© 2010 The McGraw-Hill Companies, Inc. Systems Design: Job- Order Costing Chapter 3.

© 2010 The McGraw-Hill Companies, Inc.

Systems Design: Job-Systems Design: Job-Order CostingOrder Costing

Chapter 3Chapter 3


Types of Product Costing Types of Product Costing SystemsSystems

ProcessCosting

Job-orderCosting

A company produces many units of a single A company produces many units of a single product. product.

One unit of product is indistinguishable from One unit of product is indistinguishable from other units of product.other units of product.

The identical nature of each unit of product The identical nature of each unit of product enables enables assigning the same average cost per unit.assigning the same average cost per unit.






ProcessCosting

Job-orderCosting







Example companies:Example companies:1. Weyerhaeuser (paper manufacturing)1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)3. Coca-Cola (mixing and bottling beverages)

Example companies:Example companies:1. Weyerhaeuser (paper manufacturing)1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)3. Coca-Cola (mixing and bottling beverages)



ProcessCosting

Job-orderCosting

Many different products are produced each period. Many different products are produced each period.

Products are manufactured to order.Products are manufactured to order.

The unique nature of each order requires tracing or The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost allocating costs to each job, and maintaining cost

records for each job.records for each job.







ProcessCosting

Job-orderCosting









Example companies:Example companies:1. Boeing (aircraft manufacturing)1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)3. Walt Disney Studios (movie production)

Example companies:Example companies:1. Boeing (aircraft manufacturing)1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)3. Walt Disney Studios (movie production)


Comparing Process and Comparing Process and Job-Order CostingJob-Order Costing

Job-Order Process

Number of jobs worked Many Single Product

Cost accumulated byIndividual

Job Department

Average cost computed by Job Department


Quick Check Quick Check Which of the following companies Which of the following companies

would be likely to use job-order would be likely to use job-order costing rather than process costing?costing rather than process costing?

a. Scott Paper Company for Kleenex.a. Scott Paper Company for Kleenex.

b. Architects.b. Architects.

c. Heinz for ketchup.c. Heinz for ketchup.

d. Caterer for a wedding reception.d. Caterer for a wedding reception.

e. Builder of commercial fishing e. Builder of commercial fishing vessels.vessels.

Which of the following companies Which of the following companies would be likely to use job-order would be likely to use job-order costing rather than process costing?costing rather than process costing?

a. Scott Paper Company for Kleenex.a. Scott Paper Company for Kleenex.

b. Architects.b. Architects.

c. Heinz for ketchup.c. Heinz for ketchup.

d. Caterer for a wedding reception.d. Caterer for a wedding reception.

e. Builder of commercial fishing e. Builder of commercial fishing vessels.vessels.


Manufacturing Overhead


Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3

Charge direct

material and direct labor

costs to each job as

work is performed.

Charge direct

material and direct labor

costs to each job as

work is performed.

Job-Order Costing – An Job-Order Costing – An OverviewOverview

Direct MaterialsDirect Materials

Direct LaborDirect Labor


Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, , are allocated are allocated

to all jobs to all jobs rather than rather than

directly traced directly traced to each job.to each job.

Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, , are allocated are allocated

to all jobs to all jobs rather than rather than

directly traced directly traced to each job.to each job.

Indirect Manufacturing Indirect Manufacturing CostsCosts

Direct MaterialsDirect Materials

Direct LaborDirect Labor

Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3Manufacturing Overhead



PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-09Date Completed

Department B3 Units CompletedItem Wooden cargo crate

Direct Materials Direct Labor Manufacturing OverheadReq. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units ShippedDirect Materials Date Number BalanceDirect LaborManufacturing OverheadTotal CostUnit Product Cost

The Job Cost SheetThe Job Cost Sheet


Measuring Direct Materials CostMeasuring Direct Materials Cost

Will E. Delite


Measuring Direct Materials CostMeasuring Direct Materials Cost


Measuring Direct Labor CostsMeasuring Direct Labor Costs


Job-Order Cost AccountingJob-Order Cost Accounting


Why Use an Allocation Base?Why Use an Allocation Base?Manufacturing overhead is applied to jobs that are Manufacturing overhead is applied to jobs that are

in process. An allocation base, such as direct in process. An allocation base, such as direct labor hours, direct labor dollars, or machine hours, labor hours, direct labor dollars, or machine hours,

is used to assign manufacturing overhead to is used to assign manufacturing overhead to individual jobs.individual jobs.

