Systems Design: Job-Order Costing

Chapter 3
FB2101 (2010/11 Sem B)

2010 The McGraw-Hill Companies, Inc.

 Learning Objective 1

Distinguish between
process costing and job-
order costing and identify
companies that would use
each costing method.

McGraw-Hill/Irwin Slide 2
 Types of Product Costing Systems

Process Job-order
Costing Costing

AA company
company produces
produces many
many units
units of
of aa single
single
product.
product.

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

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

McGraw-Hill/Irwin Slide 3
 Types of Product Costing Systems

Process Job-order
Costing Costing

AA company
company produces
produces many
many units
units of
of aa single
single
Example
Example companies:
product.
product. companies:
1.
Weyerhaeuser
1.One
Weyerhaeuser
One unit
unit of (paper
(paper
of product
product is manufacturing)
manufacturing) from
is indistinguishable
indistinguishable from
other2.
other Reynolds
2.units of Aluminum
Aluminum (refining
of product.
Reynolds
units product. (refining aluminum
aluminum ingots)
ingots)
3.
Coca-Cola
3.The
The identical(mixing
Coca-Cola
identical nature and
(mixing
nature and
of bottling
of each
each unit beverages)
bottling
unit beverages)
of
of product
product enables
enables
assigning
assigning the
the same
same average
average cost
cost per
per unit.
unit.

McGraw-Hill/Irwin Slide 4
 Types of Product Costing Systems

Process Job-order
Costing Costing

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

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

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

McGraw-Hill/Irwin Slide 5
 Types of Product Costing Systems

Process Job-order
Costing Costing

Many
Many different
different products
products are are produced
produced each
each period.
period.
Example companies:
Example companies:

1.Products
1. Products
Boeing are
are manufactured
manufactured
Boeing (aircraft
(aircraft manufacturing)to
manufacturing)to order.
order.

2. Bechtel
2.The
Bechtel
The International
unique nature
nature of
International
unique (large
of each
(large
each scale
order
scale
order construction)
requires
requires tracing
tracing or
construction) or
3.allocating
3. Walt
allocating costs
Walt Disney
Disney to
to each
Studios
costs
Studios job,
job, and
(movie
each(movie maintaining
maintaining cost
production)
and
production) cost
records
records for
for each
each job.
job.

McGraw-Hill/Irwin Slide 6
 Comparing Process and Job-Order Costing

McGraw-Hill/Irwin Slide 7
 Quick Check

Which
Which of of the
the following
following companies
companies would
would bebe
likely
likely to
to use
use job-order
job-order costing
costing rather
rather than
than
process
process costing?
costing?
a.
a. Scott
Scott Paper
Paper Company
Company forfor Kleenex.
Kleenex.
b.
b. Architects.
Architects.
c.
c. Heinz
Heinz for
for ketchup.
ketchup.
d.
d. Caterer
Caterer for
for aa wedding
wedding reception.
reception.
e.
e. Builder
Builder of
of commercial
commercial fishing
fishing vessels.
vessels.

McGraw-Hill/Irwin Slide 8
 Learning Objective 2

Identify the documents

used in a job-order costing
system.

McGraw-Hill/Irwin Slide 9
 Job-Order Costing An Overview

Direct Materials
Charge
Job No. 1 direct
material and
Direct Labor direct labor
Job No. 2
costs to
Manufacturing Job No. 3 each job as
Overhead work is
performed.

McGraw-Hill/Irwin Slide 10
 Indirect Manufacturing Costs

Manufacturing
Manufacturing
Overhead,
Overhead,
Direct Materials including
including
Job No. 1 indirect
indirect
materials
materials and and
Direct Labor indirect
Job No. 2 indirect labor labor,,
are
are allocated
allocated
Manufacturing to
to allall jobs
jobs
Job No. 3
Overhead rather
rather than than
directly
directly traced traced
to
to eacheach job.
job.
McGraw-Hill/Irwin Slide 11
 The Job Cost Sheet
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 Overhead
Req. 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

McGraw-Hill/Irwin Slide 12
 Measuring Direct Materials Cost

Will E. Delite

McGraw-Hill/Irwin Slide 13
 Measuring Direct Materials Cost

McGraw-Hill/Irwin Slide 14
 Measuring Direct Labor Costs

McGraw-Hill/Irwin Slide 15
 Job-Order Cost Accounting

McGraw-Hill/Irwin Slide 16
 Learning Objective 3
Compute predetermined
overhead rates and explain
why estimated overhead
costs (rather than actual
overhead costs) are used in
the costing process.

