Costing Systems I: Job, Batch, and Simple Service Costing

Learning objectives

By the end of this chapter you should be able to:

• Explain job costing and prepare a job cost sheet to support costing, profitability analysis, and pricing decisions.
• Apply batch costing to determine total batch cost and unit cost, using an appropriate overhead absorption rate and allowing for losses or rework.
• Apply simple service costing by selecting a sensible cost unit and calculating a cost per service unit for pricing and performance evaluation.
• Interpret cost outputs for quotations, pricing, and cost control, linking costing information to inventory/work-in-progress and cost of sales where relevant.
• Identify and avoid common pitfalls in costing systems, including wastage, rework, rejects, and unsuitable overhead absorption bases.

Overview & key concepts

Costing systems collect and assign costs to outputs so that work can be priced, quotations can be prepared, and performance can be controlled. Where outputs are identifiable—an individual job, a batch of units, or a measurable service unit—cost information becomes more reliable and more useful.

A practical way to remember the logic of costing systems is:

Trace → Allocate → Absorb → Review

• Tracedirect materials, direct labour, and direct expenses to the cost object (job, batch, or service activity).
• Allocateshared support costs using a sensible basis where direct tracing is not practical.
• Absorbproduction overhead using a predetermined rate and the activity actually used.
• Reviewthe result for pricing decisions and operational issues (waste, rework, capacity, and under/over absorption).

Job costing

Where it is used

Job costing is used where each order is distinct, customer-specific, or varies significantly in design and resource usage (e.g., bespoke manufacturing, specialist repair work, tailored projects).

Building the cost of a job

A job cost is normally built from:

• Direct materials: materials traced economically to the job.
• Direct labour: labour time identified with the job (often from timesheets).
• Direct expenses: other job-specific costs (e.g., specialist hire used only for that job).

These make up prime cost:

Prime cost = Direct materials + Direct labour + Direct expenses

Absorbing production overhead (OAR)

Production overheads are indirect production costs that cannot be traced to individual jobs (e.g., factory rent, supervision, depreciation). They are absorbed into job cost using an overhead absorption rate (OAR).

A common approach is:

OAR = Budgeted production overhead ÷ Budgeted activity level

The activity level should reflect what drives overhead consumption (labour hours in labour-intensive work, machine hours in automated environments).

Under/over absorption
Because absorption uses budgeted figures, differences between budgeted and actual overhead or activity will create under-absorption or over-absorption. The resulting difference is then adjusted according to the approach required (for example, written off, carried forward, or adjusted through inventories/cost of sales). In exam questions you will be told—or can assume from the instruction style—whether to write off or adjust; follow the requirement given.

The job cost sheet

A job cost sheet is the record that summarises:

• direct materials, direct labour, direct expenses
• absorbed production overhead (OAR × job activity)
• total job cost (and cost per unit if the job contains multiple units)

Batch costing

Where it is used

Batch costing is used where identical units are produced together in a batch. The batch is treated as the cost object and total batch cost is then averaged.

Unit cost

Unit cost = Total batch cost ÷ Number of good units produced

Losses, rejects, rework, and scrap value (exam-focused)

• Normal loss(expected): the cost of the loss is absorbed by good units, increasing unit cost. If the loss hasscrap value, the proceeds reduce the cost to be spread over good units.
• Exam expression (normal loss with scrap):
• Unit cost = (Total batch cost − scrap proceeds from normal loss) ÷ good units
• Abnormal loss(unexpected): the cost is separated out for reporting and control purposes (often charged to a loss/variance account). It isnotaveraged into the unit cost of good production.

Rejects vs rework (terminology clarity)

• Rejectsare units that fail inspection and cannot be brought up to standard. They may be scrapped (sometimes with scrap value) or sold as seconds if the question indicates.
• Reworkis additional processing needed to bring units up to standard. The extra cost may be treated asnormal(included in unit cost) orabnormal(reported separately), depending on the scenario and the instruction given.

This treatment avoids hiding inefficiency inside product cost and highlights operational problems (quality failures, poor handling, machine issues).

Simple service costing

Where it is used

Service costing is used where the output is a service rather than a physical product (e.g., transport, delivery, clinics, hotels, professional services). The aim is to calculate cost per meaningful service unit.

Choosing the service cost unit

A good service cost unit is:

• measurable and easy to record,
• closely linked to workload and resource usage,
• meaningful for pricing and performance comparisons.

Examples include cost per delivery, cost per passenger-kilometre, cost per room-night, cost per patient-day, or cost per consultation.

Collecting and assigning service costs

Service costs are usually accumulated over a period and expressed per service cost unit. Costs may be:

• direct(clearly attributable to the service activity), and/or
• indirect/support(allocated using a rational basis such as time, usage, headcount, or floor area).

