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2010 The McGraw-Hill Companies, Inc.

Systems Design: Job-Order Costing

Chapter 3

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McGraw-Hill/Irwin Slide 2

Learning Objective 1

Distinguish betweenprocess costing and job-order costing and identifycompanies that would use

each costing method.

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Types of Product Costing Systems

ProcessCosting

Job-orderCosting

A company produces many units of a singleproduct.

One unit of product is indistinguishable fromother units of product.

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

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ProcessCosting

Job-orderCosting

A company produces many units of a singleproduct.

One unit of product is indistinguishable fromother units of product.

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

Example companies:

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

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ProcessCosting

Job-orderCosting

Many different products are produced each period.

Products are manufactured to order.

The unique nature of each order requires tracing orallocating costs to each job, and maintaining costrecords for each job.

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ProcessCosting

Job-orderCosting

Many different products are produced each period.

Products are manufactured to order.

The unique nature of each order requires tracing orallocating costs to each job, and maintaining costrecords for each job.

Example companies:1. Boeing (aircraft manufacturing)

2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)

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Comparing Process and Job-Order Costing

Job-Order Process

Number of jobs worked Many Single Product

Cost accumulated by

Job Department

Average cost computed by Job Department

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Quick Check

Which of the following companies would belikely to use job-order costing rather thanprocess costing?

a. Scott Paper Company for Kleenex.b. Architects.

c. Heinz for ketchup.

d. Caterer for a wedding reception.e. Builder of commercial fishing vessels.

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Identify the documents

used in a job-order costingsystem.

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ManufacturingOverhead

Job No. 1

Job No. 2

Job No. 3

Chargedirect

material anddirect labor

costs to

each job aswork is

performed.

Job-Order CostingAn Overview

Direct Materials

Direct Labor

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ManufacturingOverhead,includingindirect

materialsandindirect labor,are allocated

to all jobsrather thandirectly tracedto each job.

Indirect Manufacturing Costs

Direct Materials

Direct Labor

Job No. 1

Job No. 2

Job No. 3ManufacturingOverhead

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PearCo Job Cost Sheet

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

Date Completed

Department B3 Units Completed

Item Wooden cargo crate

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

Cost Summary Units Shipped

Direct Materials Date Number Balance

Direct Labor

Manufacturing Overhead

Total Cost

Unit Product Cost

The Job Cost Sheet

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Measuring Direct Materials Cost

Will E. Delite

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Measuring Direct Materials Cost

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Measuring Direct Labor Costs

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Job-Order Cost Accounting

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Compute predeterminedoverhead rates and explainwhy estimated overhead

costs (rather than actualoverhead costs) are used inthe costing process.

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Why Use an Allocation Base?

Manufacturing overhead is applied to jobs that arein process. An allocation base, such as directlabor hours, direct labor dollars, or machine hours,

is used to assign manufacturing overhead to

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 rangingfrom the grease used in machines to production managers salary.

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

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The predetermined overhead rate (POHR)used toapply overhead to jobs is determined before theperiod begins.

Manufacturing Overhead Application

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

Ideally, the allocation baseis a cost driver that causes

overhead.

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

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

The Need for a POHR

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Determining Predetermined Overhead Rates

Predetermined overhead rates are calculatedusing a three-step process.

Estimate the level of

production for theperiod.

Estimate total amountof the allocation base

for the period.

Estimate totalmanufacturing

overhead costs.

POHR =

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Actual amount of allocation isbased upon the actual level of

activity (normal costing system).

Based on est imates, anddetermined before the

period begins.

Application of Manufacturing Overhead

Overhead applied = POHR Actual activity

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

Overhead 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 =

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Interpreting 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.

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Quick Check

Job WR53 at NW Fab, Inc. required $200 of directmaterials and 10 direct labor hours at $15 per hour.Estimated total overhead for the year was $760,000and 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.