McGraw-Hill/Irwin Slide 17
 Why Use an Allocation Base?
Manufacturing overhead is applied to jobs that are
in process. An allocation base, such as direct
labor 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 ranging
from the grease used in machines to production managers salary.
3.Many types of manufacturing overhead costs are fixed even though
output fluctuates during the period.

McGraw-Hill/Irwin Slide 18
 Manufacturing Overhead Application
The predetermined overhead rate (POHR) used
to apply overhead to jobs is determined before
the period begins.

McGraw-Hill/Irwin Slide 19
 The Need for a POHR

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.

McGraw-Hill/Irwin Slide 20
 Determining Predetermined Overhead
Rates
Predetermined overhead rates are calculated
using a three-step process.

Estimate
Estimate the
the level
level of
of Estimate
Estimate total
total amount
amount Estimate
Estimate total
total
production
production for
for the
the of
of the
the allocation
allocation base
base manufacturing
manufacturing
period.
period. for
for the
the period.
period. overhead
overhead costs.
costs.

POHR =
McGraw-Hill/Irwin Slide 21
 Application of Manufacturing Overhead

Based
Based on
on estimates,
estimates, and
and
determined
determined before
before the
the
period
period begins.
begins.

Overhead applied = POHR Actual activity

Actual
Actual amount
amount of
of allocation
allocation is
is
based
based upon
upon the
the actual
actual level
level of
of
activity
activity (normal
(normal costing
costing system).
system).

McGraw-Hill/Irwin Slide 22
 Overhead Application Rate
Estimated total manufacturing
overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

$640,000
POHR =
160,000 direct labor hours (DLH)

POHR = $4.00 per DLH

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

McGraw-Hill/Irwin Slide 23
 Job-Order Cost Accounting

McGraw-Hill/Irwin Slide 24
 Job-Order Cost Accounting

McGraw-Hill/Irwin Slide 25
 Interpreting the Average Unit Cost

The average unit cost should not be interpreted

as the costs that would actually be incurred if an
additional unit was produced.

Fixed overhead would not change if another unit

was produced, so the incremental cost of
another unit is something less than $118.

McGraw-Hill/Irwin Slide 26
 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.

McGraw-Hill/Irwin Slide 27
 Learning Objective 4

Understand the flow of costs

in a job-order costing system
and prepare appropriate
journal entries to record
costs.

McGraw-Hill/Irwin Slide 28
 Job-Order Costing
Document Flow Summary

A
A sales
sales order
order isis the
the AA production
production
basis
basis of
of issuing
issuing aa order
order initiates
initiates
production
production order.
order. work
work on
on aa job.
job.

McGraw-Hill/Irwin Slide 29
 Job-Order Costing
Document Flow Summary

Materials
Materials
used
used may
may be be Direct Job Cost
either
either direct
direct or
or materials Sheets
indirect.
indirect.
Materials
Requisition

Manufacturing
Indirect
Overhead
materials
Account

McGraw-Hill/Irwin Slide 30
 Job-Order Costing
Document Flow Summary
An
employees
time may be either Direct Job Cost
Labor Sheets
direct or
indirect.
Employee Time
Ticket

Manufacturing
Indirect
Overhead
Labor
Account

McGraw-Hill/Irwin Slide 31
 Job-Order Costing
Document Flow Summary

Materials Indirect
Requisition Material POHR
rate used
to apply
Other Manufacturing overhead
Job Cost
Actual OH Overhead
Sheets
Charges Account

Employee Indirect
Time Ticket Labor

McGraw-Hill/Irwin Slide 32
 Learning Objectives 4 and 7
Understand the flow of costs in a job-
order costing system and prepare
appropriate journal entries to record
costs.

Use T-accounts to show the flow of

costs in a job-order costing system.

McGraw-Hill/Irwin Slide 33
 Job-Order Costing: The Flow of Costs

The transactions (in T-

account and journal
entry form) that capture
the flow of costs in a
job-order costing
system are illustrated on
the following slides.

