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Principles of Accounting, Volume 2: Managerial Accounting

4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment

Principles of Accounting, Volume 2: Managerial Accounting4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment
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  1. Preface
  2. 1 Accounting as a Tool for Managers
    1. Why It Matters
    2. 1.1 Define Managerial Accounting and Identify the Three Primary Responsibilities of Management
    3. 1.2 Distinguish between Financial and Managerial Accounting
    4. 1.3 Explain the Primary Roles and Skills Required of Managerial Accountants
    5. 1.4 Describe the Role of the Institute of Management Accountants and the Use of Ethical Standards
    6. 1.5 Describe Trends in Today’s Business Environment and Analyze Their Impact on Accounting
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Thought Provokers
  3. 2 Building Blocks of Managerial Accounting
    1. Why It Matters
    2. 2.1 Distinguish between Merchandising, Manufacturing, and Service Organizations
    3. 2.2 Identify and Apply Basic Cost Behavior Patterns
    4. 2.3 Estimate a Variable and Fixed Cost Equation and Predict Future Costs
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Cost-Volume-Profit Analysis
    1. Why It Matters
    2. 3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin
    3. 3.2 Calculate a Break-Even Point in Units and Dollars
    4. 3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations
    5. 3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations
    6. 3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  5. 4 Job Order Costing
    1. Why It Matters
    2. 4.1 Distinguish between Job Order Costing and Process Costing
    3. 4.2 Describe and Identify the Three Major Components of Product Costs under Job Order Costing
    4. 4.3 Use the Job Order Costing Method to Trace the Flow of Product Costs through the Inventory Accounts
    5. 4.4 Compute a Predetermined Overhead Rate and Apply Overhead to Production
    6. 4.5 Compute the Cost of a Job Using Job Order Costing
    7. 4.6 Determine and Dispose of Underapplied or Overapplied Overhead
    8. 4.7 Prepare Journal Entries for a Job Order Cost System
    9. 4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment
    10. Key Terms
    11. Summary
    12. Multiple Choice
    13. Questions
    14. Exercise Set A
    15. Exercise Set B
    16. Problem Set A
    17. Problem Set B
    18. Thought Provokers
  6. 5 Process Costing
    1. Why It Matters
    2. 5.1 Compare and Contrast Job Order Costing and Process Costing
    3. 5.2 Explain and Identify Conversion Costs
    4. 5.3 Explain and Compute Equivalent Units and Total Cost of Production in an Initial Processing Stage
    5. 5.4 Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage
    6. 5.5 Prepare Journal Entries for a Process Costing System
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  7. 6 Activity-Based, Variable, and Absorption Costing
    1. Why It Matters
    2. 6.1 Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method
    3. 6.2 Describe and Identify Cost Drivers
    4. 6.3 Calculate Activity-Based Product Costs
    5. 6.4 Compare and Contrast Traditional and Activity-Based Costing Systems
    6. 6.5 Compare and Contrast Variable and Absorption Costing
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  8. 7 Budgeting
    1. Why It Matters
    2. 7.1 Describe How and Why Managers Use Budgets
    3. 7.2 Prepare Operating Budgets
    4. 7.3 Prepare Financial Budgets
    5. 7.4 Prepare Flexible Budgets
    6. 7.5 Explain How Budgets Are Used to Evaluate Goals
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Standard Costs and Variances
    1. Why It Matters
    2. 8.1 Explain How and Why a Standard Cost Is Developed
    3. 8.2 Compute and Evaluate Materials Variances
    4. 8.3 Compute and Evaluate Labor Variances
    5. 8.4 Compute and Evaluate Overhead Variances
    6. 8.5 Describe How Companies Use Variance Analysis
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  10. 9 Responsibility Accounting and Decentralization
    1. Why It Matters
    2. 9.1 Differentiate between Centralized and Decentralized Management
    3. 9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments
    4. 9.3 Describe the Types of Responsibility Centers
    5. 9.4 Describe the Effects of Various Decisions on Performance Evaluation of Responsibility Centers
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  11. 10 Short-Term Decision Making
    1. Why It Matters
    2. 10.1 Identify Relevant Information for Decision-Making
    3. 10.2 Evaluate and Determine Whether to Accept or Reject a Special Order
    4. 10.3 Evaluate and Determine Whether to Make or Buy a Component
    5. 10.4 Evaluate and Determine Whether to Keep or Discontinue a Segment or Product
    6. 10.5 Evaluate and Determine Whether to Sell or Process Further
    7. 10.6 Evaluate and Determine How to Make Decisions When Resources Are Constrained
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  12. 11 Capital Budgeting Decisions
    1. Why It Matters
    2. 11.1 Describe Capital Investment Decisions and How They Are Applied
    3. 11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions
    4. 11.3 Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities
    5. 11.4 Use Discounted Cash Flow Models to Make Capital Investment Decisions
    6. 11.5 Compare and Contrast Non-Time Value-Based Methods and Time Value-Based Methods in Capital Investment Decisions
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Balanced Scorecard and Other Performance Measures
    1. Why It Matters
    2. 12.1 Explain the Importance of Performance Measurement
    3. 12.2 Identify the Characteristics of an Effective Performance Measure
    4. 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added
    5. 12.4 Describe the Balanced Scorecard and Explain How It Is Used
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  14. 13 Sustainability Reporting
    1. Why It Matters
    2. 13.1 Describe Sustainability and the Way It Creates Business Value
    3. 13.2 Identify User Needs for Information
    4. 13.3 Discuss Examples of Major Sustainability Initiatives
    5. 13.4 Future Issues in Sustainability
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Thought Provokers
  15. Financial Statement Analysis
  16. Time Value of Money
  17. Suggested Resources
  18. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
  19. Index

Job order cost systems can be used beyond the manufacturing realm and are often used in the production of services. The same cost tracking and journaling techniques apply, as the outcome still consists of materials, labor, and overhead. However, the terminology changes in a nonmanufacturing environment. For example, a movie production studio and an accounting firm produce movies and financial statement audits, respectively, instead of manufacturing units.

