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Interest Coverage Ratio – Meaning, Assumptions and Interpretation
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Companies incur a variety of costs in their day to day operation. These costs are very different from one another and need to be treated differently by the accountants to give a fair picture of the organization.
Here is a list of the different types of costs that are usually incurred by an organization as well as their implications when it comes to job order costing.
Since job order costing is mostly followed in the manufacturing sector, materials used are the first types of costs that are incurred. Calculating these costs is pretty straightforward.
Most companies have already done a variety of jobs and they can accurate with remarkable precision the material that will be required to do the job. There might be minor differences in the projected and actual material costs but these differences are negligible unless there has been inefficient management or massive wastage.
In job order costing, as and when materials are consumed, they become part of the inventory. Raw material becomes work in progress. Then it becomes finished goods which is then immediately sold because the job was done only after an agreement was made about a sale.
Direct labour is a lot like direct materials. This cost also can be determined with a high degree of precision. However, contrary to popular belief, labour is not expensed immediately. It is also a product cost. This means that just like materials, the costs of labour are added to the raw material and stored as inventory till the sale is complete.
The overheads need to be classified in a job order costing system. The classification is done on the basis of whether or not the overheads are related to manufacturing. This is because manufacturing overheads are product costs.
Like labour and materials, they are added to the price of the inventory and listed down as an expense only when the inventory is sold and the transaction is complete.
The last category is the overheads that cannot be traced directly to any manufacturing activity. Since these costs are not manufacturing costs, their value is not stored in the inventory.
A good example would be office rent. This is an overhead which is spent irrespective of whether there is any production or not. This expenditure is determined by the period of time that has passed. If the month has ended the rent in due, no matter what! Hence these costs are called period costs as opposed to all the other product costs mentioned earlier. They need to expensed in the period when these costs were incurred.
The differences between product and period costs are very subtle. Wages paid to employees in the factory are added to inventory whereas salaries paid to office personnel are expensed immediately.
Rent for factory can be added to the cost of inventory while rent for office needs to be expensed immediately. The same costs can become product or period costs depending on whether they were incurred in the office or at the factory.
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