McGraw-Hill/Irwin Slide 34
 The Purchase and Issue of Raw Materials

Raw Materials Work in Process

Material Direct
(Job Cost Sheet)
Purchases Materials Direct
Indirect Materials
Materials

Mfg. Overhead
Actual Applied
Indirect

Materials

McGraw-Hill/Irwin Slide 35
 Cost Flows Material Purchases
Raw material purchases are recorded in an
inventory account.

McGraw-Hill/Irwin Slide 36
 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.

McGraw-Hill/Irwin Slide 37
 The Recording of Labor Costs

Salaries and Work in Process

Wages Payable (Job Cost Sheet)
Direct Direct
Labor
Indirect
Materials
Direct

Labor Labor

Mfg. Overhead
Actual Applied
Indirect

Materials
Indirect

Labor
McGraw-Hill/Irwin Slide 38
 The Recording of Labor Costs
The cost of direct labor incurred increases Work
in Process and the cost of indirect labor
increases Manufacturing Overhead.

McGraw-Hill/Irwin Slide 39
 Recording Actual Manufacturing Overhead
Salaries and Work in Process
Wages Payable (Job Cost Sheet)
Direct Direct
Labor
Indirect
Materials
Direct

Labor Labor
Mfg. Overhead
Actual Applied
Indirect

Materials
Indirect

Labor
Other

Overhead
McGraw-Hill/Irwin Slide 40
 Recording Actual Manufacturing Overhead
In addition to indirect materials and indirect labor,
other manufacturing overhead costs are charged
to the Manufacturing Overhead account as they
are incurred.

McGraw-Hill/Irwin Slide 41
 Learning Objective 5

Apply overhead cost to

Work in Process using a
predetermined overhead
rate.

McGraw-Hill/Irwin Slide 42
 Applying Manufacturing Overhead
Salaries and Work in Process
Wages Payable (Job Cost Sheet)
Direct Direct
Labor
Indirect
Materials
Direct

Labor Labor
Overhead
Mfg. Overhead
Actual Applied Applied
Indirect
If actual and
and applied
Materials Overhead
Indirect
manufacturing overhead
Applied to are not equal, a year-end
Labor Work in adjustment is required.
Other
required.
Process
Overhead
McGraw-Hill/Irwin Slide 43
 Applying Manufacturing Overhead
Work in Process is increased when Manufacturing
Overhead is applied to jobs.

McGraw-Hill/Irwin Slide 44
 Accounting for Nonmanufacturing Cost

Nonmanufacturing costs are not assigned to

individual jobs, rather they are expensed in the
period incurred.

Examples:
Examples:
1.
1. Salary
Salary expense
expense of of employees
employees
who
who work
work in
in aa marketing,
marketing, selling,
selling,
or
or administrative
administrative capacity.
capacity.
2.
2. Advertising
Advertising expenses
expenses areare expensed
expensed
in
in the
the period
period incurred.
incurred.

McGraw-Hill/Irwin Slide 45
 Accounting for Nonmanufacturing Cost
Nonmanufacturing costs (period expenses) are
charged to expense as they are incurred.

McGraw-Hill/Irwin Slide 46
 Learning Objective 6

Prepare schedules of cost

of goods manufactured
and cost of goods sold.

McGraw-Hill/Irwin Slide 47
 Transferring Completed Units

Work in Process Finished Goods

(Job Cost Sheet )
Direct Cost of

Cost of

Goods
Materials
Direct
Goods Mfd.
Mfd.
Labor
Overhead

Applied

McGraw-Hill/Irwin Slide 48
 Transferring Completed Units
As jobs are completed, the Cost of Goods
Manufactured is transferred to Finished Goods from
Work in Process.

McGraw-Hill/Irwin Slide 49
 Transferring Units Sold

Work in Process Finished Goods

(Job Cost Sheet)
Direct Cost of Cost of

Cost of

Goods Goods
Materials
Direct
Goods Mfd. Sold
Mfd.
Labor
Overhead

Applied Cost of Goods Sold

Cost of
Goods
Sold

McGraw-Hill/Irwin Slide 50
 Transferring Units Sold
When finished goods are sold, two entries are
required: (1) to record the sale, and (2) to record
the Cost of Goods Sold.