Manufacturing overhead is applied to jobs that are Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct in process. An allocation base, such as direct

labor hours, direct labor dollars, or machine hours, labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to is used to assign manufacturing overhead to

individual jobs.individual jobs.

We use an allocation base because:

1.It is impossible or difficult to trace overhead costs to particular jobs.

2.Manufacturing overhead consists of many different items ranging from the grease used in machines to production manager’s salary.

3.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.


The predetermined overhead rate The predetermined overhead rate ((POHRPOHR)) used to apply overhead to jobs used to apply overhead to jobs is determined before the period begins.is determined before the period begins.

Manufacturing Overhead ApplicationManufacturing Overhead Application


Using a predetermined rate makes itUsing a predetermined rate makes itpossible to estimate total job costs sooner.possible to estimate total job costs sooner.

Actual overhead for the period is notActual overhead for the period is notknown until the end of the period.known until the end of the period.

The Need for a POHRThe Need for a POHR


Determining Predetermined Determining Predetermined Overhead RatesOverhead Rates

Predetermined overhead rates are calculated using a three-step process.

Estimate the level of

production for the period.

Estimate the level of

production for the period.

Estimate total amount of the allocation base

for the period.

Estimate total amount of the allocation base

for the period.

Estimate total manufacturing

overhead costs.

Estimate total manufacturing

overhead costs.

POHR = ÷


Actual amount of allocation is based upon the actual level of

activity (normal costing system).

Actual amount of allocation is based upon the actual level of

activity (normal costing system).

Based on estimates, and determined before the

period begins.

Based on estimates, and determined before the

period begins.

Application of Application of Manufacturing OverheadManufacturing Overhead

Overhead applied = POHR × Actual activity


For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

Overhead Application RateOverhead Application Rate

POHR = $4.00 per DLH

$640,000

160,000 direct labor hours (DLH)POHR =

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =


Job-Order Cost AccountingJob-Order Cost Accounting


Interpreting the Average Unit CostInterpreting the Average Unit Cost

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional unit was produced.

Fixed overhead would not change if another unitwas produced, so the incremental cost of another unit is something less than $118.

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional unit was produced.

Fixed overhead would not change if another unitwas produced, so the incremental cost of another unit is something less than $118.


Quick Check Quick Check Job WR53 at NW Fab, Inc. required $200 of

direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.b. $350.c. $380.d. $730.


Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.b. $350.c. $380.d. $730.

Quick Check Quick Check


Job-Order Costing Job-Order Costing Document Flow SummaryDocument Flow Summary

A sales order is the A sales order is the basis of issuing a basis of issuing a production order. production order.

A sales order is the A sales order is the basis of issuing a basis of issuing a production order. production order.

A production A production order initiates order initiates work on a job.work on a job.

A production A production order initiates order initiates work on a job.work on a job.


Job-Order CostingJob-Order CostingDocument Flow SummaryDocument Flow Summary

Job Cost Sheets

Job Cost Sheets

MaterialsRequisitionMaterials

Requisition

Manufacturing Overhead Account


Direct materials

Indirect materials

MaterialsMaterialsused may beused may be

either direct oreither direct orindirect.indirect.

MaterialsMaterialsused may beused may be

either direct oreither direct orindirect.indirect.



Job Cost Sheets

Job Cost Sheets

Employee Time Ticket

Employee Time Ticket



Anemployee’s

time may be eitherdirect orindirect.

Anemployee’s

time may be eitherdirect orindirect.

Direct Labor

Indirect Labor





OtherActual OHCharges

OtherActual OHCharges

Job Cost Sheets

Job Cost Sheets

POHR rate used to apply overhead

MaterialsRequisitionMaterials

Requisition

EmployeeTime TicketEmployee

Time TicketIndirectLabor

IndirectMaterial


Raw MaterialsMaterial

Purchases

Mfg. Overhead

Work in Process(Job Cost Sheet)

Actual Applied

Direct Materials Direct

Materials

Indirect Materials

Indirect Materials

The Purchase and Issue of Raw The Purchase and Issue of Raw MaterialsMaterials


Cost Flows – Material Purchases Cost Flows – Material Purchases Raw material purchases are recorded in anRaw material purchases are recorded in an

inventory account. inventory account.