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Job WR53 at NW Fab, Inc. required $200 of directmaterials and 10 direct labor hours at $15 per hour.Estimated total overhead for the year was $760,000and 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

POHR = $760,000/20,000 hours $38

Direct materials $200Direct labor $15 x 10 hours $150

Manufacturing overhead $38 x 10 hours $380

Total cost $730

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Understand the flow of costsin a job-order costing system

and prepare appropriate

journal entries to recordcosts.

J b O d C ti

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Job-Order CostingDocument Flow Summary

A sales order is thebasis of issuing a

production order.

A productionorder initiates

work on a job.

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Job CostSheets

MaterialsRequisition

ManufacturingOverheadAccount

Directmaterials

Indirectmaterials

Materialsused may be

either direct or

indirect.

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Job CostSheets

Employee TimeTicket


Anemployeestime may be either

direct or

indirect.

DirectLabor

IndirectLabor

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OtherActual OHCharges

Job CostSheets

POHR

rate used

to apply

overhead

MaterialsRequisition

EmployeeTime Ticket

Indirect

Labor

Indirect

Material

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Learning Objectives 4 and 7

Understand the flow of costs in a job-order costing system and prepareappropriate journal entries to record

costs.

Use T-accounts to show the flow ofcosts in a job-order costing system.

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Job-Order Costing: The Flow of Costs

The transactions (in T-account and journal

entry form) that capturethe flow of costs in a

job-order costingsystem are illustrated on

the following slides.

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Raw MaterialsMaterial

Purchases

Mfg. Overhead

Work in Process(Job Cost Sheet)

Actual Appl ied

DirectMaterials Direct

Materials

IndirectMaterials

Indirect

Materials

The Purchase and Issue of Raw Materials

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Cost FlowsMaterial Purchases

Raw material purchases are recorded in aninventory account.

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Cost FlowsMaterial Usage

Direct materials issued to a job increase Work inProcess and decrease Raw Materials. Indirectmaterials used are charged to ManufacturingOverhead and also decrease Raw Materials.

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Mfg. Overhead

Salaries andWages Payable Work in Process(Job Cost Sheet)

DirectMaterials

DirectLabor

DirectLabor

IndirectMaterials

Actual Appl ied

IndirectLabor

IndirectLabor

The Recording of Labor Costs

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The Recording of Labor Costs

The cost of direct labor incurred increases Workin Process and the cost of indirect labor

increases Manufacturing Overhead.

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Mfg. Overhead

Salaries and

Wages Payable

Work in Process

(Job Cost Sheet)Direct

Materials

Direct

Labor

DirectLabor

Indirect

Materials

Actual Appl ied

IndirectLabor

Indirect

Labor

Recording Actual Manufacturing Overhead

OtherOverhead

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Recording Actual Manufacturing Overhead

In addition to indirect materials and indirect labor,other manufacturing overhead costs are chargedto the Manufacturing Overhead account as they

are incurred.

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Apply overhead cost toWork in Process using apredetermined overhead

rate.

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Mfg. Overhead

Salaries and

Wages Payable

Work in Process

(Job Cost Sheet)Direct

Materials

Direct

Labor

DirectLabor

Indirect

Materials

Actual Appl ied

IndirectLabor

Indirect

Labor

Applying Manufacturing Overhead

OtherOverhead

OverheadApplied

OverheadApplied to

Work inProcess

If actual and appliedmanufacturing overheadare not equal, a year-endadjustment is required.

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Applying Manufacturing Overhead

Work in Process is increased when ManufacturingOverhead is applied to jobs.

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Accounting for Nonmanufacturing Cost

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

period incurred.

Examples:1. Salary expense of employees

who work in a marketing, selling,

or administrative capacity.2. Advertising expenses are expensedin the period incurred.

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Accounting for Nonmanufacturing Cost

Nonmanufacturing costs (period expenses) arecharged to expense as they are incurred.

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Finished GoodsWork in Process(Job Cost Sheet )

DirectMaterials

DirectLabor

OverheadApplied

Cost ofGoods

Mfd.

