Job order costing: inventory valuation and cost of goods sold

Calculating inventory values and cost of goods sold

In a job order costing system, inventory values and cost of goods sold (COGS) are calculated based on the accumulated costs for each job. These costs include:

• Direct Materials (DM)
• Direct Labor (DL)
• Manufacturing Overhead

Direct materials and direct labor

In job order costing, direct materials and direct labor are traced directly to specific jobs, allowing precise assignment of these costs.

Manufacturing overhead

Manufacturing overhead cannot be directly traced, so it is applied to each job using a predetermined overhead rate, typically based on labor hours or machine hours. This method provides timely and consistent cost allocation, even if actual overhead expenses fluctuate during the period.

$$\text{Applied Overhead}=\text{Predetermined Overhead Rate}\times \text{Actual Activity Base (e.g., DL hours, machine hours)}$$

This results in a more consistent and practical way to assign overhead during the period, with adjustments for over- or underapplied overhead made at period-end.

Example: Job #301 – Custom Bookshelf

A company manufactures a custom bookshelf for a customer. The following costs are recorded:

Cost Element	Details	Amount (USD)
Direct Materials	Wood panels, glue, hardware	$600
Direct Labor	10 hours @ $20/hour	$200
Predetermined Overhead Rate	$25 per direct labor hour	–
Applied Overhead (applied using DL hours)	10 hours × $25	$250
Total Job Cost		$1,050

The job is completed and moved to Finished Goods Inventory at a cost of $1,050. When sold, the same amount is transferred to COGS. The following are the simplified journal entries for this job:

No.	Transaction	Debit	Credit	Description
1	Assign Direct Costs	Work-in-Process – Job #301: $800	Raw Materials Inventory or Wages Payable: $800	To record direct materials and direct labor assigned to Job #301
2	Apply Overhead	Work-in-Process – Job #301: $250	Manufacturing Overhead Applied: $250	To apply overhead to Job #301 using the predetermined rate
3	Completion of Job	Finished Goods Inventory: $1,050	Work-in-Process – Job #301: $1,050	To transfer completed job from WIP to Finished Goods
4	Sale of Job (COGS side only)	Cost of Goods Sold: $1,050	Finished Goods Inventory: $1,050	To record the cost of goods sold when Job #301 is delivered

Job order costing enables precise cost tracking for customized work. Direct costs are assigned; overhead is applied, not traced. This distinction is central to understanding job profitability and overall cost control.