Cost Flows – Material UsageCost Flows – Material Usage

Direct materials issued to a job increase Direct materials issued to a job increase Work in Process and decrease Raw Work in Process and decrease Raw

Materials. Indirect materials used are Materials. Indirect materials used are charged to Manufacturing Overhead charged to Manufacturing Overhead and also decrease Raw Materials. and also decrease Raw Materials.


Mfg. Overhead

Salaries and Wages Payable


Direct

MaterialsDirect Labor

Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

IndirectLabor

The Recording of Labor CostsThe Recording of Labor Costs


The Recording of Labor CostsThe Recording of Labor Costs

The cost of direct labor incurred The cost of direct labor incurred increases Work in Process and the cost increases Work in Process and the cost

of indirect labor increases of indirect labor increases Manufacturing Overhead. Manufacturing Overhead.


Mfg. Overhead



Direct


Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

IndirectLabor

Recording Actual Recording Actual Manufacturing OverheadManufacturing Overhead

OtherOverhead


Recording Actual Manufacturing Recording Actual Manufacturing OverheadOverhead

In addition to indirect materials and In addition to indirect materials and indirect labor, other manufacturing indirect labor, other manufacturing overhead costs are charged to the overhead costs are charged to the

Manufacturing Overhead account as Manufacturing Overhead account as they are incurred. they are incurred.


Mfg. Overhead



Direct


Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

IndirectLabor

Applying Manufacturing OverheadApplying Manufacturing Overhead

OtherOverhead

Overhead Applied

OverheadApplied to

Work inProcess

If actual and applied manufacturing overheadare not equal, a year-end adjustment is required.

If actual and applied manufacturing overheadare not equal, a year-end adjustment is required.


Applying Manufacturing Applying Manufacturing OverheadOverhead

Work in Process is increased when Work in Process is increased when Manufacturing Overhead is applied to jobs. Manufacturing Overhead is applied to jobs.


Accounting for Accounting for Nonmanufacturing CostNonmanufacturing Cost

Nonmanufacturing costs are not assigned to individual jobs, rather they are expensed in the

period incurred.

Examples:Examples:1. 1. Salary expense of employeesSalary expense of employees

who work in a marketing, selling,who work in a marketing, selling,or administrative capacity.or administrative capacity.

2. 2. Advertising expenses are expensedAdvertising expenses are expensedin the period incurred.in the period incurred.

Examples:Examples:1. 1. Salary expense of employeesSalary expense of employees

who work in a marketing, selling,who work in a marketing, selling,or administrative capacity.or administrative capacity.

2. 2. Advertising expenses are expensedAdvertising expenses are expensedin the period incurred.in the period incurred.


Accounting for Accounting for Nonmanufacturing CostNonmanufacturing Cost

Nonmanufacturing costs (period Nonmanufacturing costs (period expenses) are charged to expense as they expenses) are charged to expense as they

are incurred. are incurred.


Finished GoodsWork in Process(Job Cost Sheet)

Direct


Overhead Applied

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Transferring Completed UnitsTransferring Completed Units


Transferring Completed UnitsTransferring Completed Units As jobs are completed, the Cost of Goods As jobs are completed, the Cost of Goods

Manufactured is transferred to Finished Manufactured is transferred to Finished Goods from Work in Process. Goods from Work in Process.


Finished Goods

Cost of Goods Sold


Direct


Overhead Applied

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Cost ofGoodsSold

Cost ofGoodsSold

Transferring Units SoldTransferring Units Sold


Transferring Units SoldTransferring Units Sold When finished goods are sold, two entries When finished goods are sold, two entries

are required: (1) to record the sale, and (2) are required: (1) to record the sale, and (2) to record the Cost of Goods Sold. to record the Cost of Goods Sold.


Problems of Overhead ApplicationProblems of Overhead Application

The difference between the overhead cost applied to Work in Process and the actual overhead costs of a

period is referred to as either underapplied or overapplied overhead.

Underapplied overhead exists when the amount of overhead applied to jobs

during the period using the predetermined overhead rate is less than the total

amount of overhead actually incurred during the period.

Underapplied overhead exists when the amount of overhead applied to jobs

during the period using the predetermined overhead rate is less than the total

amount of overhead actually incurred during the period.

Overapplied overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.

Overapplied overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.


