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A job order system is a cost allocation method used in management accounting. The job order system works best for companies that produce individual goods or distinct customer services. The system tracks direct materials, direct labor, and manufacturing overhead for each project individually. Service companies also use this system heavily. For example, accountants and lawyers bill clients for specific activity related to a job. Record keeping can be quite complex to accurately track all the paperwork in the system.
Direct materials represent all raw goods necessary to produce a product. The job order system will typically require a bill of goods to start tracking the job. Management accountants will record the information from this ticket into a ledger report. Any additional bills of goods for the project will also go on this report. The information contains data related only to the materials used and allocated to the project.
Direct labor includes all man-hours required to transform raw materials into finished goods. The job order system tracks this information by job using employee time cards. Accountants record the time each employee worked on the job or project. Most companies can keep track of this information daily using an electronic time-keeping system. Manual systems may require recording and reporting of data on a weekly or monthly basis to reduce the time spent on this process.
Manufacturing overhead is the last cost piece in the job order system. Overhead represents all items indirectly related to the production of goods or services. Most companies apply manufacturing overhead using a predetermined overhead rate. The calculation for this is estimated overhead costs divided by estimated production output. A common divisor is expected direct labor hours for the project; the resulting figure is then applied to the project using direct labor hours.
A company is expecting $400,000 US Dollars (USD) in manufacturing overhead and 40,000 direct labor hours for a project. The manufacturing overhead application rate is $10 USD per labor hour. If actual labor costs for the project are 38,000 direct labor hours, the total manufacturing overhead for the project is $380,000 USD. This completes the application of costs for the project, save writing off the difference in expected manufacturing overhead.
The remaining $20,000 USD in manufacturing overhead needs a correcting journal entry in the company’s books. Most companies will book estimated manufacturing overhead into their ledgers under a job order system. The entry to remove this information is to credit the cost of goods sold account to remove the unneeded portion of manufacturing overhead.