for income taxes. It assumes that as the owner, you keep $100,000 in your pocket with no taxes paid. Assume a 30 percent tax rate. You can calculate the pre-tax dollars needed to earn $100,000 after taxes:
Pre-tax dollars = cost of item ÷ (1 - tax rate)
Pre-tax dollars = $100,000 ÷ (1 - 0.30)
Pre-tax dollars = $100,000 ÷ 0.70)
Pre-tax dollars = $142,857.14
The taxes paid are $42,857.14. And you’re probably saying, “Oh, I get it. To earn $100,000 after tax, I need to increase my sales to cover the taxes.” And you’re right. Ideally, sales prices and volume are sufficient to cover the burden of taxes.
Consider an example, using Pizza Gone Wild. The plan for profitability was to sell 10,000 units at $20 each, but that won’t pay the taxes. Calculate the number of units you need to sell to cover profits and taxes ($142,857.14):
$142,857.14 = (units × $20) – (units × $8) – $20,000
$142,857.14 = units × ($20 – $8) – $20,000
$142,857.14 = units × $12 – $20,000
To finish the calculation, add $20,000 to both sides of the equation. Then divide both sides by $12.
You need to sell 13,571 units to handle the $142,857.14. That’s 10,000 units for your profit and 3,571 units to handle the taxes. You gotta sell a lotta dough to make a little dough.
Chapter 4
Estimating Costs with Job Costing
IN THIS CHAPTER
Job costing is a costing methodology you use when your customers incur unique amounts of costs. Job costing assesses costs by the job and allows you to provide detailed price estimates based on the product constructed or service provided.
By contrast, process costing (the topic of Chapter 16) assumes that individual product costs are nearly the same for every customer. For example, if you manufacture office chairs, each chair of a particular model has the same costs. You use the same amount of metal and material, and assemble the chair using the same amount of labor. If you calculate the cost for one chair, you know the cost for every chair of that model. In other words, the customer does not have the option to create his or her own unique product with unique costs.
Roofs (for example) aren’t like chairs. If your business puts roofs on houses, each client’s costs will be different. The amount of material depends on the type of roof and the square footage. Labor time varies, depending on the roof’s size, pitch, and unique angles. This is an example of job costing.
When you’re deciding on which costing method to use, keep in mind how specific or unique your product or service is. Do the costs differ a great deal from one customer to another? If they do, your business should probably use job costing. Otherwise, use process costing.
In this chapter, you see when job costing is the appropriate costing method to use. You also see how to apply both direct and indirect costs. (If you’re not sure about the definitions of direct and indirect costs, they’re covered later in this chapter.)
Understanding How Job Costing Works
For some businesses, nearly every customer job has different costs, and that’s where job costing asserts its value. You need a job costing estimate in order to get the customer’s business, and you need to track costs accurately so you generate a reasonable profit.
The different costs for different jobs will often be self-evident. Material costs, labor hours, mileage cost, and type of equipment used are likely to vary. For example, a tree trimming company would incur more costs to remove a 30-foot tree than to remove a small stump. The big tree takes more labor and different equipment.
Some factors could lower costs and make a business more competitive in price (or improve its bottom line). For example, every few months I receive a flyer in the mail or a knock on my front door from a tree trimming company working on a job in my neighborhood. They offer me a free estimate while they are in my neighborhood. It’s a smart business move. If you’ve incurred the cost to locate your employees and equipment in a certain area, why not perform as much work as possible while you’re there? You can spread some costs (mileage, for example) over several jobs. As a result, your cost per job in that neighborhood is lower, and you increase your profit.
The business lesson is that a little bit of flyer can go a long way.
Cost objects: The sponges that absorb money
A cost object is anything that causes you to incur costs. Think about a cost object as a sponge that absorbs your money. The object can be a customer, job, a product line, or a company division. Carefully identifying cost objects will help you cost your product or service accurately.
Assume you manage a group of plumbers. You’re reviewing the month’s mileage expense (the equivalent of gasoline) for your staff and notice a 20 percent increase from the prior month. Why? You start asking questions. As it turns out, the customer demand for plumbing work required your staff to drive more miles. The average customer lived farther away.
You grumble, “That driving ran up a lot of costs!” Yes, it did, and you do the driving to meet the needs of your customers. In this example, the cost object was the group of customers for the month. Without any customers, you wouldn’t have paid for all the gas. (Well, you wouldn’t have had any income either, but never mind that.) No cost object means no costs incurred.
Direct costs are traced to the cost object, and indirect costs are allocated to the cost object.
Indirect costs can be fixed or variable. Insurance costs on vehicles would be a fixed indirect cost. The premiums are fixed, and the cost is indirect to the job because you can’t trace the vehicle insurance cost directly to a specific job. Utility costs for the office (such as heating and cooling) are variable indirect costs. Costs vary with the weather, but as with the insurance premiums, you can’t trace them directly to any one job.
