Stan Snyder, CPA and expert bean counter
Job costing is the process of tracking the expenses incurred on a job against the revenue produced by that job. Job costing is an important tool for those who are pairing a relatively high dollar volume per customer with a relatively low number of customers. For example, building contractors, subcontractors, architects and consultants often use job costing, whereas a hardware store or convenience store would not use job costing.
Job costing using accounting software enables you to track a number of factors and analyze the results to aid decision making. A Job costing report helps you ensure that all costs involved in a job have been properly invoiced to the customer. An Estimates vs. Actuals report compares quoted costs to actual costs, and quoted revenues to actual revenues so that you can analyze any variances between your quote and the actual result. You can then use the results of your analysis to create more accurate quotes when you bid on future jobs.
Using job costing will allow you to identify the most and least profitable areas of your business, so that you can focus on the profitable elements, and try to make the less profitable aspects of your business more efficient. It will help you to quote new jobs more accurately, and assist you in managing jobs in progress.
Components of job costing
There are numerous aspects to job costing, and you may use many, some or none of them. If you want to use job costing, you need to:
- Track the costs involved in the job
- Make sure all of the costs are invoiced to the customer
- Produce reports showing details of costs and revenues by job
The fundamental components of job costing are:
- Quotes – also known as estimates, bids, or proposals
- Fixed fee jobs
- Time and materials jobs
- Direct costs
- Standard costs
Let's take a look at the meaning of each of these components and how you might use them in job costing.
Most people are familiar with quotes. Quotes are non-posting transactions. They do not affect your financial statements or your general ledger. You prepare a quote to give your customer an estimate of projected costs, before a job is awarded. However, quotes also provide a means to track costs as the job progresses, so that costs do not get out of line, or so that cost variances can be identified and dealt with quickly.
Fixed fee jobs
Fixed fee jobs are an agreement to complete a job for a customer for a set price, no matter what costs are incurred. While this may seem like a good deal for the customer, an experienced estimator will set a price high enough to cover any contingencies, which may result in a higher price than a time and materials job.
Time and materials job
On a time and materials job, costs of labor and materials are passed on to the customer. A markup for overhead and profit may be built-in as a percentage of each item or stated as a separate line item. Time and materials jobs are often preferred by the seller, as any unforeseen costs may be passed on to the customer.
Revenues are critical to the life of any business. In job costing, revenues are not only categorized by account, but also by customer, job and item. Think of jobs as sub-categories of customers and items as sub-categories of revenue/expense. This creates a new way of analyzing your revenues and the costs incurred to produce them.
Expenses become revenues; as costs are incurred for a job, they are marked up and passed on to the customer as revenues. To be able to compare your costs to the revenues they produce, you should create matching categories in your revenue accounts and cost of goods sold accounts (COGS).
The accounts in your chart of accounts should represent general overall categories of your business, and not individual customers, vendors or detailed sales/cost information. Those details are recorded using items, the customer list and the vendor list. A sample section of the chart of accounts for a general contractor might look something like this:
||Cost of goods sold
|General requirements – materials revenue
||General requirements – materials COGS
|General requirements – labor revenue
||General requirements – labor COGS
|Sitework – materials revenue
||Sitework – materials COGS
|Sitework – labor revenue
||Sitework – labor COGS
|Concrete – materials revenue
||Concrete – materials COGS
|Concrete – labor revenue
||Concrete – labor COGS
|Masonry – materials revenue
||Masonry – materials COGS
|Masonry – labor revenue
||Masonry – labor COGS
|Metals – materials revenue
||Metals – materials COGS
|Metals – labor revenue
||Metals – labor COGS
|Wood and plastic – materials revenue
||Wood and plastic – materials COGS
|Wood and plastic – labor revenue
||Wood and plastic – labor COGS
You should see a pattern in these revenue and expense accounts. Each revenue account represents a category or logical division of the goods and services provided by your business. For each revenue account, there is a corresponding cost of goods sold account. This allows an overview of the company’s direct expenses in comparison to revenues by category – concrete, masonry, wood & plastics, etc. – and a calculation of the gross profit percentage and profit margin by category.
Items represent the products and services that your business sells. You may have many items for each of the revenue/expense account categories in your chart of accounts. Using items, you enter the details about what you buy and sell, then “map” or link the detailed items to the more generalized accounts in the chart of accounts. You can map many detailed items to a single account in your chart of accounts. This allows a greater level of detail in the item list while keeping the chart of accounts list concise.
Note logically – a single item would be mapped to a matching pair of accounts in the chart of accounts; e.g. a Masonry hourly labor item would be mapped to masonry labor revenue in the item setup dialog box under I sell this item, and to masonry labor COGS under I buy this item.
Items focus on revenues; they are the goods and services your company sells. Use service items for labor, and non-inventory items for materials. The non-inventory name just indicates that you are not tracking unit quantities or unit costs; they are still goods and materials that you hold in inventory.
To track unit quantities and unit costs, use inventory items, but be forewarned; do not use inventory items lightly. Using inventory items means that you are tracking and entering unit quantities when you buy and sell as well as reconciling your accounting records to the physical quantities on hand in between buying and selling. This is not an item type for the faint-hearted!
