Job Costing Chapter 3 2
Life Fitness • Introduce the world’s first computerized exercise bike in 1970s • Design, manufacture, and market over 300 different cardio and strength-training products. • How does the company figure out the profit margins on each of its 300 different model? • The company use product costing systems to trace the direct materials and direct labor used by each job. • The company can use the cost information to make vital business decisions which include as follows: • Setting selling prices that will lead to profits on each product • Identifying opportunities to cut costs • Determining which products are most profitable and therefore deserve the most marketing emphasis
Cost of Manufacturing a Product • Most Manufacturers use one of two product costing systems in order to find the cost of producing their products. • Process Costing • Job Costing
Learning Objective 1 Distinguish between job costing and process costing 5
Process Costing • Mass production: produce extremely large numbers of identical units through a series of uniform production steps or processes. • Similar items • Total costs are averaged over all units • Examples • Paint manufacturers • Oil refineries • Cereal manufacturers 6
Job Costing • Unique, custom products or small batches • Total costs are accumulated by job • Examples • Hospitals • Custom home builders • Advertising agencies
S3-1: Examples of Process and Job Costing • A manufacturer of fiberglass insulation • A residential plumbing contractor c. A manufacturer of fiber optic cable d. A professional home builder e. A hospital
Learning Objective 2 Understand the flow of production and how direct materials and direct labor are traced to jobs
Flow of Inventory Through a Manufacturing System Raw Materials Storeroom Work in process Production Department Finished Goods Ready for sale Cost of Goods Sold Sold
Bill of Materials • Purchasing will then: • compute stock available. • determine purchasing needs. • make sure raw materials are on hand by production date.
Purchasing Process Purchasing department will issue a purchase order to its suppliers for the needed parts. Incoming shipments of raw materials are counted and recorded on a receiving report, which is typically just a duplicate of the purchase order but without the quantity pre-listed on the form. Accounting department will not pay the invoice (bill from the supplier) unless it agrees with the quantity of parts both ordered and received. Shipping and receiving prepare receiving report Purchasing determines ordering needs Purchasing issues purchase order Accounting matches invoice with purchase order Accounting pays the invoice
Work in Process Inventory The job cost records on incomplete jobs sum to the total Work in Process Inventory shown on the balance sheet
Learning Objective 3 Compute a predetermined manufacturing overhead rate and use it to allocate MOH to jobs
Manufacturing Overhead • Other manufacturing costs that cannot be directly traced to specific jobs are called Manufacturing Overhead. • These indirect costs, otherwise known as manufacturing overhead, include depreciation on the factory plant and equipment, utilities to run the plant, property taxes and insurance on plant, equipment maintenance, the salaries of plant janitors and supervisors, machine lubricants, and so forth. • We cannot tell exactly how much of these costs are attributable to producing a specific job. Therefore, we cannot trace these costs to jobs, as we did with direct materials and direct labor. Rather, we will have to allocate some reasonable amount of these costs to each job. • Generally accepted accounting principles (GAAP) mandate that manufacturing overhead must be treated as an inventoriable product cost for financial reporting purposes. The rationale is that these costs are a necessary part of the production process: Jobs could not be produced without incurring these costs.
Manufacturing Overhead • Management needs some other reasonable basis for allocating the total manufacturing overhead costs to all of the jobs. • A cost driver is the primary factor that causes a cost. For example, in many companies manufacturing overhead costs rise and fall with the amount of work performed in the factory. • There are four steps in calculating the Predetermined Manufacturing Overhead Rate: • Estimate total manufacturing overhead costs • Select an allocation base (cost driver) • Estimate the total amount of allocation base to be used • Calculate predetermined manufacturing overhead rate (POHR) • This rate will be used throughout the coming year. It is not revised, unless the company finds that either the manufacturing overhead costs or the total amount of the allocation base being used in the factory have substantially shifted away from the estimated amounts. If this is the case, management might find it necessary to revise the rate part way through the year.