Cost ofGoods

Mfd.

Transferring Completed Units

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Transferring Completed Units

As jobs are completed, the Cost of GoodsManufactured is transferred to Finished Goods from

Work in Process.

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Finished Goods

Cost of Goods Sold

Work in Process(Job Cost Sheet)

DirectMaterials

DirectLabor

OverheadApplied

Cost ofGoods

Mfd.

Cost ofGoods

Mfd.

Cost ofGoodsSold

Cost ofGoods

Sold

Transferring Units Sold

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Transferring Units Sold

When finished goods are sold, two entries arerequired: (1) to record the sale, and (2) to record

the Cost of Goods Sold.

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Compute underapplied oroverapplied overhead cost andprepare the journal entry to

close the balance in

Manufacturing Overhead to theappropriate accounts.

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Problems of Overhead Application

The difference between the overhead cost applied toWork in Process and the actual overhead costs of aperiod is referred to as either underapplied or

overapplied overhead.

Underapplied overheadexists when the amount ofoverhead applied to jobs

during the period using the

predetermined overheadrate is less thanthe total

amount of overhead actuallyincurred during the period.

Overapplied overheadexists when the amount ofoverhead applied to jobs

during the period using the

predetermined overheadrate is greater thanthe totalamount of overhead actuallyincurred during the period.

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PearCos actual overheadfor the year was $650,000with a total of 170,000direct labor hours worked on

jobs.

How much total overhead was applied to PearCos jobs

during the year? Use PearCos predeterminedoverhead rate of $4.00 per direct labor hour.

Overhead Application Example

Overhead Applied During the Period

Applied Overhead = POHR Actual Direct Labor Hours

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

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PearCos actual overheadfor the year was $650,000with a total of 170,000direct labor hours worked on

jobs.

How much total overhead was applied to PearCos jobs

during the year? Use PearCos predeterminedoverhead rate of $4.00 per 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 Example

PearCo has overappliedoverhead for the yearby $30,000. What will

PearCo do?

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Tiger, Inc. had actual manufacturing overheadcosts of $1,210,000 and a predetermined overheadrate of $4.00 per machine hour. Tiger, Inc. worked290,000 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.

Quick Check

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

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

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Disposition of

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Disposition ofUnder- or Overapplied Overhead

PearCosMfg. Overhead

Actual

overheadcosts

$650,000

$30,000overapplied

PearCos Costof Goods Sold

Unadjusted

Balance

AdjustedBalance $30,000

$30,000

Overhead

appliedto jobs

$680,000

Allocating Under- or Overapplied

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g ppOverhead Between Accounts

Assume the overhead applied in ending Work inProcess Inventory, ending Finished GoodsInventory, and Cost of Goods Sold is shown below:

Amount

Percent of

Total

Allocation

of $30,000Work in process 68,000$ 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$


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Amount

Percent of

Total

Allocation

of $30,000Work in process 68,000$ 10% 3,000$



Total 680,000$ 100% 30,000$

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

10% $30,000


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Amount Percent ofTotal Allocation of$30,000

Work in process 68,000$ 10% 3,000$



Total 680,000$ 100% 30,000$

Overapplied and Underapplied Manufacturing

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Overapplied and Underapplied ManufacturingOverhead - Summary

Alternative 1 Alternative 2

If Manufacturing Close to Cost

Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASECost of Goods Sold Work in Process

(Applied OH is less Finished Goods

than actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASE

Cost of Goods Sold Work in Process(Applied OH is greater Finished Goods

than actual OH) Cost of Goods Sold

PearCos

Method

More accurate but more complex to compute.

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Quick Check

What effect will the overappliedoverhead haveon PearCosnet operating income?

a. Net operating income will increase.

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

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Quick Check

What effect will the overapplied overhead haveon PearCosnet operating income?

a. Net operating income will increase.

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

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May be more complexbut . . .

Multiple Predetermined Overhead Rates

To this point, we have assumed that there is a singlepredetermined overhead rate called a plantwideoverhead rate.