Fundamentals of the Job Order Costing Method for Service Entities

Instead of being dependent on materials, service industries depend on labor. Since their work is labor intensive, it makes sense to use labor as an activity base with billable hours often as the best allocation base. For example, in an audit, there often will be several accountants, with differing levels of experience and expertise involved in the assignment. The accounting firms have more billable hours at the staff level and fewer billable hours at the partner level. And since the firm bills the partner’s time at a significantly higher rate than the staff, it makes sense to apply overhead at the billable hours instead of the billable costs.

In service industries, there is no manufacturing overhead because they are not manufacturing a product, but instead are providing a service. Accordingly, overhead is called operating overhead.

Another terminology difference is the inventory accounts. The jobs are considered movies or assignments in process, and are transferred to a cost of service sold account instead of to a finished goods inventory.

Concepts In Practice

Tracking Costs in Healthcare

Healthcare is one of the industries that keeps track of materials, such as medicine. In this industry, direct labor is shown to the patient as the cost of the provider, such as a physician, physician assistant, or nurse practitioner. Indirect labor includes all other personnel from front desk staff to the nurse who gathers vital signs or a technician who performs tests. Patients do not see the overhead cost on their bill, but it is built into the invoice as part of the practitioner or testing fees.

Service Entity Use of a Job Order Costing System

To understand how a service provider uses a job order cost system, let’s consider the case of IFixIT. IFixIT Systems is a Sony-authorized repair provider that fixes audiovisual equipment brought in by customers. IFixIT requires customers to pay $50 to diagnose the problem. IFixIt pays its employees $25 per hour and assigns overhead equal to its direct labor cost. The customers’ bills do not show overhead and are instead itemized as parts plus labor, where the cost for parts is the original cost plus a markup, and the labor rate is $80 per hour.

A customer brought in his TV and paid the $50 diagnostic fee. IFixIT determined a new power cord was needed. To fix it, IFixIT purchases the part from its suppliers at $42 and pays $75 in direct labor for 3 hours at $25 per hour. Overhead is applied equal to the direct labor cost of $75. The customer is charged $310, consisting of $70 for the part and 3 hours of labor at a rate of $80 per hour. IFixIT records the journal entries shown:

A journal with four columns headed “Date”, “Account”, “Debit”, and “Credit.” There are six entries (not dated.) The first one shows in the “Account” column a debit to “Cash, a credit (indented) to Diagnosis revenue, and the entry description, which reads “Diagnosis of Sony Bravia for Job 4740325”. The amount of 50 is listed in the debit column across from the “Cash” debit and in the credit column across from the “Diagnosis Revenue” credit. The second entry shows in the “Account” column a debit to “Repair in process”, a credit (indented) to “Accounts Payable”, and the entry description, which reads “Purchase of new power cord for Job 4740325.” The amount of 42 is shown across from each of these in the respective debit and credit columns. The third entry shows in the “Account” column a debit to “Repair in process”, a credit (indented) to “Salaries Expense”, and the entry description, which reads “Assigning labor to Job 4740325.” The amount of 75 is shown across from each of these in the respective debit and credit columns. The fourth entry shows in the “Account” column a debit to “Repair in process”, a credit (indented) to “Operating Overhead”, and the entry description, which reads “Assigning overhead costs to Job 4740325.” The amount of 75 is shown across from each of these in the respective debit and credit columns. The fifth entry shows in the “Account” column a debit to “Cost of completed repair”, a credit (indented) to “Repair in process”, and the entry description, which reads “Completion of Job 4740325.” The amount of 192 is shown across from each of these in the respective debit and credit columns. The sixth entry shows in the “Account” column a debit to “Cash” , a credit (indented) to “Repair Service”, and the entry description, which reads “Completion of Job 4740325.” The amount of 310 is shown across from each of these in the respective debit and credit columns.

Ethical Considerations

Subcontractor Misrepresentation of Costs of Jobs Used to Overbill Clients

Construction is a typical industry where job order costing and related accounting misstatements can be used to commit fraud. A construction subcontractor might overstate the units of production accomplished, the units of labor, or the equipment actually used.2 This occurs most commonly with subcontractor fraud, where the subcontractor does not perform the work but bills for it anyway.

Another complicating issue is that many subcontractors are disadvantaged business enterprises that are required by law to be included in governmental construction contracts. In Chicago, for example, McHugh Construction paid $12 million in fines to settle the claims that its disadvantaged business enterprise subcontractor did not perform work.3 The subcontractor received a prison sentence, and a related party was put on probation. An accountant had to prepare the invoices that allowed this common type of scheme to operate.

Footnotes

  • 2 Jim Schmid and Todd F. Taggart, “The Most Common Types of Construction Fraud,” Construction Business Owner, November 2, 2011, http://www.constructionbusinessowner.com/insurance/risk-management/most-common-types-construction-fraud.
  • 3 Kim Slowey, “Chicago Subcontractor Sentenced to 1-year Prison Term for DBE Fraud Scheme,” Construction Dive, March 20, 2017, https://www.constructiondive.com/news/chicago-subcontractor-sentenced-to-1-year-prison-term-for-dbe-fraud-scheme/438441/.
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