Chapter 2: Manufacturing Costs and Job-Order Costing

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Managerial Accounting
by James Jiambalvo
Chapter 2:
Manufacturing Costs and JobOrder Costing Systems
Slides Prepared by:
Scott Peterson
Northern State University
Chapter 2: Manufacturing costs
and Job-Order Costing Systems
Chapter Themes:

It’s all about the concept
of inventories.

Think about how costs
can be attached to
products.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
More
Chapter 2: Manufacturing costs
and Job-Order Costing Systems
Chapter Themes:

It’s all about the concept
of inventories.

Think about how costs
are attached to products.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
More
Chapter 2: Manufacturing costs
and Job-Order Costing Systems
Chapter Themes:

It’s all about the concept
of inventories.

Think about how costs
are attached to products.
Related Learning Objectives:
8.
9.
Explain why the difference
between actual overhead and
overhead allocated to jobs using a
predetermined rate is closed to
Cost of Goods Sold or
apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Cost Classifications for
Manufacturing Firms
Unlike retailers who purchase
goods for resale,
manufacturers make what
they sell. Therefore, the
manufacturer must
differentiate between
manufacturing and
nonmanufacturing costs to
determine what their goods
cost.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Manufacturing Costs
Manufacturing costs, by
definition, are all costs which
are associated with the
production of goods. The
three traditional categories of
manufacturing costs include:
1. Direct Materials
2. Direct Labor
3. Manufacturing Overhead
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Direct Material
Direct material costs include
raw materials and
components that are directly
traceable to the final finished
product.
Here think of a home
builder’s direct material
costs. Raw materials include
lumber and sheetrock.
Components include light
fixtures and sprinkler system
components. Materiality IS
important here…
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
More
Direct Material
…because direct materials
DO NOT include minor
material costs which are not
easily or cost justifiably
traced to the final finished
product. The home builder
would probably not include
nails, screws and other small,
inexpensive fasteners in
direct materials.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Direct Labor
Direct labor costs, like direct
material costs, include labor
that is directly traceable to
the final finished product.
Using the home builder
example, salaries of
carpenters are considered
direct labor. Construction
supervisory salaries, though,
are not.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Manufacturing Overhead
Manufacturing Overhead
includes all manufacturing
costs that are not considered
Direct Materials or Direct
Labor. By definition, it
includes Indirect Materials
and Indirect Labor.
Using the home builder
example, Manufacturing
Overhead might include
construction supervisor
salaries and fasteners such
as screws, nails and tape.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Nonmanufacturing Costs
Nonmanufacturing costs
are simply costs which
are not associated with
the production of goods.
Sometimes called period
costs, this category
includes selling, general
and administrative
costs. For the home
builder, this includes the
bookkeeper’s salary.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Selling Costs
As the name implies,
selling costs include
costs associated with
securing and filling
customer orders.
Examples include
advertising, sales
salaries and
commissions, and other
support costs for this
function.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
General and Administrative
Costs
As the name implies, General
and Administrative Costs
include costs associated with
the firm’s general
management. Often
associated with corporate
headquarters including
executive salaries,
depreciation on office
equipment and buildings etc..
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Product and Period Costs
These two terms are
synonymous with
Manufacturing and
Nonmanufacturing costs,
respectively, discussed
previously. They are
important because they refer
to the timing of expenses as
much as the description.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Product Costs
Product costs, a.k.a.
manufacturing costs, are also
called inventoriable costs.
The reason is that these
costs, Direct Materials, Direct
Labor and Manufacturing
Overhead, are inventoried
until which time they are sold
and become expenses; Cost
of Goods Sold.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Period Costs
Period Costs, a.k.a.,
nonmanufacturing costs,
include Selling, General and
Administrative. They are
called Period Costs because
they are expensed in a certain
accounting period regardless
of production schedules.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Product Cost Information in Financial
Reporting and Decision Making
Often the information needed
by internal managers stands
in sharp contrast to external
reporting requirements
promulgated by Generally
Accepted Accounting
Principles (GAAP). GAAP
requires Full Costing and
management decision making
requires incremental
information.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Balance Sheet Presentation of
Product Costs
Until sold, Product Costs
(Inventoriable Costs) are
carried in one of three
inventory accounts on
the balance sheet:
1.
Raw Materials Inventory.
2.
Work in Process
Inventory.
3.
Finished Goods
Inventory.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product
costs in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Raw Materials Inventory
Raw Materials Inventory
includes the cost of raw
materials on-hand which are
to be used in forthcoming
production. Using the home
builder example, Raw
Materials might include
lumber, sheetrock, shingles
etc… Bear in mind, however,
most home builders do not
often carry inventory, rather
they use a form of Just-inTime and rely on delivery.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Work in Process Inventory
Work in Process inventory
includes production which
