Manufacturing businesses present a bookkeeping challenge that most accounting software is not well-configured to handle out of the box: the gap between when costs are incurred and when revenue is recognised. In a retail business, you buy stock and sell it — cost and revenue are closely linked. In manufacturing, you accumulate raw materials, apply labour and machine time, carry work in progress for days or weeks, and only recognise revenue when the finished product ships. Without a disciplined job costing system, you cannot tell whether you are profitable at the job level — and your BAS may be missing significant GST on materials that have been consumed and not tracked.
Direct Costs vs Indirect Costs: The Foundation
Every job costing system begins with the same classification: costs that can be traced directly to a specific job, and costs that cannot.
Direct materials are raw materials and components that are consumed in producing a specific job. If you are fabricating a steel frame for a construction client, the steel, fasteners, and protective coating are direct materials. Their cost goes directly to that job's cost card.
Direct labour is the time of workers who are physically working on the job. Time-sheeting is essential — without it, you are allocating labour on estimates that compound into significant inaccuracies over a month of production. Even a simple paper timesheet signed off by the supervisor, entered weekly into the job costing system, is better than no tracking at all.
Indirect costs (overheads) are costs that cannot be traced to a single job: factory rent, electricity, equipment depreciation, factory management salaries, safety equipment, and consumables. These are real costs that must be recovered in your pricing — the question is how to allocate them to individual jobs.
Overhead Absorption Rates
The standard approach is to calculate a predetermined overhead absorption rate (OAR) at the start of the financial year, based on budgeted overhead and a budgeted activity measure. The most common activity measures in Australian manufacturing are:
- Machine hours: Used where machinery is the primary cost driver (metal fabrication, plastics, food processing).
- Direct labour hours: Used where labour is the primary input (custom joinery, specialised assembly).
- Direct labour cost: Used where wage rates vary significantly across the workforce.
The formula is straightforward:
OAR = Budgeted total overhead ÷ Budgeted activity level
If a workshop budgets $360,000 in overhead and 9,000 machine hours per year, the OAR is $40 per machine hour. Every job is then charged $40 for each machine hour it consumes, regardless of the actual overhead incurred in any given week.
At year end, compare actual overhead incurred to overhead absorbed (OAR × actual activity). The variance — over-absorbed or under-absorbed — is written off to cost of goods sold. Tracking this variance quarterly tells you whether your OAR is calibrated correctly and whether your prices are covering true overhead.
Work in Progress and Finished Goods
The balance sheet for a manufacturer includes two stock categories that do not appear in retail: work in progress (WIP) and finished goods.
WIP is the accumulated cost of jobs that have been started but not yet completed at the reporting date. The value of WIP at any point is:
- Direct materials issued to the job.
- Direct labour charged to the job (hours × rate).
- Overhead absorbed to the job (machine/labour hours × OAR).
Finished goods are jobs that are complete but not yet invoiced to the customer. They carry their full manufactured cost on the balance sheet until the revenue recognition event (typically shipment or delivery under the contract terms).
The journal flow is:
- Materials purchased: Dr Raw Materials Inventory / Cr Accounts Payable
- Materials issued to job: Dr WIP / Cr Raw Materials Inventory
- Labour charged: Dr WIP / Cr Wages Payable (or Labour Clearing Account)
- Overhead absorbed: Dr WIP / Cr Overhead Absorbed
- Job completed: Dr Finished Goods / Cr WIP
- Job invoiced: Dr Accounts Receivable / Cr Revenue; Dr COGS / Cr Finished Goods
The critical control: the sum of all open job cost cards (WIP) should reconcile to the WIP general ledger account. Discrepancies indicate materials that were issued without being recorded on a job, or labour that was charged to a job that has already been closed. Perform this reconciliation monthly.
Variance Analysis: Where Job Costing Pays for Itself
The real value of job costing is not the historical record — it is the variance analysis that tells you why actual profit differs from expected profit.
Three variances matter most:
Materials price variance: Did you pay more or less for materials than budgeted? If steel costs rose mid-year but your quotes are based on the beginning-of-year price, every job is absorbing a materials price adverse variance. This is your earliest signal that prices need to increase.
Labour efficiency variance: Did workers take more or fewer hours than the standard allowed for the job? Persistent adverse labour efficiency variances point to a standards problem (the standard hours are too tight), a training issue, or a scheduling problem causing rework.
Overhead volume variance: If actual activity falls below budgeted activity, overhead is under-absorbed — you have not recovered all your overhead through the OAR. In a slow trading month, this under-absorption represents real unrecovered fixed cost that reduces profit.
GST Implications for Manufacturers
Manufacturing businesses have several GST complexities that feed directly into the BAS:
GST on materials: All domestic purchases of raw materials from GST-registered suppliers attract GST, which is claimable as a GST credit. Track these credits at the purchase order level — do not wait for the month-end creditor reconciliation to identify GST.
Export sales: Goods exported from Australia are GST-free under subdivision 38-E. This means no GST on the invoice, but you retain the GST credits on inputs used to produce the exported goods. Exporters with significant export revenue may be in a regular refund position for GST — consider monthly BAS lodgement if the refunds are material.
Taxable use of stock: If finished goods are applied to personal use by the owner, or given as gifts (beyond the minor benefit threshold), a taxable supply arises and GST must be accounted for on the market value of the goods.
A clean job costing system gives you the GST-coded transaction detail that makes BAS preparation straightforward. The cost card for each job identifies whether the materials attracted GST, whether the sale is taxable or GST-free (export), and whether any stock has been applied to private use. Without job costing, these figures have to be reconstructed at BAS time — a slow, error-prone process that experienced manufacturing bookkeepers work hard to avoid.