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Chapter 3 Anup Kumar Saha. Systems Design: Job-Order Costing. Chapter Three. A company produces many units of a single product. One unit of product is indistinguishable from other units of product.

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Chapter 3

Anup Kumar Saha


Systems Design: Job-Order Costing

Chapter Three


  • A company produces many units of a single product.

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

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

Types of Product Costing Systems

ProcessCosting

Job-orderCosting


  • A company produces many units of a single product.

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

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

Types of Product Costing Systems

ProcessCosting

Job-orderCosting

Example companies:1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)

3. Coca-Cola (mixing and bottling beverages)


  • Many different products are produced each period.

  • Products are manufactured to order.

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

Types of Product Costing Systems

ProcessCosting

Job-orderCosting


  • Many different products are produced each period.

  • Products are manufactured to order.

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

Types of Product Costing Systems

ProcessCosting

Job-orderCosting

Example companies:1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)

3. Walt Disney Studios (movie production)


Comparing Process and Job-Order Costing


Quick Check 

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


Quick Check 

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


Direct Manufacturing Costs

Charge direct material and direct labor costs to each job as work is performed.

Direct Materials

Job No. 1

Direct Labor

Job No. 2

Manufacturing Overhead

Job No. 3


Direct Manufacturing Costs

Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job.

Direct Materials

Job No. 1

Direct Labor

Job No. 2

Manufacturing Overhead

Job No. 3


PearCo Job Cost Sheet

Job Number A - 143

Date Initiated 3-4-05

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

Job-Order Cost Accounting


Will E. Delite

Materials Requisition Form


Job-Order Cost Accounting


Employee Time Ticket


Job-Order Cost Accounting


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:

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

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

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


Estimated total manufacturingoverhead cost for the coming period

POHR =

Estimated total units in theallocation base for the coming period

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

Manufacturing Overhead Application

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


The Need for a POHR

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.

$


Overhead applied = POHR × Actual activity

Application of Manufacturing Overhead

Based on estimates, and determined before the period begins.

Actual amount of the allocation based upon the actual level of activity.


Estimated total manufacturingoverhead cost for the coming period

POHR =

Estimated total units in theallocation base for the coming period

$640,000

POHR =

160,000 direct labor hours (DLH)

Overhead Application Rate

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.


Job-Order Cost Accounting


Job-Order Cost Accounting


Interpreting the Average Unit Cost

The average unit cost should not be interpreted

as the costs that would actually be incurred if anadditional unit were produced.Fixed overhead would not change if another unitwere produced, so the incremental cost of another unit may be somewhat less than $118.


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.


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.


Let’s summarize the document flow in a job-order costing system.

Job-Order CostingDocument Flow Summary


Job-Order CostingDocument Flow Summary

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

A production order initiates work on a job.


Direct materials

Indirect materials

Job-Order CostingDocument Flow Summary

Materials usedmay be eitherdirect orindirect.

Job Cost Sheets

MaterialsRequisition

Manufacturing Overhead Account


Direct Labor

Indirect Labor

Job-Order CostingDocument Flow Summary

An employee’stime may be eitherdirect or indirect.

Job Cost Sheets

Employee Time Ticket

Manufacturing Overhead Account


IndirectLabor

AppliedOverhead

IndirectMaterial

Job-Order CostingDocument Flow Summary

EmployeeTime Ticket

OtherActual OHCharges

Manufacturing Overhead Account

Job Cost Sheets

MaterialsRequisition


Let’s examine the cost flows in a job-order costing system.

Job-Order System Cost Flows


  • Direct Materials

  • Direct Materials

  • Indirect Materials

  • Indirect Materials

Job-Order System Cost Flows

Raw Materials

Work in Process(Job Cost Sheet)

  • Material

    Purchases

Mfg. Overhead

Actual

Applied


Cost Flows – Material Purchases

Raw material purchases are recorded in aninventory account.


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.


  • Direct Labor

  • IndirectLabor

  • Direct Labor

  • IndirectLabor

Job-Order System Cost Flows

Work in Process(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Materials

Mfg. Overhead

Actual

Applied

  • Indirect Materials


Cost Flows – Labor

The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.