Calculating Predetermined Manufacturing Overhead Rate Total estimated mfg overhead costs Total estimated amount of allocation base POHR*=
Allocating Manufacturing Overhead (MOH) to Individual Jobs Allocated MOH = POHR x Amount of cost allocation activity used
Allocating MOH to Individual Job Example: Total estimated manufacturing overhead costs = $1,000,000 Cost allocation base is direct labor hours (DLH) Total estimated direct labor hours for the year = 62,500 DLHs Job #603 used 500 DLHs $1,000,000 estimated overhead costs 62,500 direct labor hours POHR = = $16 per direct labor hours *POHR stands for “Predetermined Manufacturing Overhead Rate”
Allocating MOH to Individual Job • Why does the company use a predetermined MOH rate, based on estimated or budgeted data, rather than an actual MOH rate based on actual data for the year? In order to get actual data, the company would have to wait until the end of the year to set its MOH rate. By then, the information is too late to be useful for making pricing and other decisions related to individual jobs. Managers are willing to sacrifice some accuracy in order to get timely information on how much each job costs to produce. • The $16 POHR in the example in the slide means that, for every direct labor hour used in a job, $16 will be allocated to the job for manufacturing overhead.
Allocating MOH to Individual Job (continued) Allocated MOH for Job #603 = $16 x 500 DLHs = $8,000 Here we are continuing the example from the previous slide. On the prior slide, we found that the predetermined manufacturing overhead rate was $16 per direct labor hour. The given facts from the example told us that 500 direct labor hours were used for Job #603. To calculate the amount of manufacturing overhead to be allocated to Job #603, take the predetermined manufacturing overhead rate of $16 per direct labor hour TIMES the actual direct labor hours used for the job of 500. The $8,000 is the amount of manufacturing overhead which will be allocated to Job #603. *POHR stands for “Predetermined Manufacturing Overhead Rate”
When is Manufacturing Overhead Allocated? The job’s cost, as shown on the job cost record, becomes the basis for valuing inventory and the cost of goods sold. In most sophisticated systems, some manufacturing overhead is allocated to the job each time some of the allocation base is posted to the job cost record. In less sophisticated systems, manufacturing overhead is allocated only once: as soon as the job is complete and the total amount of allocation base used by the job is known. If the balance sheet date arrives before the job is complete, a company would need to allocate some manufacturing overhead to the job based on the number of direct labor hours used on the job thus far.
Direct Indirect FinishedGoods Allocate Indirect Cost of GoodsSold Direct When is Manufacturing Overhead Allocated? Materials FactoryOverhead Work in Process Labor
Cost Flow Direct costs are charged to the job cost record. As goods are finished, they move to finished goods inventory. As finished goods are sold, the cost of those goods sold is expensed to cost of goods sold. Gross profit can be determined by subtracting the cost of goods sold from the sales revenue. Direct Materials Direct Labor Manufacturing Overhead Cost of GoodsSold Work in Process FinishedGoods
E3-18A • E3-18A asks you to compute a predetermined overhead rate and calculate cost of job. • Dellroy Restaurant Supply manufactures commercial stoves and ovens for restaurants and bakeries. Dellroy uses job costing to calculate the costs of its jobs with direct labor cost as its manufacturing overhead allocation base. At the beginning of the current year, Dellroy estimated that its overhead for the coming year would be $300,000. It also anticipated using 25,000 direct labor hours for the year. Dellroy pays its employees an average of $20 per direct labor hour. Dellroy just finished Job 371, which consisted of two large ovens for a regional bakery. The costs for Job 371 were as follows: • Job 371 • Direct materials used $13,000 • Direct labor hours used 110 • What is Dellroy’s predetermined manufacturing overhead rate based on direct labor cost?
E3-18A • Calculate the manufacturing overhead to be allocated based on direct labor cost to Job 371.
