Job Costing II: Why Classifying Cost as Indirect Saves Time

This is the second in a series of articles on job costing. Since Data Guidance Group implements ERP and accounting software, we’ve learned that it’s often as important to understand the business implications of the software as it is to know how to use the software itself.

As we mentioned in the previous post on job costing, all costs need to be divided into two categories: direct and indirect. Direct costs are “charged” directly to the job. This means that such things as employee labor hours must be tracked along with a job number, and perhaps a category. This information is put into the payroll or job cost system so that it appears as a cost of the job.

Indirect costs are charged directly to a general ledger account without specifying a particular job. This is because (usually) an indirect cost is difficult to trace to a specific job. As an example, consider tool depreciation. Since tools are used on many different jobs, tracking the depreciation per job would be difficult. Also, since the amount of depreciation is typically minimal, the cost of tracking this would be prohibitive.

What some companies using job cost don’t realize is that not every cost that could be considered direct cost needs to be direct. For example, suppose that employees use gloves that cost $5 on every job. The gloves are thrown away at the end of the job. It would be possible to keep up with how many pairs of gloves were used on the job, and charge that to the job. However, the time involved in tracking this exceeds the value of the information. It saves significant time and money to simply allocate gloves as an indirect expense.

Some supplies that have significant costs might also be tracked as indirect expenses. Suppose that a particular type of polishing compound is used for every job. Suppose further that each job uses very close to a drum. If a drum costs $5000, it may still be acceptable to treated it as an indirect cost. This works well if every job uses the same amount (and so would be charged approximately $5000).

The critical significance of all of this is that tracking direct costs, costs money. The more direct costs tracked, the more accounting effort involved. By reducing the number of direct costs tracked, accounting costs go down. So if you’re preparing job cost records, you might want to reevaluate the direct and indirect cost classifications.

It is important, however, to evaluate the reduction in accuracy of the cost. In many cases no reduction in accuracy is observed, and substantial savings are realized.

If you have any questions about this or any other accounting technique for use with automated systems, feel free to contact us.