Large companiesoften use multiple

predeterminedoverhead rates.

May be more accurate becauseit reflects differences across

departments.

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Job-Order Costing in Service Companies

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

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The Use of Information Technology

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

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

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

manual clerical processes.

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2010 The McGraw-Hill Companies, Inc.

The Predetermined Overhead Rateand Capacity

Appendix 3A

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(Appendix 3A)Understand the implications of

basing the predeterminedoverhead rate on activity at

capacity rather than onestimated activity for the period.

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Predetermined Overhead Rate and Capacity

Calculating predetermined overhead rates using anestimated, or budgeted amount of the allocation basehas been criticized because:

1.Basing the predetermined overhead rate uponbudgeted activity results in product costs that fluctuatedepending upon the activity level.

2.Calculating predetermined rates based upon

budgeted activity charges products for costs that theydo not use.

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Capacity-Based Overhead Rates

Criticisms can be overcome by usingestimated total units in the allocation base

at capacity in the denominator of the

predetermined overhead rate calculation.

Lets look at the difference!

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An Example

Equipment is leased for $100,000 peryear. Running at full capacity, 50,000units may be produced. The company

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

the predetermined overhead rate?

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An Example

Equipment is leased for $100,000 per year.Running at full capacity, 50,000 units may beproduced. The company estimates that 40,000 units

will be produced and sold next year.

TraditionalMethod

= $2.50 per unit$100,000

40,000=

CapacityMethod

= $2.00 per unit$100,00050,000

=

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Quick Check

Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. At fullcapacity, it can cork 50,000 cases of wine peryear. The company estimates 40,000 cases of

wine will be produced and sold next year. Whatis the predetermined overhead rate based on theestimatednumber of cases of wine?

a. $2.00 per case.

b. $2.50 per case.c. $4.00 per case.

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wine will be produced and sold next year. Whatis the predetermined overhead rate based on theestimatednumber of cases of wine?

a. $2.00 per case.


Quick Check

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Quick Check


wine will be produced and sold next year. Whatis the predetermined overhead rate based on thenumber of cases of wineat capacity?

a. $2.00 per case.


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wine will be produced and sold next year. Whatis the predetermined overhead rate based on thenumber of cases of wineat capacity?

a. $2.00 per case.


Quick Check

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Quick Check

When capacityis used in the denominator of the

predetermined rate, what happens to thepredetermined overhead rate as estimated activitydecreases?

a. The predetermined overhead rate goes up when activity

goes down.

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

c. The predetermined overhead rate goes down when activity

goes down.

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When capacityis used in the denominator of the

predetermined rate, what happens to thepredetermined overhead rate as estimated activitydecreases?

a. The predetermined overhead rate goes up when activity

goes down.

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

c. The predetermined overhead rate goes down when activity

goes down.

Quick Check

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Quick Check

When estimated activityis used in the

denominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?

a. The predetermined overhead rate goes up when

activity goes down.

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

c. The predetermined overhead rate goes down when

activity goes down.

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When estimated activityis used in the

denominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?

a. The predetermined overhead rate goes up when

activity goes down.

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

c. The predetermined overhead rate goes down when

activity goes down.

Quick Check

I S P i C i

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Income Statement PreparationCapacity

Actual volume 40,000 cases

Selling price $40.00 per caseVariable production cost $24.00 per case

Fixed manufacturing overhead $100,000 per year

Capacity 50,000 cases

Predetermined overhead rate $2.00 per case

Fixed 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 20,000Selling and admin. expense 500,000

Net operating income 40,000$

I St t t P ti T diti l

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Income Statement PreparationTraditional

Actual volume 40,000 cases

Selling price $40.00 per caseVariable production cost $24.00 per case

Fixed manufacturing overhead $100,000 per year

Capacity 40,000 cases

Predetermined overhead rate $2.50 per case

Fixed 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$

E d f Ch t 3

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End of Chapter 3

Chap 003 cost

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