McGraw-Hill/Irwin Slide 51
 Learning Objective 8
Compute underapplied or
overapplied overhead cost and
prepare the journal entry to
close the balance in
Manufacturing Overhead to the
appropriate accounts.

McGraw-Hill/Irwin Slide 52
 Problems 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 Overapplied 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.
McGraw-Hill/Irwin
exists when the amount of
overhead applied to jobs
during the period using the
predetermined overhead
rate is greater than the total
amount of overhead actually
incurred during the period.
Slide 53
 Overhead Application Example

PearCos actual overhead for the year was $650,000

with a total of 170,000 direct labor hours worked on
jobs.
How much total overhead was applied to PearCos jobs
during the year? Use PearCos predetermined
overhead 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

McGraw-Hill/Irwin Slide 54
 Overhead Application Example

PearCos actual overhead for the year was

$650,000 with a total of 170,000 direct labor
hours worked on jobs.
How much total overhead was applied to PearCos
jobs during the year? Use PearCos
predetermined overhead 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

McGraw-Hill/Irwin Slide 55
 Quick Check

Tiger,
Tiger,Inc.
Inc. had
had actual
actual manufacturing
manufacturing overhead
overhead
costs
costs of
of $1,210,000
$1,210,000 and
and aa predetermined
predetermined
overhead
overhead rate
rate of
of $4.00
$4.00 per
per machine
machine hour.
hour. Tiger,
Tiger,
Inc.
Inc. worked
worked 290,000
290,000 machine
machine hours
hours during
during the
the
period.
period. Tigers
Tigersmanufacturing
manufacturing overhead
overhead is
is
a.
a. $50,000
$50,000 overapplied.
overapplied.
b.
b. $50,000
$50,000 underapplied.
underapplied.
c.
c. $60,000
$60,000 overapplied.
overapplied.
d.
d. $60,000
$60,000 underapplied.
underapplied.

McGraw-Hill/Irwin Slide 56
 Disposition of Under- or Overapplied
Overhead
PearCos Method

$30,000 $30,000 may be

may be allocated closed directly to
to these accounts. cost of goods sold.
OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold

McGraw-Hill/Irwin Slide 57
 Disposition of
Under- or Overapplied Overhead

PearCos Cost PearCos

of Goods Sold Mfg. Overhead
Unadjusted Actual Overhead
Balance overhead applied
costs to jobs
$30,000
$650,000 $680,000
Adjusted $30,000 $30,000
Balance overapplied

McGraw-Hill/Irwin Slide 58
 Allocating Under- or Overapplied
Overhead Between Accounts
Assume the overhead applied in ending Work in
Process Inventory, ending Finished Goods
Inventory, and Cost of Goods Sold is shown below:

McGraw-Hill/Irwin Slide 59
 Allocating Under- or Overapplied
Overhead Between Accounts
We would complete the following allocation of
$30,000 overapplied overhead:

10%
10% $30,000
$30,000

McGraw-Hill/Irwin Slide 60
 Allocating Under- or Overapplied
Overhead Between Accounts

McGraw-Hill/Irwin Slide 61
 Overapplied and Underapplied Manufacturing
Overhead - Summary
PearCos
Method
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASE

Cost 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

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

McGraw-Hill/Irwin Slide 62
 Quick Check

What
What effect
effect will
will the
the overapplied
overapplied overhead
overhead have
have
on
on PearCos
PearCos net
net operating
operating income?
income?
a.
a. Net
Net operating
operating income
income will
will increase.
increase.
b.
b. Net
Net operating
operating income
income will
will be
be unaffected.
unaffected.
c.
c. Net
Net operating
operating income
income will
will decrease.
decrease.

McGraw-Hill/Irwin Slide 63
 Multiple Predetermined Overhead Rates
To this point, we have assumed that there is a single
predetermined overhead rate called a plantwide
overhead rate.

Large companies May be more complex

often use multiple but . . .
predetermined
overhead rates.
May be more accurate because
it reflects differences across
departments.

McGraw-Hill/Irwin Slide 64
 Job-Order Costing in Service Companies

Job-order costing is used in many different

types of service companies.

McGraw-Hill/Irwin Slide 65
 End of Chapter 3

McGraw-Hill/Irwin Slide 66