Job-Order System Cost Flows

Work in Process(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Labor

  • Direct Materials

  • IndirectLabor

  • Direct Labor

Mfg. Overhead

Actual

Applied

  • Indirect Materials

  • IndirectLabor

  • OtherOverhead


Cost Flows – Actual Overhead

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


  • Overhead Applied

  • OverheadApplied to Work inProcess

Job-Order System Cost Flows

Work in Process(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Labor

  • Direct Materials

  • IndirectLabor

  • Direct Labor

Mfg. Overhead

Actual

Applied

  • Indirect Materials

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

  • IndirectLabor

  • OtherOverhead


Cost Flows – Overhead Applied

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


Nonmanufacturing Cost Flows

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

Examples:1. Salary expense of employeesthat work in a marketing, selling,or administrative capacity.

2. Advertising expenses are expensedin the period incurred.


Nonmanufacturing Cost Flows

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


  • Cost ofGoodsMfd.

  • Cost ofGoodsMfd.

Job-Order System Cost Flows

Work in Process(Job Cost Sheet)

Finished Goods

  • Direct Materials

  • Direct Labor

  • Overhead Applied


Cost Flows – Cost of Goods Manufactured

As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.


  • Cost ofGoodsSold

  • Cost ofGoodsSold

Job-Order System Cost Flows

Work in Process(Job Cost Sheet)

Finished Goods

  • Cost ofGoodsMfd.

  • Direct Materials

  • Cost ofGoodsMfd.

  • Direct Labor

  • Overhead Applied

Cost of Goods Sold


Cost Flows – Sales

When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods.


Defining Under- and Overapplied Overhead

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

Overapplied overhead 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.


Overhead Application Example

PearCo’s 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 PearCo’s jobs during the year? Use PearCo’s 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


PearCo has overappliedoverhead for the yearby $30,000. What willPearCo do?

Overhead Application Example

PearCo’s 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 PearCo’s jobs during the year? Use PearCo’s 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


Quick Check 

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. Tiger’s manufacturing overhead is

a. $50,000 overapplied.b. $50,000 underapplied.c. $60,000 overapplied.d. $60,000 underapplied.


Quick Check 

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. Tiger’s manufacturing overhead is

a. $50,000 overapplied.b. $50,000 underapplied.c. $60,000 overapplied.d. $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


PearCo’s Method

$30,000may be allocatedto these accounts.

$30,000 may beclosed directly to cost of goods sold.

Work inProcess

FinishedGoods

Cost of Goods Sold

Cost of Goods Sold

Disposition of Under- or Overapplied Overhead

OR


$30,000

$30,000

Disposition of Under- or Overapplied Overhead

PearCo’sMfg. Overhead

PearCo’s Costof Goods Sold

Unadjusted Balance

Actualoverhead costs

$650,000

Overhead appliedto jobs

$680,000

AdjustedBalance

$30,000 overapplied


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:


Allocating Under- or Overapplied Overhead Between Accounts

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


Allocating Under- or Overapplied Overhead Between Accounts


Overapplied and Underapplied Manufacturing Overhead - Summary

PearCo’s Method


Quick Check 

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

a. Net operating income will increase.

b. Net operating income will be unaffected.

c. Net operating income will decrease.


Quick Check 

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

a. Net operating income will increase.

b. Net operating income will be unaffected.

c. Net operating income will decrease.


May be more complex but . . .

May be more accurate because it reflects differences across departments.

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 often use multiple predetermined overhead rates.


Job-Order Costing in Service Companies

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


The Use of Information Technology

Technology plays an important part in many job-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.


Appendix 3a

The Predetermined Overhead Rate & Capacity


Predetermined Overhead Rate and Capacity

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

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

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


Capacity-Based Overhead Rates

Criticisms can be overcome by using estimated total units in the allocation base at capacity in the denominator of the predetermined overhead rate calculation.

Let’s look at the difference!


An Example

Equipment 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?


TraditionalMethod

$100,000

40,000

=

= $2.50 per unit

Capacity Method

$100,000

50,000

=

= $2.00 per unit

An Example

Equipment 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?


Quick Check 

Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run 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 

Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run 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 

Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run 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 

Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run 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 

When capacity is used in the denominator in 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; it is not affected by changes in activity.

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


Quick Check 

When capacity is used in the denominator in 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; it is not affected by changes in activity.

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


Quick Check 

When estimated activity is used in the denominator in 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; it is not affected by changes in activity.

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


Quick Check 

When estimated activity is used in the denominator in 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; it is not affected by changes in activity.

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


Basing the rate on capacity


Basing the rate on expected volume


End of Chapter 3


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