Most service costs are period costs; occasionally, separately identifiable incomplete work may be carried forward as work in progress if the reporting policy allows.

Quotation and pricing

A quotation is usually based on estimated or computed cost plus a profit addition. Two common approaches must not be confused:

• Mark-up on cost: profit is a percentage of cost.
• Margin on selling price: profit is a percentage of selling price.

A mark-up produces a lower margin than the same percentage stated as a margin.

Exam tip: converting mark-up to margin
If mark-up is m% on cost, then selling price = cost × (1 + m).
Profit margin = profit ÷ selling price = m ÷ (1 + m).
Example: 20% mark-up → margin = 0.20 ÷ 1.20 = 16.67%.

Worked example

Narrative scenario

A small manufacturing company produces bespoke furniture for retail clients. Each order is unique, requiring specific materials and labour. The company uses job costing to allocate production costs to jobs and to support pricing.

The following information relates to a custom dining table job:

• Direct materials: 150 kg of oak wood at £10 per kg.
• Direct labour: 60 hours at £15 per hour.
• Direct expenses: specialist varnish costing £100.
• Budgeted production overhead: £50,000 per year.
• Budgeted labour hours: 10,000 per year.
• Opening balance of raw materials inventory: £5,000.
• Closing balance of raw materials inventory: £3,500.
• Quotation policy: add a 20% mark-up on total job cost.

Required

1. Calculate the prime cost for the custom dining table.
2. Compute the absorbed overhead using the OAR.
3. Determine the total job cost and quotation price.
4. Analyse the financial statement impact at key stages (production and sale).
5. Identify potential pitfalls in the costing process.

Solution

1) Prime cost

Direct materials
150 kg × £10 = £1,500

Direct labour
60 hours × £15 = £900

Direct expenses
Special varnish = £100

Prime cost
£1,500 + £900 + £100 = £2,500

2) Absorbed overhead using the OAR

OAR
£50,000 ÷ 10,000 labour hours = £5 per labour hour

Absorbed overhead
60 hours × £5 = £300

3) Total job cost and quotation price

Total job cost
£2,500 + £300 = £2,800

Quotation price (20% mark-up on cost)
£2,800 × 1.20 = £3,360

Profit implied by the quotation
£3,360 − £2,800 = £560

Profit margin (for comparison)
£560 ÷ £3,360 = 16.67% (to 2 d.p.)

4) Financial statement impact at key stages

Costing calculations support pricing and control. Financial statement recognition depends on when costs are held as inventory/work-in-progress and when a sale occurs.

Stage A: During production (cost accumulation)

Costs are accumulated into work-in-progress (WIP). They do not become cost of sales until the goods are sold.

Illustrative entries (account names and formats vary by entity):

Issue of direct materials to production

• Dr WIP£1,500
• Cr Raw materials inventory£1,500

Direct labour charged to production (wages incurred)

• Dr WIP£900
• Cr Cash / Wages payable£900

Direct expense charged to production

• Dr WIP£100
• Cr Cash / Payables£100

Production overhead absorbed into WIP (absorption entry)

• Dr WIP£300
• Cr Overhead absorbed / Production overhead control£300

(Actual overhead costs incurred would be recorded separately; any under/over absorption is adjusted according to the approach required by the reporting policy or the question instruction.)

Exam tip: inventory movements
Do not assume there are no purchases or no other issues of materials unless the question states this.

Stage B: Completion and sale (recognising revenue and cost of sales)

A quotation is an offer; it does not create revenue or a receivable. Revenue and receivables arise when the sale occurs (for example, on delivery and invoicing).

A typical sequence is:

On completion: transfer WIP to finished goods

• Dr Finished goods inventory£2,800
• Cr WIP£2,800

On sale (credit sale at the quoted price): recognise revenue and receivable

• Dr Trade receivables£3,360
• Cr Revenue£3,360

On sale: recognise cost of sales and reduce inventory

• Dr Cost of sales£2,800
• Cr Finished goods inventory£2,800

Income statement effect (on sale):
Revenue increases by £3,360, cost of sales increases by £2,800, so gross profit increases by £560 (before other operating expenses).

5) Potential pitfalls in the costing process

• Wastage and shrinkage: poor recording of materials usage distorts job cost and weakens control.
• Rework and rectification: failing to record rework separately can hide quality issues and overstate profitability.
• Overhead base choice: labour hours may be unsuitable where overhead is driven mainly by machine time or set-ups.
• Under/over absorption: a predetermined OAR will rarely match actual results; adjust as required by instruction/policy.
• Mark-up vs margin confusion: applying the wrong profit basis leads to incorrect prices.
• Treating quotations as accounting entries: quotations do not create revenue or receivables.

