Job and Batch Costing

Learning objectives

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

• Explain how job costing and batch costing are used to measure product costs in customised and small-run production.
• Prepare a job or batch cost sheet using direct materials, direct labour, and absorbed production overhead to determine total and unit costs.
• Calculate and apply a predetermined overhead absorption rate and use full cost information to support quotations using mark-up and margin.
• Compare estimated and actual costs, calculate key variances, and explain how the information supports control and learning.
• Interpret cost information to improve pricing decisions and protect profitability.

Overview & key concepts

Job and batch costing are costing systems designed for situations where production is not continuous and uniform. Instead of averaging costs across very large volumes (as in process environments), costs are collected and analysed for a specific customer order (a job) or for a small run of similar items (a batch).

The practical benefits are straightforward:

• clearer visibility of what each job or batch truly costs,
• stronger pricing and quotation decisions,
• better control through comparison of estimated and actual costs.

Job costing

Job costing collects and records costs for a single identifiable order (for example, a bespoke dining table). Direct materials and direct labour are traced to that job, while indirect production costs are allocated using an absorption approach.

Financial reporting link (high level): costs incurred on unfinished jobs are normally shown within inventory (work in progress) until the goods are completed. When the finished item is sold, the accumulated production cost is released from inventory and recognised as cost of sales. Sales revenue is recorded in line with the contract terms—typically when the customer obtains control of the goods (for many simple sales, this is on delivery or acceptance).

Batch costing

Batch costing collects costs for a group of similar units produced together (for example, 50 identical chairs). The batch is treated as the cost unit for collecting materials, labour, and absorbed overhead. A unit cost is then calculated by dividing total batch cost by the number of good units produced.

The accounting flow is similar to job costing: production costs are held in inventory (work in progress and finished goods) until the goods are sold.

Direct materials and direct labour

• Direct materials are materials that can be traced to a specific job or batch in a practical and economical way.
• Direct labour is the labour time spent specifically on producing the job or batch, tracked using time records.

These are often grouped as prime cost:

Prime cost = Direct materials + Direct labour

Production overhead and absorption

Production overheads are indirect manufacturing costs that cannot be traced directly to a job or batch (for example, factory rent, depreciation of production equipment, indirect factory labour, and utilities for the factory).

To include a fair share of these costs in job and batch costs, a predetermined overhead absorption rate is used. The rate is set using budgeted overhead and a budgeted activity level (such as labour hours or machine hours), then applied to actual activity.

A common approach is:

Overhead absorption rate = Budgeted production overhead / Budgeted activity level

Mark-up and margin

Both concepts relate profit to selling price, but they use different bases:

Mark-up % = Profit / Cost

Margin % = Profit / Selling price

If cost is £100 and selling price is £125:

• profit is £25
• mark-up is 25/100 = 25%
• margin is 25/125 = 20%

Work in progress and under/over absorption

Work in progress (WIP) is incomplete production at the reporting date. It is presented as part of inventory and measured using the costs incurred to date (direct materials, direct labour, and an appropriate share of production overhead).

Under- or over-absorption occurs because overhead is applied using a predetermined rate, but actual overhead incurred rarely matches the amount absorbed:

• Under-absorption: absorbed overhead is less than actual overhead incurred.
• Over-absorption: absorbed overhead is greater than actual overhead incurred.

In practice, the difference is adjusted in profit (often through cost of sales), unless it is material and requires a more refined allocation between inventory and cost of sales.

Core theory and frameworks

1) Cost collection and documentation

A costing system needs reliable source documentation:

• materials requisitions (what materials were issued to each job/batch),
• time records or job cards (labour hours worked on each job/batch),
• overhead records (actual overhead incurred and the chosen allocation base).

A job or batch cost sheet is then used to summarise:

• direct materials,
• direct labour,
• absorbed production overhead,
• total production cost,
• unit cost (for batches).

2) Production cost versus non-production cost

For product costing and inventory valuation, the focus is on production costs. Examples:

• Production cost: factory rent, depreciation of production machinery, indirect factory labour.
• Non-production cost: head office admin, marketing, and distribution to customers.

A common exam trap is to mix distribution costs into inventory cost. Delivery to a customer is normally a selling/distribution cost and is recognised as an expense when incurred. However, it may still be included in a quotation as part of “full cost for pricing” if management wants to recover it through the selling price. The key is to keep the production cost figure clear and separate from non-production items.

3) Predetermined overhead absorption rate

A predetermined absorption rate is a practical shortcut: it lets you attach an overhead share to jobs and batches as production happens, rather than waiting for the period-end overhead total. That makes interim unit costs usable for quotes and control. The rate works best when the activity base chosen reflects what actually drives overhead in that environment (for example, machine hours where automation is high).

4) Pricing using cost-plus approaches

Cost-plus pricing adds a profit loading to an identified cost base. The cost base must be stated clearly:

• production cost only, or
• “full cost for pricing” (production cost plus specific non-production costs that management wants to recover).

