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Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Chapter 3

Anup Kumar Saha


Chapter Three

Systems Design: Job-Order Costing


Types of Product Costing Systems

ProcessCosting

Job-orderCosting

A company produces many units of a single A company produces many units of a single product. product.

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

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






ProcessCosting

Job-orderCosting







Example companies:Example companies:1. Weyerhaeuser (paper manufacturing)1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)3. Coca-Cola (mixing and bottling beverages)

Example companies:Example companies:1. Weyerhaeuser (paper manufacturing)1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)3. Coca-Cola (mixing and bottling beverages)



ProcessCosting

Job-orderCosting

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

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

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

records for each job.records for each job.







ProcessCosting

Job-orderCosting









Example companies:Example companies:1. Boeing (aircraft manufacturing)1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)3. Walt Disney Studios (movie production)

Example companies:Example companies:1. Boeing (aircraft manufacturing)1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)3. Walt Disney Studios (movie production)


Comparing Process and Job-Order Costing

Job-Order Process

Number of jobs worked Many Single Product

Cost accumulated byIndividual

Job Department

Average cost computed by Job Department


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.



b. Architects.





Quick Check



b. Architects.






b. Architects.





Manufacturing Overhead


Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3

Charge Charge direct direct

material and material and direct labor direct labor

costs to costs to each job as each job as

work is work is performed.performed.

Charge Charge direct direct

material and material and direct labor direct labor

costs to costs to each job as each job as

work is work is performed.performed.

Direct Manufacturing Costs

Direct MaterialsDirect Materials

Direct LaborDirect Labor


Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, ,

are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.

Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, ,

are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.

Direct Manufacturing Costs

Direct MaterialsDirect Materials

Direct LaborDirect Labor

Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3Manufacturing Overhead



PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-05Date Completed

Department B3 Units CompletedItem Wooden cargo crate

Direct Materials Direct Labor Manufacturing OverheadReq. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units ShippedDirect Materials Date Number BalanceDirect LaborManufacturing OverheadTotal CostUnit Product Cost

Job-Order Cost Accounting


Materials Requisition Form

Will E. Delite




Employee Time Ticket




Why Use an Allocation Base?

Manufacturing overhead is applied to jobs that Manufacturing overhead is applied to jobs that are in process. An allocation base, such as are in process. An allocation base, such as

direct labor hours, direct labor dollars, or direct labor hours, direct labor dollars, or machine hours, is used to assign machine hours, is used to assign

manufacturing overhead to individual jobs.manufacturing overhead to individual jobs.

Manufacturing overhead is applied to jobs that Manufacturing overhead is applied to jobs that are in process. An allocation base, such as are in process. An allocation base, such as

direct labor hours, direct labor dollars, or direct labor hours, direct labor dollars, or machine hours, is used to assign machine hours, is used to assign

manufacturing overhead to individual jobs.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 manager’s salary.

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


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

Estimated total units in theallocation base for the coming period

POHR =

Ideally, the allocation base is a cost driver that causes

overhead.

Ideally, the allocation base is a cost driver that causes

overhead.


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

$


Actual amount of the allocation based upon the actual level of

activity.

Actual amount of the allocation based upon the actual level of

activity.

Based on estimates, and determined before the

period begins.

Based on estimates, and determined before the

period begins.

Application of Manufacturing Overhead

Overhead applied = POHR × Actual activity


For each direct labor hour worked on a particular job, $4.00 of factory overhead

will be applied to that job.

For each direct labor hour worked on a particular job, $4.00 of factory overhead

will be applied to that job.

Overhead Application Rate

POHR = $4.00 per DLH

$640,000

160,000 direct labor hours (DLH)POHR =

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =






Interpreting the Average Unit Cost

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional 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.

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional 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.


a. $200.

b. $350.

c. $380.

d. $730.


Quick Check


a. $200.

b. $350.

c. $380.

d. $730.


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



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

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

A production A production order initiates order initiates work on a job.work on a job.

A production A production order initiates order initiates work on a job.work on a job.



Job Cost Sheets

Job Cost Sheets

MaterialsRequisition


Manufacturing Overhead Account


Direct materials

Indirect materials

Materials usedMaterials usedmay be eithermay be either

direct ordirect orindirect.indirect.