Interpretation of the results

The computed job cost of £2,800 represents the manufacturing cost assigned to the dining table job, built from direct costs plus absorbed production overhead. A 20% mark-up on cost produces a quotation of £3,360, implying a gross profit of £560 if the job is sold at that price and the cost estimate is achieved.

Operationally, the job cost sheet supports control: expected costs can be compared with actual materials usage, labour time, and overhead recovery to identify inefficiency and waste.

Common pitfalls and misunderstandings

• Charging indirect production costs directly to jobs without a consistent basis.
• Omitting rework costs or failing to distinguish rework from rejects.
• Using an unsuitable overhead absorption base, leading to distorted job/batch costs.
• Ignoring scrap value in normal loss questions, overstating unit cost.
• Averaging abnormal loss into unit cost, hiding inefficiency.
• Failing to deal with under/over absorption as required by the question.
• Choosing service cost units that are not representative of output or workload.
• Treating a quotation as if it creates revenue or a trade receivable.
• Treating all production costs as immediate cost of sales rather than inventory/WIP until sale.

Summary and further reading

Job, batch, and simple service costing provide structured methods for assigning costs to outputs for pricing, quotation, and performance control. Job and batch costing build cost from traced direct costs plus absorbed overhead using a predetermined OAR. Batch costing often requires careful treatment of normal loss, abnormal loss, rejects, rework, and scrap value. Service costing expresses accumulated service costs per meaningful service unit and supports operational control and pricing.

A quotation is not an accounting entry. Production costs remain in WIP/inventory until sale, and cost of sales is recognised only when goods are sold. Overhead absorption differences arise because OARs are set in advance; deal with under/over absorption exactly as instructed.

FAQ

What is the primary purpose of job costing?

To accumulate and assign production costs to a specific job so that total cost and profitability can be assessed. It supports pricing, quotation decisions, and cost control.

How does batch costing differ from job costing?

Batch costing accumulates costs for a batch of identical units and computes a unit cost by dividing net batch cost by the good output. Job costing focuses on a single, distinct job that may be customer-specific.

Why is the choice of overhead absorption base important?

Because the absorption base determines how overhead is spread across jobs or batches. If the base does not reflect what drives overhead usage, costs and profitability analysis will be distorted.

What happens when actual overhead differs from absorbed overhead?

Under- or over-absorption arises because a predetermined OAR is based on budgets. The difference is then adjusted using the approach required (often stated in the question), such as writing off or making an inventory/cost of sales adjustment.

How should normal and abnormal loss be treated in batch costing?

Normal loss is absorbed by the cost of good units, usually after deducting any scrap proceeds. Abnormal loss is separated for reporting/control and is not averaged into unit costs.

Glossary

Job costing
A costing method that accumulates direct costs and absorbed overhead for a specific, distinct job to determine total job cost and profitability.

Job cost sheet
A structured record summarising the costs assigned to a job, including direct materials, direct labour, direct expenses, and absorbed production overhead.

Batch costing
A costing method that accumulates costs for a batch of identical units and calculates unit cost by averaging net batch cost over good units produced.

Normal loss
An expected loss arising under efficient operating conditions. Its cost is absorbed by good output, usually net of any scrap proceeds.

Abnormal loss
An unexpected loss that is separated for control and reporting and is not included in the unit cost of good output.

Rejects
Units that fail inspection and cannot be brought up to standard. They may be scrapped (sometimes with scrap value) or sold as seconds if indicated.

Rework
Additional processing needed to bring units up to standard. The extra cost may be treated as normal or abnormal depending on the scenario and instruction.

Simple service costing
A method of accumulating service operation costs over a period and expressing them per service cost unit to support pricing and performance analysis.

Cost unit
The unit of output used to express costs (for example, per job, per batch unit, per kilometre, per patient-day).

Direct materials
Materials that can be traced economically to a specific job, batch, or service output.

Direct labour
Labour time that can be identified with a specific job, batch, or service output, commonly recorded via timesheets.

Direct expenses
Job- or service-specific costs other than materials and labour that are traceable to a single cost object.

Prime cost
The total of direct materials, direct labour, and direct expenses.

Production overhead
Indirect production costs that cannot be traced directly to a single job or batch and are assigned using an absorption method.

Overhead absorption rate (OAR)
A predetermined rate used to absorb production overhead into job or batch costs, commonly calculated using budgeted overhead and budgeted activity.

Under/over absorption
The difference between overhead absorbed using the predetermined OAR and the actual overhead incurred, requiring adjustment as instructed by policy or the question.