Variations of Normal Costing: A Service-Sector Example

Learning Objective 8 Understand variations of normal costing

• some variations of normal costing use budgeted direct-cost rates

Job costing is also very useful in service organizations such as accounting and consulting firms, advertising agencies, auto repair shops, and hospitals. In an accounting firm, each audit is a job. The costs of each audit are accumulated in a job-cost record, much like the document used by Robinson Company, based on the seven-step approach described earlier. On the basis of labor-time sheets, direct labor costs of the professional staff—audit partners, audit managers, and audit staff—are traced to individual jobs. Other direct costs, such as travel, out-of-town meals, and lodging are also traced to jobs. The costs of secretarial support, office staff, rent, and depreciation of furniture and equipment are indirect costs because these costs cannot easily be traced to jobs. Indirect costs are allocated to jobs, for example, using a cost-allocation base such as number of professional labor-hours.

In some service organizations, a variation of normal costing is helpful because actual direct-labor costs, the largest component of total costs in many service organizations, can be difficult to trace to jobs as they are completed. For example, the actual direct-labor costs of an audit may include bonuses that become known only at the end of the year (a numerator reason). Also, the hours worked each period might vary significantly depending on the number of working days each month and the demand for services (a denominator reason) while the direct-labor costs remain largely fixed. It would be inappropriate to charge a job with higher actual direct labor costs simply because a month had fewer working days or demand for services was low in that month. Using budgeted rates gives a better picture of the direct labor cost per hour that the company had planned when it hired the workers. In situations like these, a company needing timely cost information during the progress of an audit will use budgeted rates for some direct costs in addition to the budgeted rates for indirect costs. All budgeted rates are calculated at the start of the fiscal year. Recall that “pure” normal costing uses actual cost rates for all direct costs and budgeted cost rates only for indirect costs.

The mechanics of using budgeted rates for direct costs are similar to the methods employed when using budgeted rates for indirect costs. We illustrate this for Donahue and Associates, a public accounting firm. For 2020, Donahue budgets total direct-labor costs of $14,400,000, total indirect costs of $12,960,000, and total direct (professional) labor-hours of 288,000. In this case,

Assuming only one indirect-cost pool and total direct-labor costs as the cost-allocation base,

Suppose that in March 2020, an audit of Hanley Transport, a client of Donahue, uses 800 direct labor-hours. Donahue calculates the direct-labor costs of the audit by multiplying the budgeted direct-labor cost rate, $50 per direct labor-hour, by 800, the actual quantity of direct labor-hours. The indirect costs allocated to the Hanley Transport audit are determined by multiplying the budgeted indirect-cost rate (90%) by the direct-labor costs assigned to the job ($40,000). Assuming no other direct costs for travel and the like, the cost of the Hanley Transport audit is

At the end of the fiscal year, the direct costs traced to jobs using budgeted rates will generally not equal actual direct costs because the actual rate and the budgeted rate are developed at different times using different information. End-of-year adjustments for under- or overallocated direct costs would need to be made in the same way that adjustments are made for under- or overallocated indirect costs.

The Donahue and Associates example illustrates that most costing systems used in practice do not exactly match either the actual-costing system or the normal-costing system described earlier in the chapter. As another example, engineering consulting firms, such as Tata Consulting Engineers in India and Terracon Consulting Engineers in the United States, often use budgeted rates to allocate indirect costs (such as engineering and office-support costs) as well as some direct costs (such as professional labor-hours) and trace some actual direct costs (such as the cost of making blueprints and fees paid to outside experts). Users of costing systems should be aware that they may encounter different systems.