Job Order Costing

Chapter
3
Systems Design: Job-Order costing
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LEARNING OBJECTIVES
After studying this chapter, you should be able to: 1. Distinguish between process costing and joborder costing and identify companies that would use each costing method. 2. Identify the documents used in a job-order costing system. 3. Compute predetermined overhead rates and explain why estimated overhead costs are used in the costing process. 4. Record the journal entries that reflect the flow of costs in a job-order costing system.
McGraw-Hill Ryerson Limited., 2004
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LEARNING OBJECTIVES
After studying this chapter, you should be able to:
5. Apply overhead cost to Work in Process using a predetermined overhead rate. 6. Prepare the schedules of cost of goods manufactured and cost of goods sold that summarize the flow of costs. 7. Compute under- or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts. 8. (Appendix 3A) Explain the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.
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Types of Costing Systems Used to Determine Product Costs

Process Costing Job-order Costing
Many units of a single, homogeneous product flow evenly through a continuous production process.
One unit of product is indistinguishable from any other unit of product. Each unit of product is assigned the same average cost.
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Process Costing
Chapter 4 Many different products are produced each period. Products are manufactured to order. Cost are traced or allocated to jobs. Cost records must be maintained for each distinct product or job.
Job-order Costing
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Process Costing Job-order Costing
Typical job-order cost applications: Special-order printing Building construction Also used in the service industry Hospitals Law firms
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Job-Order Costing
Manufacturing overhead (OH) Direct material Applied to each job using a predetermined rate
THE JOB
Direct labour
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Sequence of Events in a Job-Order Costing System

Receive orders from customers Begin production
Schedule jobs
Order materials
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Direct Materials
Job No. 1
Direct Labour Job No. 2 Job No. 3
Manufacturing Overhead
Charge direct material and direct labour costs to each job as work is performed.
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Direct Materials
Job No. 1
Direct Labour Job No. 2 Job No. 3
Manufacturing Overhead
Apply overhead to each job using a predetermined rate.
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Job-Order Cost Accounting

The primary document for tracking the costs associated with a given job is the job cost sheet.
Lets investigate
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A materials requisition form is used to authorize the use of materials on a job.

Lets see one
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Materials Requisition Form
Will E. Delite
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Materials Requisition Form
Cost of material is charged to job A-143.
Type, quantity, and total cost of material charged to job A-143.
Will E. Delite
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3-17
Workers use time tickets to record the time spent on each job.
Lets see one
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Employee Time Ticket
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Apply manufacturing overhead to jobs using a predetermined overhead rate of $4 per direct labour hour (DLH). Lets do it
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Application of Manufacturing Overhead

The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.
Estimated total manufacturing overhead cost for the coming period
POHR =
Estimated total units in the allocation base for the coming period
Ideally, the allocation base is a cost driver that causes overhead.

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Based on estimates, and determined before the period begins.
Overhead applied = POHR Actual activity

Actual amount of the cost driver such as units produced, direct labour hours, or machine hours incurred during the period.
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Overhead applied = POHR Actual activity
Recall the wooden crate example where:

Overhead applied = $4 per DLH 8 DLH = $32
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The Need for a Predetermined Manufacturing Overhead Rate

Using a predetermined rate makes it possible to estimate total job costs sooner.
Actual overhead for the period is not known until the end of the period.
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Overhead Application Example

PearCo applies overhead based on direct labour hours. Total estimated overhead for the year is $640,000. Total estimated labour cost is $1,400,000 and total estimated labour hours are 160,000. What is PearCos predetermined overhead rate per hour?
3-27

POHR =
Estimated total manufacturing overhead cost for the coming period
Estimated total units in the allocation base for the coming period
$640,000
POHR =
160,000 direct labour hours (DLH)
POHR = $4.00 per DLH
For each direct labour hour worked on a job, $4.00 of factory overhead will be applied to the job.
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What amount of overhead will PearCo apply to Job X-32?
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Job-Order Costing Document Flow Summary
Lets summarize the document flow we have been discussing in a job-order costing system.
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Materials used may be either direct or indirect. Direct material s Materials Requisition Indirect materials Manufacturing Overhead Account Job Cost Sheets
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An employees time may be either direct or indirect. Direct labour Job Cost Sheets
Employee Time Ticket Indirect labour Manufacturing Overhead Account
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Employee Time Ticket Indirect labour
Other Actual OH Charges
Manufacturing Applied Overhead Overhead Account
Job Cost Sheets
Materials Requisition
Indirect material
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Job-Order System Cost Flows
Lets examine the cost flows in a job-order costing system. We will use T-accounts and start with materials.
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Raw Materials
Material Direct Purchases Materials Indirect Materials
Work in Process (Job Cost Sheet)

Direct Materials
Mfg. Overhead
Actual Applied Indirect Materials
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Next lets add labour costs and applied manufacturing overhead to the job-order cost flows. Are you with me?
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Salaries and Wages Payable
Direct Labour Indirect Labour

Direct Materials Direct Labour Overhead Applied
Mfg. Overhead
Actual Applied Indirect Overhead Materials Applied to Work in Indirect Process Labour
If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.
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Now lets complete the goods and sell them. Still with me?
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Direct Materials Direct Labour Overhead Applied
Finished Goods
Cost of Goods Mfd.
Cost of Goods Mfd.
Cost of Goods Sold
Cost of Goods Sold
Cost of Goods Sold

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Lets return to PearCo and see what we will do if actual and applied overhead are not equal.
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PearCos actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCos jobs during the year? Use PearCos predetermined overhead rate of $4.00 per direct labour hour.
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PearCos actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCos jobs during the year? Use PearCos predetermined overhead rate of $4.00 per direct labour hour.
SOLUTION
Applied Overhead = POHR Actual Direct Labour Hours
Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
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PearCos actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCos PearCo has overapplied jobs during the year? Use PearCos predetermined overhead for the year per direct labour hour, overhead rate of $4.00 by $30,000. What will PearCo do?
SOLUTION
Applied Overhead = POHR Actual Direct labour Hours
Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
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Overapplied and Underapplied Manufacturing Overhead