Direct costs are the costs of the products and services sold. These are the costs involved in job costing. Direct costs can be directly associated with a job and can be identified as a part of the finished product. For a mason, direct costs would include the costs of bricks and mortar, as well as the cost of the labor to prepare the mortar and lay the bricks.
Direct costs are distinguished from indirect costs, or overhead. Indirect costs are costs that cannot be identified in the finished product, even though they were incurred, indirectly, in the process of completing the job. Examples of indirect costs are rent, insurance and administrative payroll. Indirect costs are not included in job cost reports. Direct costs are categorized on the profit and loss report as cost of goods sold, whereas indirect costs are categorized as operating expenses.
Standard costs represent direct costs that include a calculated (or estimated) portion of related costs that are not billed separately to your customers. They are often theoretical calculations, done in a spreadsheet, that give a more accurate picture of the direct costs involved in a job. Examples of standard costs include:
- For every 100 feet of electrical cable installed, on the average we use 20 staples, 6 wire nuts and 2 electrical connectors. The staples, wire nuts and connectors are purchased in bulk and not individually billed to the job. The purchase price for this item is the cost of the electrical cable alone. The standard cost for the item includes the cost of the cable, staples, wire nuts and connectors.
- For every hour of labor paid, we also incur 8.9% in payroll taxes and 5% in worker’s compensation. When creating this labor item, the purchase price is the hourly cost of the labor. The standard cost includes the hourly cost of the labor, plus the payroll taxes and worker’s compensation.
While you should carefully identify your standard costs, they are used only in job cost reports; they are not the costs stored in the general ledger or reported in your financial statements.
Note When creating items in Small Business Accounting, the item dialog box asks for three different amounts: sales price, purchase price and standard cost. Unless you override the standard cost field, your purchase price becomes the standard cost. The wonderful thing about standard costs is that if you invoice using an item that has a standard cost, the standard cost will appear in job profitability reports, even though you did not assign the cost to a particular customer or job when it was purchased.
Secrets of job costing
OK, these aren’t really secrets, but if you want to use job costing effectively, you need to understand these three concepts. The people who are frustrated with job costing most likely don’t understand these concepts.
- Job costing uses items. You should use items when purchasing as well as when selling goods and services if you want to use job costing. This means using an item type instead of an expense type on a check, bill or credit card charge.
- Items must be set up properly. In the new item dialog box, you select the I buy this item check box for items that are purchased, the I sell this item check box for items that are sold, and fill out the standard cost field if you are using standard costs.
- The same items used to record costs for a job must be used to invoice for the job. Expenses become revenues, and to be able to compare direct costs to gross revenues, you must use the same item on both sides of the transaction.
Of these three secrets, the third may be the most difficult to achieve. Often the bookkeeper meticulously enters bills and records checks using items, and has the items set up properly, only to have the owner invoice the job using a generic item rather than the items used to record costs for the job. If this is your situation, you have two options: either re-educate the owner about proper invoicing procedures, or, if the owner insists on a simple invoice for the job, let the owner create job invoices in Excel or Word, and create a matching invoice in Small Business Accounting using the proper items.
Think about how you purchase for a job
Can you identify your customers when you purchase materials for a job? If so, then you can enter the job name in the bill or check and associate the expenditure with a specific job. Now you can use Small Business Accounting not only to track your expenses by job, but you can also convert those bills into invoices, making sure that all expenses are accounted for and nothing falls through the cracks. By using the same item on the bill that is used on the invoice, your job cost reports will show cost, revenue and profitability by item.
Do you have items that are purchased in bulk and later allocated to a job, so that at the time of purchase you don’t know which customer will receive each item? If so, then you can use standard costs. Since you don’t know which customer will receive the item being purchased, you cannot assign the cost to the customer at the time of purchase, but by using standard costs, the standard cost will show in job cost reports when the item is used on an invoice.
Do you have large dollar amount items that you keep in stock, and don’t purchase for a specific customer? Use inventory items to track the cost of these items, and your job profitability reports will show revenues and actual costs on a first-in, first-out basis.
Job cost reports
Job profitability summary and job profitability detail reports show revenues, standard costs, billed costs, the gross profit margin by dollar and percentage, grouped by customer. Within each customer, these reports show each invoice and each item with the profitability detail by item. These reports may be filtered by customer to see the details for a specific customer, or filtered by margin to see the most or least profitable items for any time period. Keep in mind that the standard costs you see on these reports are theoretical costs, and are not used in the financial statements.
The job estimates vs. actuals summary and job estimates vs. actuals detail reports compare quotes to bills and invoices, showing the variance between estimated costs and actual costs and the variance between estimated revenue and actual revenue. These reports are useful for controlling costs during the progress of a job, and as a guideline for preparing quotes for new jobs.
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About the author
Stan Snyder is a certified public accountant with over 25 years experience dealing with the accounting and computer problems that small business owners face. He teaches computerized accounting classes at Colorado Mountain College, and regularly consults with small business owners using accounting software of all types. If you have questions about this topic or another accounting topic, send Stan some feedback by responding to the question below "Was this article helpful?" Stan may use your questions or topic ideas in an upcoming column.