs of that job to the revenue earned from it.
2. Using profitable jobs as a benchmark, managers can break down costs to create more accurate forecasts for future jobs. This type of analysis can help while jobs are in progress so that project efficiency is monitored and any issues are addressed promptly.
3. More accurate and detailed data helps businesses make better financial decisions based on clear and accurate financial reporting. 

How to calculate job costs

The key to calculating job costs is identifying the direct materials, direct labour, and overhead to be allocated to the job.

Formula:

Total job cost = Direct materials + Direct labour + Overhead

Direct materials

These are materials used for a specific job.

For example, a graphic design agency working on a custom branding package for a client might have direct materials of stock images, printing materials, and specialized design software that will only be used for that project.

Direct labour costs

Direct labour costs are the wages and salaries of employees who are directly working on the project. This would also include any fees paid to subcontractors working on the project.

Overhead

Because overhead costs apply to more than one specific project, these costs must be allocated in a predetermined way.

There are several ways to allocate overhead costs. The most common are:

• Direct labour cost
• Direct labour hours
• Machine hour rate
• Activity-based costing (ABC)
• Predetermined overhead rate

How to allocate overhead costs

Let's take a look at some of the ways overhead costs can be allocated and determine when to use each one.

Direct labour cost

Labour costs are a significant expense of many projects, so this method is widely used. The overhead rate is calculated as total overhead divided by direct labour costs. This method is best used when labour is the primary cost driver of the project, such as for a custom home build.

Example:

If total overhead is $50,000 and total direct labour costs are $100,000, the overhead rate is 0.50 ($50,000/$100,000).

To calculate the overhead for the project, multiply this rate by the direct labour costs for the project.

If direct labour costs are $20,000, the overhead allocated to the project is $10,000 ($20,000/0.50).

Direct labour hours

This method is similar to the direct labour cost method, except it uses labour hours for the calculation rather than dollars. The overhead rate equals total overhead divided by total direct labour hours.

Example:

Let's say total overhead is $30,000 and total labour hours are 1,500. The overhead rate is $30,000/1,500 hours = $20 per labour hour.

If a job takes 50 hours, then its overhead allocation is 50 hours x $20 = $1,000.

This method is best for industries where labour drives costs, such as creative services or manual production.

Machine hour rate

Using the machine hour rate, the overhead allocation is calculated using machine hours.

Overhead rate = Total overhead / Total machine hours

Example:

If total overhead is $40,000 and total machine hours is 2,000, the overhead rate is $20 per machine hour.

If the job uses 100 machine hours, the overhead allocated to the project is 100 hours x $20 = $2,000.

This method is best for manufacturing companies with machine-intensive processes.

ABC method

The ABC method of allocating overhead is more complicated because it uses multiple cost drivers that relate to the activities involved in the project. This method is also more precise because of that.

To use the ABC method, you must identify major activities involved in a project (such as machine set-up and quality control), assign costs to those activities, determine the cost drivers for each activity, and apply the overhead rate based on the usage of cost drivers.

Example:

Say machine set-up costs $10,000. The number of set-ups during that period is 50.

Cost per set-up is $10,000/50 = $200 per set-up.

If a project involves 3 set-ups, then the overhead costs for that project are $600 (3 set-ups x $200).

This method is best for businesses with diverse activities, like manufacturing projects with multiple production stages.

Predetermined overhead rate

A predetermined overhead rate is calculated at the beginning of a project based on estimates rather than actual costs.

To calculate the predetermined overhead rate, take the estimated total overhead and divide by the estimated activity base (such as hours or costs).

Example:

If total overhead is estimated at $25,000 and total hours during that period are 5,000, the predetermined overhead rate is $25,000/5,000 hours = $5 per labour hour.

If a project takes 200 hours to complete, the overhead for that project is 200 hours x $5 = $1,000.

This method is best for companies looking for simplicity, where actual costs aren't available or are difficult to predict.

Job costing example

Let's calculate job costs for a furniture manufacturing company that builds custom dining tables for a client.

From looking at the company's books and records, we know that:

• Direct materials of lumber, paint, and varnish cost $2,000
• Direct labour is the carpenter's wages of 50 hours at $40 per hour = $2,000
• Total overhead for all jobs during the period = $50,000
• Direct labour costs for all jobs during the same period = $100,000

Because this is a custom project where hours could vary, the overhead is best calculated using the direct labour method.

The job costs are calculated using the following steps:

1. Calculate the overhead rate using the direct labour cost method

Overhead rate = Total overhead for all jobs / Direct labour for all jobs

Overhead rate = $50,000/$100,000 = .50 or 50%

2. Calculate overhead for the dining table job

Reminder: Direct labour costs for the job are $2,000.

Overhead for the job = $2,000 x 50% = $1,000

3. Calculate total job costs

Total job costs = Direct materials + Direct labour + Overhead

$2,000 + $2,000 + $1,000 = $5,000

The total cost of building the custom dining table is $5,000.

Job costing best practices for mid-sized businesses

To avoid costly mistakes when job costing, consider automating time tracking and expense recording. Integrate systems to ensure consistent data flow from one tool to the next. Regular reviews of job costing reports will help identify missing expenses or calculations that have been done incorrectly.

It's also important to properly train the team that will be responsible for data entry and cost reporting. Solutions like QuickBooks Online Advanced can help with automation, data flow, and reporting.

When it comes to job costing, QuickBooks Online Advanced is ideal for growing businesses with complex workflows.

Some of the features that relate directly to job costing include:

• Job cost tracking
• Customizable reports
• Integration with time-tracking apps

You can also automate manual tasks and view insights through user-friendly dashboards to ensure your data is optimized for decision-making.

Get in touch with QuickBooks for more information.

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