PearCos Method $30,000 may be allocated to these accounts. $30,000 may be closed directly to cost of goods sold.
OR
Work in Process Finished Goods Cost of Goods Sold
Cost of Goods Sold
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Overapplied and Underapplied Manufacturing Overhead

PearCos Cost of Goods Sold
Unadjusted Balance $30,000 Adjusted Balance
PearCos Mfg. Overhead

Actual Overhead overhead applied costs to jobs
$650,000
$30,000
$680,000
$30,000 overapplied
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Overapplied and Underapplied Manufacturing Overhead - Summary

PearCos Method
If Manufacturing Overhead is . . . UNDERAPPLIED (Applied OH is less than actual OH) OVERAPPLIED (Applied OH is greater than actual OH) DECREASE Cost of Goods Sold Alternative 1 Close to Cost of Goods Sold INCREASE Cost of Goods Sold Alternative 2 Allocation INCREASE Work in Process Finished Goods Cost of Goods Sold DECREASE Work in Process Finished Goods Cost of Goods Sold
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Overhead Application Question 1

Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tigers manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
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Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tigers manufacturing overhead is a. $50,000 overapplied.
Overhead Applied b. $50,000 underapplied. 290,000 hours $4.00 per hour = $1,160,000 c. $60,000 overapplied.
Underapplied d. $60,000 underapplied.Overhead $1,210,000 - $1,160,000 = $50,000 McGraw-Hill Ryerson Limited., 2004
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Tigers overhead was $50,000 underapplied. This amount would result in an adjustment that would decrease cost of goods sold by $50,000. a. True b. False
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Tigers overhead was $50,000 underapplied. This amount would result in an adjustment that would decrease cost of goods sold by $50,000. a. True b. False
If overhead is underapplied, cost of goods sold is understated. The adjustment will increase cost of goods sold.
Job-Order Costing Typical Accounting Entries
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Lets look at summary journal entries for a joborder costing system. Well omit the numbers so that we can focus on accounts.
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Cost Flows Material Purchases

Raw material purchases are recorded in an inventory account.
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Cost Flows Material Usage

Direct materials issued to a job increase Work in Process and decrease Raw Materials. Indirect materials used are charged to Manufacturing Overhead and also decrease Raw Materials.
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Cost Flows Labour

The cost of direct labour incurred increases Work in Process and the cost of indirect labour increases Manufacturing Overhead.
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Cost Flows Actual Overhead

In addition to indirect materials and indirect labour, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.
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Cost Flows Overhead Applied

Work in Process is increased when Manufacturing Overhead is applied to jobs.
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Cost Flows Period Expenses

Non-manufacturing costs (period expenses) are charged to expense as they are incurred.
Cost Flows Cost of Goods Manufactured

As jobs are completed, the cost of goods manufactured is transferred to Finished Goods from Work in Process.
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Cost Flows Sales

When finished goods are sold, two entries are required: (1) to record the sale; and (2) to record Cost of Goods Sold and reduce Finished Goods.
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Scrap and Rework

Improving quality reduces the costs associated with rework, delays in production, warranty cost, and poor customer relations.
Increased Quality
Increased Profitabilit y
Leads to
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Scrap
The loss from scrap can be: 1. Allocated across all good units, or 2. Charged to overhead and in turn charged to all jobs.
If scrap items are sold, the recovery can then be credited to : 1. The job, or 2. Manufacturing overhead.
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Rework
When some rework is undertaken, the materials and labour involved in the rework could be charged to : 1. The job, or 2. Manufacturing overhead and spread over all the jobs.
Appendix
3A
The Predetermined Overhead Rate and Capacity
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The Capacity Issue

When estimated activity is less than activity at capacity, two problems arise: 1. Unit product costs will fluctuate depending on the budgeted level of activity for the period. As budget levels decrease, overhead cost per unit (and unit product costs) will increase. 2. Products will be charged for resources they did not use.
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End of Chapter 3

Job Order Costing

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Chapter

Types of Costing Systems Used to Determine Product Costs

Types of Costing Systems Used to Determine Product Costs

Types of Costing Systems Used to Determine Product Costs

Sequence of Events in a Job-Order Costing System

McGraw-Hill Ryerson Limited., 2004

Sequence of Events in a Job-Order Costing System

Sequence of Events in a Job-Order Costing System

Apply overhead to each job using a predetermined rate.

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

A materials requisition form is used to authorize the use of materials on a job.

Materials Requisition Form

Materials Requisition Form

Cost of material is charged to job A-143.

Type, quantity, and total cost of material charged to job A-143.

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Employee Time Ticket

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Job-Order Cost Accounting

Job-Order Cost Accounting

McGraw-Hill Ryerson Limited., 2004

Application of Manufacturing Overhead

Ideally, the allocation base is a cost driver that causes overhead.

Application of Manufacturing Overhead

Overhead applied = POHR Actual activity

Application of Manufacturing Overhead

Overhead applied = POHR Actual activity

Recall the wooden crate example where:

The Need for a Predetermined Manufacturing Overhead Rate

Overhead Application Example

McGraw-Hill Ryerson Limited., 2004

Overhead Application Example

160,000 direct labour hours (DLH)

POHR = $4.00 per DLH

Overhead Application Example

What amount of overhead will PearCo apply to Job X-32?

McGraw-Hill Ryerson Limited., 2004

Overhead Application Example

McGraw-Hill Ryerson Limited., 2004