E3-18A • What is the total cost of Job 371? • Direct materials used • Direct labor cost (110 x $20) • Manufacturing overhead allocated • Total cost of Job 371
Learning Objective 4 Determine the cost of a job and use it to make business decisions
Reasons Why Management Needs Product Cost • Control costs: By examining the exact costs traced to the job, management might be able to determine ways of reducing the cost of similar jobs produced in the future. For example, are the heart rate monitors costing more than they did on previous jobs? • Perhaps management can renegotiate its contract with its primary suppliers, or identify different suppliers that are willing to sell the parts more cheaply. • What about direct labor costs? By examining the time spent by various workers on the job, management may be able to improve the efficiency of the process so that less production time is required. • Assess profitability of products: Managers will compare the gross profit on each model to the gross profit ratio of all models to determine which products to emphasize selling. Obviously, management will want to concentrate on marketing those models that yield the higher profit margins. • Pricing decisions: Management can also use this information to determine how it will deal with pricing pressure. Say a competitor drops the price of its similar elliptical cross-trainer. A profit analysis could show that Life Fitness could drop the selling price of its elliptical cross-trainer by a similar amount and still make a reasonable profit.
Reasons Why Management Needs Product Cost • Discounts on high-volume sales: Often times, customers will expect discounts for high-volume sales. Knowing the cost of products will help Life Fitness know whether a discounted price will still be profitable for the company. • Bids on contracts: Suppose management at Life Fitness has the opportunity to bid on a contract to supply custom treadmills for a nearby university fitness center. Management can use the job cost records from past treadmill jobs to get a good idea of how much it will cost to complete the custom order. For example, the custom treadmills may require additional components not found on the standard models. The markup percentage or final bid price is agreed upon in a written contract before the company goes ahead with production. Factor in these additional costs to get an estimate of the total job cost, before it is produced. Life Fitness will most likely use cost-plus pricing to determine a sales price for the custom job. • Financial statement preparation: Finally, the job cost information is critical to preparing the company’s financial statements. Why? Because the information is used to figure out the total Cost of Goods Sold shown on the income statement, as well as the Work in Process and Finished Goods Inventory accounts shown on the balance sheet.
Learning Objective 5 Compute and dispose of overallocated or underallocated manufacturing overhead
Overhead Application Example FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000. What is FedCorp’s predetermined manufacturing overhead rate?
Overhead Application Example (continued) FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000. What is FedCorp’s predetermined manufacturing overhead rate? POHR = $200,000 ÷ 10,000 = $20 per DLH
Overhead Application Example (continued) FedCorp’s actual manufacturing overhead for the year was $190,000. A total of 11,000 direct labor hours were worked. Using FedCorp’s predetermined manufacturing overhead rate of $20 per direct labor hour, how much overhead was allocated to all of FedCorp’s jobs during the year?
Overhead Application Example (continued) FedCorp’s actual manufacturing overhead for the year was $190,000. A total of 11,000 direct labor hours were worked. Using FedCorp’s predetermined manufacturing overhead rate of $20 per direct labor hour, how much overhead was allocated to all of FedCorp’s jobs during the year? MOH Allocated = $20 x 11,000 = $220,000
Now we look at what to do if (WHEN) actual MOH does not equal allocated MOH. Continuing same example (FedCorp)
Overhead Application Example (continued) $190,000 $220,000 $ 30,000 FedCorp’s actual overhead FedCorp’s allocated overhead Difference “Target” was $190,000; actually allocated $220,000. Overapplied by $30,000.
Underallocated or Overallocated Manufacturing Overhead • Underallocated (undercosted) – not enough allocated to jobs – too little expense • Overallocated (overcosting) – too much allocated to jobs – too much expense
Underallocated or Overallocated Manufacturing Overhead • Why/How? • Estimated manufacturing overhead costs were higher or lower than actual • Used more or less of the estimated allocation base than projected • 2 Solutions: • Adjust cost of goods sold • Prorate between Cost of Goods Sold, Work in Process Inventory, Finished Goods Inventory
Learning Objective 6 Prepare journal entries for a manufacturer’s job costing system