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Systems Design: Job-Order Costing. Chapter Three. Learning Objective 1. Distinguish between process costing and job-order costing and identify companies that would use each costing method. A company produces many units of a single product.

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learning objective 1
Learning Objective 1

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

types of product costing systems

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

types of product costing systems1

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)

types of product costing systems2

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

types of product costing systems3

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)

quick check
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 check1
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.

learning objective 2
Learning Objective 2

Identify the documents used in a job-order costing system.

job order costing an overview
Job-Order Costing – An Overview

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
Direct Manufacturing Costs

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

Direct Materials

Job No. 1

Direct Labor

Job No. 2

Manufacturing Overhead

Job No. 3

the job cost sheet

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

The Job Cost Sheet
learning objective 3
Learning Objective 3

Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

why use an allocation base
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.
manufacturing overhead application

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
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.

$

application of manufacturing overhead

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.

overhead application rate

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.

interpreting the average unit cost
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 check2
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 check3
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.

learning objective 4
Learning Objective 4

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

job order costing document 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.

job order costing document flow summary1

Direct materials

Indirect materials

Job-Order CostingDocument Flow Summary

Materials usedmay be eitherdirect orindirect.

Job Cost Sheets

MaterialsRequisition

Manufacturing Overhead Account

job order costing document flow summary2

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

job order costing document flow summary3

IndirectLabor

AppliedOverhead

IndirectMaterial

Job-Order CostingDocument Flow Summary

EmployeeTime Ticket

OtherActual OHCharges

Manufacturing Overhead Account

Job Cost Sheets

MaterialsRequisition

learning objectives 4 7
Learning Objectives 4 & 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.

job order costing the flow of costs
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.

the purchase and issue of raw materials

Direct Materials

  • Direct Materials
  • Indirect Materials
  • Indirect Materials
The Purchase and Issue of Raw Materials

Raw Materials

Work in Process(Job Cost Sheet)

  • Material

Purchases

Mfg. Overhead

Actual

Applied

cost flows material purchases
Cost Flows – Material Purchases

Raw material purchases are recorded in aninventory account.

cost flows material usage
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.

the recording of labor costs

Direct Labor

  • IndirectLabor
  • Direct Labor
  • IndirectLabor
The Recording of Labor Costs

Work in Process(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Materials

Mfg. Overhead

Actual

Applied

  • Indirect Materials
the recording of labor costs1
The Recording of Labor Costs

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

recording actual manufacturing overhead
Recording Actual Manufacturing Overhead

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
recording actual manufacturing overhead1
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.

learning objective 5
Learning Objective 5

Apply overhead cost to Work in Process using a predetermined overhead rate.

applying manufacturing overhead

Overhead Applied

  • OverheadApplied to Work inProcess
Applying Manufacturing Overhead

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
applying manufacturing overhead1
Applying Manufacturing Overhead

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

accounting for nonmanufacturing cost
Accounting for Nonmanufacturing Cost

Nonmanufacturing costs are not assigned to individual 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 expensed in the period incurred.

accounting for nonmanufacturing cost1
Accounting for Nonmanufacturing Cost

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

learning objective 6
Learning Objective 6

Prepare schedules of cost of goods manufactured and cost of goods sold.

transferring completed units

Cost ofGoodsMfd.

  • Cost ofGoodsMfd.
Transferring Completed Units

Work in Process(Job Cost Sheet)

Finished Goods

  • Direct Materials
  • Direct Labor
  • Overhead Applied
transferring completed units1
Transferring Completed Units

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

transferring units sold

Cost ofGoodsSold

  • Cost ofGoodsSold
Transferring Units Sold

Work in Process(Job Cost Sheet)

Finished Goods

  • Cost ofGoodsMfd.
  • Direct Materials
  • Cost ofGoodsMfd.
  • Direct Labor
  • Overhead Applied

Cost of Goods Sold

transferring units sold1
Transferring Units Sold

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

learning objective 8
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.

problems of overhead application
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 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
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

overhead application example1

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 check4
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 check5
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

disposition of under or overapplied overhead

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

disposition of under or overapplied overhead1

$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
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 accounts1
Allocating Under- or Overapplied Overhead Between Accounts

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

quick check6
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 check7
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.

multiple predetermined overhead rates

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 in Service Companies

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

the use of information technology
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.

learning objective 9
Learning Objective 9

(Appendix 3A)

Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

predetermined overhead rate and 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
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
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?

an example1

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 check8
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 check9
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 check10
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 wineat capacity?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

quick check11
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 wineat capacity?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

quick check12
Quick Check 

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; it is not affected by changes in activity.

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

quick check13
Quick Check 

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; it is not affected by changes in activity.

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

quick check14
Quick Check 

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 same; it is not affected by changes in activity.

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

quick check15
Quick Check 

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 same; it is not affected by changes in activity.

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