Materials usedMaterials usedmay be eithermay be either

direct ordirect orindirect.indirect.



Job Cost Sheets

Job Cost Sheets





An employee’stime may be eitherdirect or indirect.

An employee’stime may be eitherdirect or indirect.

Direct Labor

Indirect Labor





OtherActual OHCharges

OtherActual OHCharges

Job Cost Sheets

Job Cost Sheets

AppliedOverhead



EmployeeTime Ticket

EmployeeTime Ticket

IndirectMaterial

IndirectLabor


Job-Order System Cost Flows

Let’s examine the cost flows in a

job-order costing system.


Raw MaterialsMaterial

Purchases

Mfg. Overhead

Work in Process(Job Cost Sheet)

Actual Applied

Direct Materials Direct

Materials

Indirect Materials

Indirect Materials



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.


Mfg. Overhead

Salaries and Wages Payable


Direct

MaterialsDirect Labor

Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

IndirectLabor



Cost Flows – Labor

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

Manufacturing Overhead.


Mfg. Overhead



Direct


Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

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.


Mfg. Overhead



Direct


Direct Labor

Indirect Materials

Actual Applied

IndirectLabor

IndirectLabor


OtherOverhead

Overhead Applied

OverheadApplied to

Work inProcess

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

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


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:Examples:1.1. Salary expense of employeesSalary expense of employees

that work in a marketing, selling,that work in a marketing, selling,or administrative capacity.or administrative capacity.

2.2. Advertising expenses are expensedAdvertising expenses are expensedin the period incurred.in the period incurred.

Examples:Examples:1.1. Salary expense of employeesSalary expense of employees

that work in a marketing, selling,that work in a marketing, selling,or administrative capacity.or administrative capacity.

2.2. Advertising expenses are expensedAdvertising expenses are expensedin the period incurred.in the period incurred.


Nonmanufacturing Cost Flows

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


Finished GoodsWork in Process(Job Cost Sheet)

Direct


Overhead Applied

Cost ofGoodsMfd.

Cost ofGoodsMfd.



Cost Flows – Cost of Goods Manufactured

As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods

from Work in Process.


Finished Goods

Cost of Goods Sold


Direct


Overhead Applied

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Cost ofGoodsSold

Cost ofGoodsSold



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.

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 overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.

Overapplied overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.


PearCo’s PearCo’s actual overheadactual overhead for the year was for the year was $650,000$650,000 with a total of with a total of 170,000170,000 direct labor direct labor

hours worked on jobs.hours worked on jobs.

How much total overhead was applied to How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s jobs during the year? Use

PearCo’s predetermined overhead rate of PearCo’s predetermined overhead rate of $4.00 per direct labor hour. $4.00 per direct labor hour.





Overhead Application Example

Overhead Applied During the PeriodApplied Overhead = POHR × Actual Direct Labor Hours

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










Overhead Application Example

Overhead Applied During the PeriodApplied Overhead = POHR × Actual Direct Labor Hours

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

PearCo has PearCo has overappliedoverappliedoverhead for the yearoverhead for the yearby $30,000. What willby $30,000. What will

PearCo do?PearCo do?

PearCo has PearCo has overappliedoverappliedoverhead for the yearoverhead for the yearby $30,000. What willby $30,000. What will

PearCo do?PearCo do?


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












Quick Check

Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000

Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

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

$30,000 may be$30,000 may beclosed directly toclosed directly to

cost of goods sold. cost of goods sold.

Cost of Goods Sold

Cost of Goods Sold

PearCo’s MethodPearCo’s Method

Work inProcessWork inProcess

FinishedGoods

FinishedGoods

Cost of Goods Sold

Cost of Goods Sold

$30,000$30,000may be allocatedmay be allocated

to these accounts.to these accounts.