Using mark-up:

Selling price = Cost × (1 + Mark-up %)

Using target margin:

Selling price = Cost / (1 − Margin %)

5) Comparing estimated and actual costs (control)

Control improves when the costing system distinguishes:

• what the job/batch was expected to consume (estimated materials, labour hours, and absorbed overhead), versus
• what it actually consumed.

At this level, it is often sufficient to calculate total cost variances (overall difference between estimated and actual). In more detailed performance management analysis, these totals are commonly split into price/rate and usage/efficiency components.

Worked example

Narrative scenario

A bespoke furniture workshop produces custom pieces for clients and also makes small runs of standard items. It uses job costing for bespoke orders and batch costing for small-run production.

The workshop budgets production overheads of £120,000 for the year and budgeted direct labour hours of 20,000. Overheads are absorbed using direct labour hours.

During the period:

• Job F21is a custom dining table for a client. Estimated direct materials are £800. Estimated direct labour is 25 hours at £20 per hour. A delivery cost of £50 will be incurred to deliver to the customer. The workshop wants a 30% mark-up on thefull cost for pricing(production cost plus delivery).
• Batch B12is a set of 50 identical chairs for a restaurant. Estimated direct materials are £1,500. Estimated direct labour is 40 hours at £18 per hour. Assume all 50 chairs are good units (no scrap).

After completion, actual costs were recorded as follows:

• Job F21: actual materials £820; actual labour 26 hours at £20 per hour; delivery cost remained £50.
• Batch B12: actual materials £1,460; actual labour 42 hours at £18 per hour.
• Actual production overhead incurred in the production department for the period was £410 (this is the department total used for overhead reconciliation).

Required

1. Calculate the overhead absorption rate.
2. Prepare a job cost sheet for Job F21 showing:

• direct materials,
• direct labour,
• absorbed production overhead,
• production cost,
• delivery as a non-production cost for pricing,
• full cost for pricing.

1. Calculate the quotation price for Job F21 using a 30% mark-up on full cost for pricing.
2. Prepare a batch cost sheet for Batch B12 showing total and unit costs.
3. Compare estimated and actual costs for Job F21 and Batch B12, and calculate:

• total materials cost variance,
• total labour cost variance,
• under/over absorbed overhead for the period.

Solution

Step 1: Overhead absorption rate

Overhead absorption rate = £120,000 / 20,000 labour hours = £6 per labour hour

Step 2: Job cost sheet for Job F21 (estimated, for quotation)

Direct materials: £800
Direct labour: 25 hours × £20 = £500
Absorbed production overhead: 25 hours × £6 = £150

Estimated production cost = £800 + £500 + £150 = £1,450

Delivery (non-production cost included for pricing only): £50

Full cost for pricing = £1,450 + £50 = £1,500

Step 3: Quotation price for Job F21 (30% mark-up on full cost for pricing)

Profit = 30% × £1,500 = £450

Quotation price = £1,500 + £450 = £1,950

Step 4: Batch cost sheet for Batch B12 (estimated)

Direct materials: £1,500
Direct labour: 40 hours × £18 = £720
Absorbed production overhead: 40 hours × £6 = £240

Estimated total batch production cost = £1,500 + £720 + £240 = £2,460

Estimated unit cost = £2,460 / 50 units = £49.20 per chair

Step 5: Comparison of estimated and actual costs (control)

(A) Job F21: estimated vs actual

Estimated materials £800; actual materials £820
Total materials cost variance (Job F21) = £820 − £800 = £20 adverse

Estimated labour: 25 hours × £20 = £500
Actual labour: 26 hours × £20 = £520
Total labour cost variance (Job F21) = £520 − £500 = £20 adverse

Absorbed overhead:

• estimated absorbed overhead: 25 × £6 = £150
• actual absorbed overhead (based on actual hours worked): 26 × £6 = £156

Delivery: estimated £50; actual £50 (no variance)

(B) Batch B12: estimated vs actual

Estimated materials £1,500; actual materials £1,460
Total materials cost variance (Batch B12) = £1,460 − £1,500 = £40 favourable

Estimated labour: 40 hours × £18 = £720
Actual labour: 42 hours × £18 = £756
Total labour cost variance (Batch B12) = £756 − £720 = £36 adverse

Absorbed overhead:

• estimated absorbed overhead: 40 × £6 = £240
• actual absorbed overhead (based on actual hours worked): 42 × £6 = £252

(C) Overhead under/over absorption (production department for the period)

Overhead absorbed in the period (based on actual labour hours):

• Job F21: 26 × £6 = £156
• Batch B12: 42 × £6 = £252

Total overhead absorbed = £156 + £252 = £408

Actual production overhead incurred in the department for the period: £410

Under-absorbed overhead = £410 − £408 = £2 adverse

Interpretation of the results

• The overhead absorption rate of £6 per labour hour provides a consistent method for loading indirect factory costs into job and batch costs during the period.
• Job F21’s actual materials and labour were slightly higher than estimated, indicating minor underestimation of inputs (both adverse by £20).
• Batch B12 performed better on materials (favourable £40) but used more labour time than expected (adverse £36), suggesting an efficiency issue or a change in working conditions.
• The overhead reconciliation shows a small under-absorption (£2 adverse), meaning slightly more overhead was incurred than was absorbed using the predetermined rate.