PearCo’s PearCo’s actual overheadactual overhead for the year was for the year was $650,000$650,000 with a total of with a total of 170,000170,000 direct labor direct labor

hours worked on jobs.hours worked on jobs.

How much total overhead was applied to How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s jobs during the year? Use

PearCo’s predetermined overhead rate of PearCo’s predetermined overhead rate of $4.00 per direct labor hour. $4.00 per direct labor hour.

Overhead Application ExampleOverhead Application Example

Overhead Applied During the PeriodApplied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000


PearCo’s PearCo’s actual overheadactual overhead for the year was for the year was $650,000$650,000 with a total of with a total of 170,000170,000 direct labor direct labor

hours worked on jobs.hours worked on jobs.

How much total overhead was applied to PearCo’s How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s jobs during the year? Use PearCo’s

predetermined overhead rate of $4.00 per predetermined overhead rate of $4.00 per direct labor hour. direct labor hour. Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

Overhead Application ExampleOverhead Application Example


Tiger, Inc. had actual manufacturing overhead Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing during the period. Tiger’s manufacturing overhead isoverhead is

a. $50,000 overapplied.a. $50,000 overapplied.

b. $50,000 underapplied.b. $50,000 underapplied.

c. $60,000 overapplied.c. $60,000 overapplied.

d. $60,000 underapplied.d. $60,000 underapplied.

Tiger, Inc. had actual manufacturing overhead Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing during the period. Tiger’s manufacturing overhead isoverhead is




d. $60,000 underapplied.d. $60,000 underapplied.



Tiger, Inc. had actual manufacturing Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s machine hours during the period. Tiger’s manufacturing overhead ismanufacturing overhead is




d. $60,000 underappliedd. $60,000 underapplied..

Tiger, Inc. had actual manufacturing Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s machine hours during the period. Tiger’s manufacturing overhead ismanufacturing overhead is




d. $60,000 underappliedd. $60,000 underapplied..


Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000

Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000

Underapplied Overhead $1,210,000 - $1,160,000 = $50,000


Disposition of Under- or Disposition of Under- or Overapplied OverheadOverapplied Overhead

$30,000 may beclosed directly to

cost of goods sold.

Cost of Goods Sold

Cost of Goods Sold

PearCo’s Method

Work inProcessWork inProcess

FinishedGoods

FinishedGoods

Cost of Goods Sold

Cost of Goods Sold

$30,000may be allocated

to these accounts.

OROROROR


Disposition of Disposition of Under- or Overapplied OverheadUnder- or Overapplied Overhead

PearCo’sMfg. Overhead

Actualoverhead

costs

$650,000$30,000

overapplied

PearCo’s Costof Goods Sold

Unadjusted Balance

AdjustedBalance

$30,000

$30,000

Overhead appliedto jobs

$680,000


Allocating Under- or Overapplied Allocating Under- or Overapplied Overhead Between AccountsOverhead Between Accounts

Assume the overhead applied in ending Work in Process Inventory, ending Finished Goods

Inventory, and Cost of Goods Sold is shown below:

Amount Percent of

Total Allocation of $30,000

Work in process 68,000$ 10% 3,000$ Finished Goods 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000

Total 680,000$ 100% 30,000$



Amount Percent of

Total Allocation of $30,000

Work in process 68,000$ 10% 3,000$ Finished Goods 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000

Total 680,000$ 100% 30,000$

We would complete the following allocation of $30,000 overapplied overhead:

10% × $30,00010% × $30,000



Amount Percent of

Total Allocation of

$30,000 Work in process 68,000$ 10% 3,000$ Finished Goods 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000 Total 680,000$ 100% 30,000$


Overapplied and Underapplied Overapplied and Underapplied Manufacturing Overhead - SummaryManufacturing Overhead - Summary

Alternative 1 Alternative 2If Manufacturing Close to Cost Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASECost of Goods Sold Work in Process

(Applied OH is less Finished Goodsthan actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASECost of Goods Sold Work in Process

(Applied OH is greater Finished Goodsthan actual OH) Cost of Goods Sold

PearCo’s Method

More accurate but more complex to compute.More accurate but more complex to compute.



What effect will the What effect will the overappliedoverapplied overhead have on PearCo’s net overhead have on PearCo’s net operating income?operating income?

a. Net operating income will increase.a. Net operating income will increase.

b. Net operating income will be b. Net operating income will be unaffected.unaffected.

c. Net operating income will decrease.c. Net operating income will decrease.

