2.3: Job Order Costing for a Service Company
Job order costing is also used for service businesses where the service and costs are unique to each customer, such as those of an attorney, accountant, physician, or event planner. Each customer, client, or patient is a separate job or project. Clients, customers, and patients incur direct costs, direct labor and applied overhead costs. And while there are no materials related to inventory for a service business, there may be expenditures associated directly with a particular project, such as travel or supplies.
2.3.1 Comprehensive Example of Job Order Costing Transactions for a Service Company
Creative Compton, Inc. is an advertising agency that designs web sites and promotional materials for medium-sized businesses. For each client project, Creative Compton accumulates the direct labor costs of its professional designersat an hourly rate of $140. The company allocates overhead costs to jobs at a rate of 35% of total direct labor cost incurred. Creative Compton, Inc. earns a 60% profit on each job.
Journalize the journal entries for the direct labor, the overhead, the sale of the project, and the reconciliation of actual to estimated overhead.
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Job 4 incurs 20 hours of professional direct labor time (20 hours x $140 per hour).
Account Debit Credit Development Costs
2,800
▲ Development Costs is an asset account
Wages Payable
2,800
▲ Wages Payable is a liability account that is increasing
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The company pays cash for the following costs that are directly related to Job 4: travel, $340; supplies, $60; and domain name filing fees, $120.
Account
Debit
Credit
Development Costs
520
▲ Development Costs is an asset account that is increasing
Cash
520
▼ Cash is an asset account that is decreasing
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Estimated overhead costs incurred for Job 4 are $980. ($2,800 direct wages cost x 35%)
Account
Debit
Credit
Development Costs
980
▲ Development Costs is an asset account that is increasing
Overhead
980
▼ Overhead is an expense account that is decreasing
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A customer is invoiced for the completed Job 4.
Account
Debit
Credit
Accounts Receivable
6,880
▲ Accounts Receivable is an asset account that is increasing
Fees Earned
6,880
▲ Sales is a revenue account that is increasing
Cost of Service
4,300
▲ Cost of Services is an expense account that is increasing
Development Costs
4,300
▼ Development Costs is an asset account that is decreasing
There are two journal entries for a sale. The first is to record the project’s selling price to the customer. The second is to reduce the development costs incurred and expense them off to Cost of Services .
Cost of the project: $2,800 direct labor + $520 direct costs + $980 overhead costs = $4,300
Selling price of the project: $4,300 costs x 1.6 to include the markup = $6,880
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Actual overhead for Job 4 is ultimately determined to be $960.
Account
Debit
Credit
Too much factory overhead was applied in transaction #3
Overhead
20
▲ Overhead is an expense account that is increasing that is increasing
Cost of Service
20
▼ Cost of Services is an expense account decreasing
In transaction #3 , recorded previously, $980 of overhead was applied to Development Costs based on an estimate of 35% of direct labor. The difference between applied factory overhead and estimated factory overhead is $20 ($980 estimated - $960 actual). Since too much had been applied, $20 now needs to be backed out by debiting the Overhead account. Cost of Services is used as the credit account rather than Development Costs in reconciling the Overhead account.