Common pitfalls and misunderstandings

• Mixing production and non-production costs in product cost: Keep delivery, marketing, and general admin separate from production cost. You may include them for pricing, but they should not be treated as manufacturing cost.
• Using an unsuitable absorption base: If overhead is driven mainly by machines, labour hours can distort job costs. Choose a base that reflects resource consumption.
• Treating absorbed overhead as “actual overhead”: Absorbed overhead is an allocation. Always reconcile absorbed overhead to actual overhead incurred.
• Forgetting that batch costing needs a unit calculation: Batch totals are useful, but pricing and margin decisions usually require a unit cost based on good units produced.
• Confusing mark-up and margin: A mark-up of 30% does not mean a margin of 30%. Always state which basis you are using.
• Comparing estimates to actuals without stating variance type: If you compute only overall differences, label them as total cost variances. More detailed analysis can split them into price/rate and usage/efficiency elements.

Summary and further reading

Job and batch costing systems measure production cost where output is customised or made in small runs. Direct materials and direct labour are traced to the job or batch, while production overhead is allocated using a predetermined absorption rate.

Cost sheets support quotation decisions and profitability analysis, while comparisons of estimated and actual costs provide feedback for control. Clear separation of production costs from non-production costs improves both pricing decisions and the reliability of product cost information.

Further study should include overhead absorption methods, variance analysis techniques, and inventory cost treatment in financial reporting.

FAQ

What is the main difference between job costing and batch costing?

Job costing collects costs for a single identifiable customer order or project. Batch costing collects costs for a group of similar units produced together and then derives a unit cost by dividing total batch cost by the number of good units produced.

How is an overhead absorption rate calculated and applied?

A predetermined rate is calculated using budgeted production overhead and a budgeted activity level (such as labour hours). The rate is then applied to actual activity (for example, actual labour hours worked on a job) to absorb overhead into product cost.

Why must direct and indirect costs be distinguished?

Direct costs can be traced to a specific job or batch and should be charged directly. Indirect production costs cannot be traced economically and must be allocated using a consistent method. Misclassification leads to unreliable unit costs, distorted pricing, and weak cost control.

Should delivery costs be included in job cost?

Delivery to the customer is normally a non-production cost and is treated as an expense when incurred. However, it may be included in a quotation as part of a “full cost for pricing” approach, provided it is clearly shown separately from production cost.

What does under-absorbed overhead mean?

It means the total overhead absorbed into jobs and batches using the predetermined rate is less than the actual production overhead incurred. The difference is typically adjusted in profit, often through cost of sales, unless material and requiring allocation between inventory and cost of sales.

What role does variance analysis play?

Variance analysis highlights differences between expected and actual costs. It supports control by prompting investigation into material usage, labour efficiency, and overhead behaviour, improving future estimates and operational performance.

Summary (Recap)

This chapter explained how job and batch costing measure production cost in customised and small-run environments. It showed how to prepare cost sheets, apply a predetermined overhead absorption rate, and use full cost information to support quotations using mark-up and margin. It also demonstrated how comparing estimated and actual costs produces useful total cost variances and an overhead reconciliation, strengthening cost control and pricing decisions.

Glossary

Job costing
A costing method that collects and analyses costs for a single identifiable order or project, with direct costs traced to the job and production overhead allocated using a consistent basis.

Batch costing
A costing method that collects costs for a group of similar units produced together, then calculates a unit cost by dividing total batch cost by the number of good units produced.

Direct materials
Materials that can be traced to a specific job or batch in a practical and economical way.

Direct labour
Labour time spent specifically on producing a job or batch, recorded using time records and charged directly.

Production overhead
Indirect manufacturing costs that support production but cannot be traced directly to individual jobs or batches.

Overhead absorption rate
A predetermined rate used to allocate production overhead to jobs or batches, typically based on labour hours, machine hours, or another activity measure.

Work in progress (WIP)
Incomplete production at the reporting date, carried as inventory and measured using production costs incurred to date.

Under/over absorption
The difference between actual production overhead incurred and overhead absorbed into jobs/batches using a predetermined rate.

Mark-up
Profit expressed as a percentage of cost.

Margin
Profit expressed as a percentage of selling price.

Prime cost
The total of direct materials and direct labour.

Variance analysis
A control technique that compares expected (estimated or standard) costs with actual costs to identify and explain differences.