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Chapter 3. System Design: Job Order Costing. 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.

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chapter 3

Chapter 3

System Design: Job Order Costing

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

LO 1

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. St. Mary’s Cement (cement mixing)2. Petro-Canada (refining oil)

3. Coca-Cola (mixing and bottling beverages)

LO 1

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

LO 1

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. Bombardier (aircraft manufacturing)2. Bechtel International (large scale construction)

3. Hallmark (greeting card design and printing)

LO 1

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.

LO 1

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.

LO 1

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

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

Direct Materials

Job No. 1

Direct Labour

Job No. 2

Job No. 3

LO 2

job order costing an overview1
Job-Order Costing – An Overview

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

Direct Materials

Job No. 1

Direct Labour

Job No. 2

Manufacturing Overhead

Job No. 3

LO 2

the job cost sheet
The Job Cost Sheet

PearCo Job Cost Sheet

Job Number A - 143

Date Initiated 3-4-11

Date Completed

Department B3

Units Completed

Item Wooden cargo crate

Direct Materials

Direct Labour

Manufacturing Overhead

Req. No.

Amount

Ticket

Hours

Amount

Hours

Rate

Amount

Cost Summary

Units Shipped

Direct Materials

Date

Number

Balance

Direct Labour

Manufacturing Overhead

Total Cost

Unit Product Cost

LO 2

slide12

Will E. Delite

Measuring Direct Materials Cost

LO 2

why use an allocation base
Why Use an Allocation Base?

An allocation base, such as direct labour hours, direct labour 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 the production manager’s salary.
  • Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

LO 3

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.

The Need for a POHR

LO 3

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

LO 3

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 labour hours (DLH)

Overhead Application Rate

POHR = $4.00 per DLH

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

LO 3

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.

LO 3

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.

LO 3

quick check2
Quick Check 

Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labour hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labour hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $380.

d. $730.

LO 3

quick check3
Quick Check 

Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labour hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labour hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $380.

d. $730.

LO 3

job order costing document flow summary1
Job-Order CostingDocument Flow Summary

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

A production order initiates work on a job.

LO 3

job order costing document flow summary2

Direct materials

Indirect materials

Job-Order CostingDocument Flow Summary

Materials usedmay be eitherdirect orindirect.

Job Cost Sheets

MaterialsRequisition

Manufacturing Overhead Account

LO 3

job order costing document flow summary3

Direct Labour

Indirect Labour

Job-Order CostingDocument Flow Summary

An employee’stime may be eitherdirect or indirect.

Job Cost Sheets

Employee Time Ticket

Manufacturing Overhead Account

LO 3

job order costing document flow summary4

IndirectLabour

AppliedOverhead

IndirectMaterial

Job-Order CostingDocument Flow Summary

EmployeeTime Ticket

OtherActual OHCharges

Manufacturing Overhead Account

Job Cost Sheets

MaterialsRequisition

LO 3

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.

LO 4

the purchase and issue of raw materials

Direct Materials

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

Raw Materials Inventory

Work in Process Inventory(Job Cost Sheet)

  • Material

Purchases

Mfg. Overhead

Actual

Applied

LO 4

cost flows material purchases
Cost Flows – Material Purchases

Raw material purchases are recorded in aninventory account.

LO 4

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.

LO 4

the recording of labour costs

Direct Labour

  • IndirectLabour
  • Direct Labour
  • IndirectLabour
The Recording of Labour Costs

Work in Process Inventory(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Materials

Mfg. Overhead

Actual

Applied

  • Indirect Materials

LO 4

the recording of labour costs1
The Recording of Labour Costs

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

LO 4

recording actual manufacturing overhead
Recording Actual Manufacturing Overhead

Work in Process Inventory(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Labour
  • Direct Materials
  • IndirectLabour
  • Direct Labour

Mfg. Overhead

Actual

Applied

  • Indirect Materials
  • IndirectLabour
  • OtherOverhead

LO 4

recording actual manufacturing overhead1
Recording Actual Manufacturing Overhead

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

LO 4

applying manufacturing overhead

Overhead Applied

  • OverheadApplied to Work inProcess
Applying Manufacturing Overhead

Work in Process Inventory(Job Cost Sheet)

Salaries and Wages Payable

  • Direct Labour
  • Direct Materials
  • IndirectLabour
  • Direct Labour

Mfg. Overhead

Actual

Applied

  • Indirect Materials

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

  • IndirectLabour
  • OtherOverhead

LO 5

applying manufacturing overhead1
Applying Manufacturing Overhead

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

LO 5

accounting for non manufacturing cost
Accounting for Non-Manufacturing Cost

Non-manufacturing 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.

LO 5

accounting for non manufacturing cost1
Accounting for Non-Manufacturing Cost

Non-manufacturing costs (period expenses) are charged to expense as they are incurred.

LO 5

transferring completed units

Cost ofGoodsMfd.

  • Cost ofGoodsMfd.
Transferring Completed Units

Work in Process Inventory(Job Cost Sheet)

Finished Goods Inventory

  • Direct Materials
  • Direct Labour
  • Overhead Applied

LO 6

transferring completed units1
Transferring Completed Units

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

LO 6

transferring units sold

Cost ofGoodsSold

  • Cost ofGoodsSold
Transferring Units Sold

Work in Process Inventory(Job Cost Sheet)

Finished Goods Inventory

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

Cost of Goods Sold

LO 6

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 Inventory.

LO 6

complications of overhead application
Complications 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.

LO 7

overhead application example
Overhead Application Example

PearCo’s actual overhead for the year was $650,000 with a total of 170,000 direct labour 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 labour hour.

Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labour Hours

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

LO 7

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 labour 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 labour hour.

Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labour Hours

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

LO 7

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.

LO 7

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

LO 7

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

LO 7

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

$0

LO 7

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:

LO 7

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:

LO 7

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.

LO 7

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.

LO 7

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.

LO 7

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.

LO 7

recorded costs for quality
Recorded Costs for Quality

Deficiencies in quality result in scrap, rework, delays in production, extra inventory, warranty claims, and poor customer relations.

  • Scrap or rework costs should be charged to:
  • overhead if the defect costs were a normal cost of all production, or
  • a particular job if the defect cost was due to a specific situation surrounding that particular job.

LO 7

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.

LO 8

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!

LO 8

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?

LO 8

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?

LO 8

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.

LO 8

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.

LO 8

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.

LO 8

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.

LO 8

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.

LO 8

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.

LO 8

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.

LO 8

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.

LO 8