What effect will the What effect will the overappliedoverapplied overhead have on PearCo’s net overhead have on PearCo’s net operating income?operating income?






What effect will the What effect will the overapplied overapplied overhead have on PearCo’s net overhead have on PearCo’s net operating income?operating income?




What effect will the What effect will the overapplied overapplied overhead have on PearCo’s net overhead have on PearCo’s net operating income?operating income?





May be more complex May be more complex but . . .but . . .

May be more complex May be more complex but . . .but . . .

Multiple Predetermined Overhead Multiple Predetermined Overhead RatesRates

To this point, we have assumed that there is a single To this point, we have assumed that there is a single predetermined overhead rate called a plantwide predetermined overhead rate called a plantwide

overhead rate.overhead rate.

To this point, we have assumed that there is a single To this point, we have assumed that there is a single predetermined overhead rate called a plantwide predetermined overhead rate called a plantwide

overhead rate.overhead rate.

Large companies Large companies often use multiple often use multiple

predetermined predetermined overhead rates.overhead rates.

Large companies Large companies often use multiple often use multiple

predetermined predetermined overhead rates.overhead rates.

May be more accurate because May be more accurate because it reflects differences across it reflects differences across

departments.departments.

May be more accurate because May be more accurate because it reflects differences across it reflects differences across

departments.departments.


Job-Order Costing in Service Job-Order Costing in Service CompaniesCompanies

Job-order costing is used in many different Job-order costing is used in many different types of service companies.types of service companies.

Job-order costing is used in many different Job-order costing is used in many different types of service companies.types of service companies.


The Use of Information The Use of Information TechnologyTechnology

Technology plays an important part in manyjob-order cost systems. When combined with

Electronic Data Interchange (EDI) or a web-based programming language called Extensible Markup

Language (XML), bar coding eliminates the inefficiencies and inaccuracies associated with

manual clerical processes.

Technology plays an important part in manyjob-order cost systems. When combined with

Electronic Data Interchange (EDI) or a web-based programming language called Extensible Markup

Language (XML), bar coding eliminates the inefficiencies and inaccuracies associated with

manual clerical processes.


The Predetermined The Predetermined Overhead Rate and Overhead Rate and

CapacityCapacityAppendix 3AAppendix 3A


Predetermined Overhead Predetermined Overhead Rate and CapacityRate and Capacity

Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because:

1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level.

2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use.

Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because:

1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level.

2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use.


Capacity-Based Overhead Capacity-Based Overhead RatesRatesCriticisms can be overcome by using Criticisms can be overcome by using

estimated total units in the allocation base estimated total units in the allocation base at capacity in the denominator of the at capacity in the denominator of the

predetermined overhead rate calculation.predetermined overhead rate calculation.

Criticisms can be overcome by using Criticisms can be overcome by using estimated total units in the allocation base estimated total units in the allocation base

at capacity in the denominator of the at capacity in the denominator of the predetermined overhead rate calculation.predetermined overhead rate calculation.

Let’s look at the difference!Let’s look at the difference!


An ExampleAn ExampleEquipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company

estimates that 40,000 units will be produced and sold next year. What is

the predetermined overhead rate?


An ExampleAn ExampleEquipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be

produced. The company estimates that 40,000 units will be produced and sold next year.

TraditionalMethod

= $2.50 per unit$100,000

40,000=

Capacity Method

= $2.00 per unit$100,000

50,000=



Crest Winery in Woodinville leases an Crest Winery in Woodinville leases an automatic corking machine for $100,000 per automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 year. At full capacity, it can cork 50,000 cases of wine per year. The company cases of wine per year. The company estimates 40,000 cases of wine will be estimates 40,000 cases of wine will be produced and sold next year. What is the produced and sold next year. What is the predetermined overhead rate based on thepredetermined overhead rate based on the estimatedestimated number of cases of wine? number of cases of wine?a. $2.00 per case.a. $2.00 per case.

b. $2.50 per case.b. $2.50 per case.

c. $4.00 per case.c. $4.00 per case.