OROROROR


Disposition of Under- or Overapplied Overhead

PearCo’sMfg. Overhead

Actualoverhead

costs

$650,000$30,000

overapplied

PearCo’s Costof Goods Sold

Unadjusted Balance

AdjustedBalance

$30,000

$30,000

Overhead appliedto jobs

$680,000


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:



Amount Percent of

Total Allocation of

$30,000 Work in process 68,000$ 10% 3,000$ Finished Goods 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000 Total 680,000$ 100% 30,000$

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



Amount Percent of

Total Allocation of

$30,000 Work in process 68,000$ 10% 3,000$ Finished Goods 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000 Total 680,000$ 100% 30,000$


Overapplied and Underapplied Manufacturing Overhead - Summary

Alternative 1 Alternative 2If Manufacturing Close to Cost Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASECost of Goods Sold Work in Process

(Applied OH is less Finished Goodsthan actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASECost of Goods Sold Work in Process

(Applied OH is greater Finished Goodsthan actual OH) Cost of Goods Sold

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










Multiple Predetermined Overhead Rates

To this point we have assumed that there is a To this point we have assumed that there is a single predetermined overhead rate called a single predetermined overhead rate called a

plantwide overhead rate.plantwide overhead rate.

To this point we have assumed that there is a To this point we have assumed that there is a single predetermined overhead rate called a single predetermined overhead rate called a

plantwide overhead rate.plantwide overhead rate.

Large companies Large companies often use multiple often use multiple predetermined predetermined overhead rates.overhead rates.

Large companies Large companies often use multiple often use multiple predetermined predetermined overhead rates.overhead rates.

May be more May be more complex but . . .complex but . . .May be more May be more complex but . . .complex but . . .

May be more accurate because it reflects differences across departments.

May be more accurate because it reflects differences across departments.


Job-Order Costing in Service Companies

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

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


The Use of Information Technology

Technology plays an important part in many Technology plays an important part in many job-order cost systems. When combined with job-order cost systems. When combined with Electronic Data Interchange (EDI) or a web-Electronic Data Interchange (EDI) or a web-

based programming language called based programming language called Extensible Markup Language (XML), bar Extensible Markup Language (XML), bar coding eliminates the inefficiencies and coding eliminates the inefficiencies and

inaccuracies associated with manual clerical inaccuracies associated with manual clerical processes.processes.

Technology plays an important part in many Technology plays an important part in many job-order cost systems. When combined with job-order cost systems. When combined with Electronic Data Interchange (EDI) or a web-Electronic Data Interchange (EDI) or a web-

based programming language called based programming language called Extensible Markup Language (XML), bar Extensible Markup Language (XML), bar coding eliminates the inefficiencies and coding eliminates the inefficiencies and

inaccuracies associated with manual clerical inaccuracies associated with manual clerical processes.processes.


Appendix 3a

The Predetermined Overhead Rate & Capacity


Predetermined Overhead Rate and Capacity

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

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

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

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

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

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


Capacity-Based Overhead Rates

Criticisms can be overcome by using Criticisms can be overcome by using estimated total units in the allocation base at estimated total units in the allocation base at

capacity in the denominator of the capacity in the denominator of the predetermined overhead rate calculation.predetermined overhead rate calculation.

Criticisms can be overcome by using Criticisms can be overcome by using estimated total units in the allocation base at estimated total units in the allocation base at

capacity in the denominator of the capacity in the denominator of the predetermined overhead rate calculation.predetermined overhead rate calculation.

Let’s look at the difference!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?


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

= $2.50 per unit$100,000

40,000=

Capacity Method

= $2.00 per unit$100,000

50,000=


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.


a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.


Quick Check


a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.


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.


a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.


Quick Check


a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.


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










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










Basing the rate on capacity

Actual volume 40,000 casesSelling price $40.00 per caseVariable production cost $24.00 per caseFixed manufacturing overhead $100,000 per yearCapacity 50,000 casesPredetermined overhead rate $2.00 per caseFixed selling and admin. expense $500,000 per year

Revenue 1,600,000$ Cost of goods sold 1,040,000 Gross margin 560,000 Cost of idle capacity 20,000 Selling and admin. expense 500,000

Net operating income 40,000$


Actual volume 40,000 casesSelling price $40.00 per caseVariable production cost $24.00 per caseFixed manufacturing overhead $100,000 per yearExpected volume 40,000 casesPredetermined overhead rate $2.50 per caseFixed selling and admin. expense $500,000 per year

Revenue 1,600,000$ Cost of goods sold 1,060,000 Gross margin 540,000 Cost of idle capacity - Selling and admin. expense 500,000

Net operating income 40,000$

Basing the rate on expected volume


End of Chapter 3