Job Costing in Construction

What is Job Costing?

Job costing is a form of accounting that tracks and categorizes all costs associated with individual jobs to determine profitability. It’s used mostly by companies that make custom products. In construction, every job is custom, because no two jobs are the exact same, and thus job costing is used. This is unlike the process costing basis which is used by manufacturers who produce the exact same product over and over. 

How Does Job Costing Work?

To explore the difference, let's use chairs as an example of process costing. 

It cost you $100,000 to make 10,000 chairs. Determining the cost is easy 

$100,000 2,500 chairs= $400 per chairs

Unfortunately, this simple approach won’t work in construction. Every job or order you take is entirely different. 

Imagine you are a home builder. Last year you built 20 houses and it cost $5 million dollars to build them. We cannot assume that $5,000,000.00  20 houses = $250,000.00 per house. 

One house could be 1,000 sqft and another could be 3,500 sqft. Each house uses a different amount of material, amount of time to complete, labor costs, etc. . 

How to Calculate Job Cost?

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Predetermined Overhead?

To calculate the total job cost, you’ll need to find the predetermined overhead rate. 

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Predetermined overhead rate = estimated total overhead estimated activity of the base unit

*the base unit is the activity that the overhead is applied to. This is typically applied to labor or machine hours

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Example

XYZ Construction 

Job: 2411 Washington Ave Custom Deck 

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Companies yearly estimated overhead = $40,000

Companies yearly estimated labor hours 2023 = 2,000 hrs

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Predetermined overhead rate = estimated total overhead estimated activity of the base unit

Predetermined overhead rate  = $40,000 / 2,000 hours = $20

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A custom deck your building takes 3 days to complete working 10 hr per day. So 30 hrs (3 days x 10hr) to complete.

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Applied overhead = $20 x 30 hours = $600

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Direct Material: $2,000

Direct Labor: $450

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Total job cost =direct materials + direct labor + applied overhead

$2,000 + $450 + $600 = $3,050

What if Applied Overhead Differs From Actual Overhead?

It’s not uncommon for applied overhead to differ from actual overhead - it can either be over or under. If we said applied overhead was $600, but it was actually $700, then the applied overhead was underestimated. Whereas if we said the applied overhead was $600, but it was actually $500, then the applied overhead was overestimated.

The 2 ways to handle the over or under applied balance are:

• Transfer the balance to cost of goods sold
• Prorate the balance throughout:

• Work in progress
• Cost of goods sold

The simplest method would be increasing or decreasing costs of goods sold.

Why is Job Costing Important in Construction?

Tracking Expenses

Job costing helps you track every expense and see where your money is going. If you see a variance in a report you can track it down and determine if there was a mistake or if you spent too much money. 

Cash Flow

Construction companies typically bear all the upfront costs on construction projects. In some cases payment is due the day the project is completed, but on larger projects they often don’t get paid for 30 - 60 days after completion. This can easily create cash flow issues. Job costing pays close attention to expenses allowing to manage and track cash flow. 

Budgeting   

Job costing allows you to project revenue and expenses on future jobs. You can accurately set budgets and make sure you're hitting goals and growing your business.

Progress

In construction large jobs have deadlines and milestones. Using job costing, construction companies can stay on top of deadlines and comprehend the percentage of completion a project is at. Getting paid at milestones is essential for managing cash flow and paying suppliers on time. 

There’s No Avoiding Job Costing in Construction!

Job costing is the universal accounting method in construction. It accounts for both your direct and indirect costs, showing you your true profitability on every job. If you feel like job costing can feel complex, you’re not alone. There are so many moving parts and independent variables that go into every job, it’s tough to stay on top of it all. Hire the right bookkeeper and you won’t have anything to worry about besides building and selling more jobs!

If you have any questions about construction bookkeeping, accounting, best practices or want to join our construction bookkeeping community, check out our resources and original content at ConstructionBookkeeping.com