Crest Winery in Woodinville leases an Crest Winery in Woodinville leases an automatic corking machine for $100,000 per automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 year. At full capacity, it can cork 50,000 cases of wine per year. The company cases of wine per year. The company estimates 40,000 cases of wine will be estimates 40,000 cases of wine will be produced and sold next year. What is the produced and sold next year. What is the predetermined overhead rate based on thepredetermined overhead rate based on the estimatedestimated number of cases of wine? number of cases of wine?a. $2.00 per case.a. $2.00 per case.




Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine?a. $2.00 per case.b. $2.50 per case.c. $4.00 per case.

Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine?a. $2.00 per case.b. $2.50 per case.c. $4.00 per case.



Quick Check Quick Check Crest Winery in Woodinville leases an Crest Winery in Woodinville leases an

automatic corking machine for $100,000 per automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 year. At full capacity, it can cork 50,000 cases of wine per year. The company cases of wine per year. The company estimates 40,000 cases of wine will be estimates 40,000 cases of wine will be produced and sold next year. What is the produced and sold next year. What is the predetermined overhead rate based on the predetermined overhead rate based on the number of cases of winenumber of cases of wine at capacityat capacity??a. $2.00 per case.a. $2.00 per case.




Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity?a. $2.00 per case.b. $2.50 per case.c. $4.00 per case.



Quick Check Quick Check When When capacitycapacity is used in the denominator is used in the denominator of the predetermined rate, what happens of the predetermined rate, what happens to the predetermined overhead rate as to the predetermined overhead rate as estimated activity decreases?estimated activity decreases?a. The predetermined overhead rate goes up a. The predetermined overhead rate goes up

when activity goes down.when activity goes down.

b. The predetermined overhead rate stays the b. The predetermined overhead rate stays the same because it is not affected by changes in same because it is not affected by changes in activity.activity.

c. The predetermined overhead rate goes down c. The predetermined overhead rate goes down when activity goes down.when activity goes down.

When When capacitycapacity is used in the denominator is used in the denominator of the predetermined rate, what happens of the predetermined rate, what happens to the predetermined overhead rate as to the predetermined overhead rate as estimated activity decreases?estimated activity decreases?a. The predetermined overhead rate goes up a. The predetermined overhead rate goes up





When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?a. The predetermined overhead rate goes up when

activity goes down.b. The predetermined overhead rate stays the

same because it is not affected by changes in activity.

c. The predetermined overhead rate goes down when activity goes down.

When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?a. The predetermined overhead rate goes up when

activity goes down.b. The predetermined overhead rate stays the





Quick Check Quick Check When When estimated activityestimated activity is used in the is used in the

denominator of the predetermined rate, denominator of the predetermined rate, what happens to the predetermined what happens to the predetermined overhead rate as estimated activity overhead rate as estimated activity decreases?decreases?a. The predetermined overhead rate goes up a. The predetermined overhead rate goes up





When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?a. The predetermined overhead rate goes up

when activity goes down.b. The predetermined overhead rate stays the





Income Statement Income Statement Preparation – Capacity Preparation – Capacity Actual volume 40,000 casesSelling price $40.00 per caseVariable production cost $24.00 per caseFixed manufacturing overhead $100,000 per yearCapacity 50,000 casesPredetermined overhead rate $2.00 per caseFixed selling and admin. expense $500,000 per year

Revenue 1,600,000$ Cost of goods sold 1,040,000 Gross margin 560,000 Cost of idle capacity 20,000 Selling and admin. expense 500,000 Net operating income 40,000$


Income Statement Income Statement Preparation – Traditional Preparation – Traditional Actual volume 40,000 casesSelling price $40.00 per caseVariable production cost $24.00 per caseFixed manufacturing overhead $100,000 per yearCapacity 40,000 casesPredetermined overhead rate $2.50 per caseFixed selling and admin. expense $500,000 per year

Revenue 1,600,000$ Cost of goods sold 1,060,000 Gross margin 540,000 Cost of idle capacity - Selling and admin. expense 500,000 Net operating income 40,000$


•Assign #3Assign #3pg. 122 – E3-10, pg. 122 – E3-10, pg. 123 – E3-12,pg. 123 – E3-12,pg. 124 – E3-14,pg. 124 – E3-14,pg. 215 – E5-1 pg. 215 – E5-1 ((due 10/15due 10/15))

© 2010 The McGraw-Hill Companies, Inc. Systems Design: Job- Order Costing Chapter 3.

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Transcript of © 2010 The McGraw-Hill Companies, Inc. Systems Design: Job- Order Costing Chapter 3.