Standard Cost vs. Job Order Cost Accounting Systems

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• 0:03 Overview of Inventory Costing
• 0:47 Job Order Costing
• 2:10 Standard Costing
• 3:35 Variance Analysis in…
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

A company's inventory can be valued using different methods. The method you choose depends upon the type of goods that the business is producing. Two such costing methods are job order costing and standard costing.

Overview of Inventory Costing

Companies must track production costs so they can determine how much to charge for their goods and services. Production costs include:

• Raw materials
• Labor

Raw materials are unprocessed items that are converted to a finished product. Labor includes the salaries of employees who are directly involved in producing the item. Overhead includes rent and salaries of those employees who are not directly involved in the production process, such as office employees. Products can be costed using several different methods. Let's look at two ways a business can track its costs: job order costing and process costing.

Job Order Costing

Job order costing is used when the product or service is unique or custom-ordered. Costs are traced directly to the product or service and can be tracked separately. For example, the cost to produce a custom-ordered chair for Wood's Fine Furniture would be calculated using job order costing.

Let's assume that Mr. Maple received an order for an oak chair to be completed next month. In his accounting system, Mr. Maple would track the cost of the raw materials (wood) and the time to cut and sculpt the wood and assemble and stain the chair. Let's assume that the chair for this special order required \$200 in raw materials (or wood), 10 hours of Mr. Maple's time at a cost of \$50 per hour, and overhead of \$200 was allocated to the chair. The total cost to manufacture the chair using job order costing would be \$900, which we would calculate as follows: \$200 + (10 hours x \$50 per hour) + \$200. Since each cost can be traced to the chair that was made, Mr. Maple can easily calculate the price to charge in order to make a profit. If Mr. Maple were to charge his customer \$1,500 for the chair, he would make a profit of \$600, which would calculate as follows: \$1,500 - \$900.

Standard Costing

In standard costing, an expected or pre-determined cost or standard is calculated for manufactured items. Just like job order costing, standard costing includes costs for raw materials and labor, as well as an allocation of overhead. In this method, all items are assumed to be the same to manufacture. A standard cost is calculated for each product and is then used as the cost basis for all items of that type that are produced. When calculating a standard cost, companies must consider how much raw material is needed to manufacture an item including the quantity, quality, and price of materials used. Labor costs must include the skill level of employees, and overhead costs must also be calculated.

Let's assume that one of Mr. Maple's competitors, Mr. Pine, owner of The Knotty Pine, mass produces its chairs and uses a standard costing system. Mr. Pine determined that each dark pine chair consisted of \$125 in raw materials, \$150 of labor costs, and \$175 of overhead costs. Therefore, the standard cost of each pine chair would be \$450, which we can calculate as follows: \$125 + \$150 + \$175.

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