was begun but not completed
during the accounting period.
At December 31, for example,
a home builder may have
several different projects
started and enclosed, but all
completed to varying
degrees, 20%, 35%, 60% and
so on. The value of these
projects are included in this
inventory account.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Finished Goods Inventory
Finished Goods Inventory
includes products which are
complete, in inventory and
ready for sale. For the home
builder this would include a
spec home which is
completed, ready for sale, for
for which an owner has not
yet been found.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing
firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Flow of Product Costs in
Accounts
In an accounting system,
product costs (does anyone
remember the buzzwords
here?) flow from one
inventory account to another.
The final resting place prior
to sale for all Product Costs
is Finished Goods Inventory.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product
costs in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Income Statement
Presentation of Product Costs
Ultimately when
manufactured goods are sold
they are moved from Finished
Goods to Cost of Goods Sold.
This is how costs of
manufacturing goods is
matched with revenue
resulting from sales of those
goods.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product
costs in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Cost of Goods Manufactured
Cost of Goods Manufactured
is an important concept. It
represents the sum of costs
attached to products which
were transferred form Work in
Process to Finished Goods
during any given time period.
It is calculated as follows:
Beginning Work in Process +
Total Manufacturing Costs –
Ending Work in Process.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product
costs in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Cost of Goods Sold
This is also an important
concept and one that most
students have seen before. It
represents the total cost of all
goods sold during a
particular accounting period.
It is calculated as follows:
Beginning Finished Goods +
Cost of Goods Manufactured
(previous slide) - Ending
Finished Goods.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product
costs in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Types of Costing Systems
There are two major types of
product costing systems, JobOrder Costing Systems and
Process Costing systems.
Generally speaking, Job-Order
costing is applicable to
situations where each unit or
batch of output is at least
somewhat unique. A good
example here is the homebuilder.
Process Costing applies to
situations where all units of
output are essentially the same.
An example here is food
processing.
Related Learning Objectives:
1.
2.
3.
4.
Distinguish between
manufacturing and
nonmanufacturing costs and
between product and period
costs.
Discuss the three inventory
accounts of a manufacturing firm.
Describe the flow of product costs
in a manufacturing firm's
accounts.
Discuss the types of product
costing systems.
Overview of Job Costs and
Financial Statement Accounts
In a Job-Order Costing
System, the three product
costs are attached to
products via the Job-Cost
Sheet.
It is important to recognize
here that cost flows through a
Job-Order system are based
on the status of jobs. That
status could be either in
process, in finished goods or
sold.
Related Learning Objectives:
5.
6.
7.
Explain the relation between
the cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Job-Order Costing System
In Job-Order Costing systems
the primary document (likely
electronic) is called a job-cost
sheet. It is used to capture
costs of producing that
product. Using the home
builder example, a job-cost
sheet would be prepared for
each home. And the costs it
captures are the usual
suspects, materials, labor
and overhead!
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Direct Material Cost
The document used to
request the release of
materials to production is
called a materials requisition.
This requisition indicates the
type, quantity and cost of
material as well as the job
number to which it will be
assigned.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Direct Labor Cost
The document which is used
to trace direct labor cost to
production is called a time
ticket (or job ticket or work
ticket or time card…). The
time ticket indicates how
much time was spent on
which job. Note that when
several employees all work
on the same job, the time
card data will be aggregated
and then applied to each job.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Manufacturing Overhead
Unlike Direct Materials and
Direct Labor which are
directly traceable to the job,
manufacturing overhead is
added to each job in a slightly
more complex manner.
Manufacturing Overhead is
applied to specific jobs as
opposed to being traced. And
it is applied based on some
common characteristic
referred to as an allocation
base.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Overhead Allocation Rate
The rate at which
Manufacturing Overhead is
applied to various jobs is a
function of the the Overhead
Allocation Rate. It is
calculated by dividing the
estimated overhead by the
allocation base discussed in
the previous slide.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Assigning Costs to Jobs: A
Summary
How are costs attached to
jobs?
Related Learning Objectives:
5.
Direct Material: Material
Requisition Forms.
6.
Direct Labor: Labor Time
Tickets.
Manufacturing Overhead:
Overhead Application Rate.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Activity-Based Costing (ABC)
and Multiple Overhead Rates
Although companies
apply overhead based
on a single factor such
as direct labor, ABC is a
method of assigning
overhead based on a
number of different
allocation bases. ABC
groups overhead costs
into cost pools.
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Predetermined Overhead
Rates
Most companies develop
overhead application rates
based on estimates of total
overhead costs (numerator)
and the estimated level of the
allocation base (denominator)
as follows:
Estimated total overhead cost
Estimated level of allocation
base
Related Learning Objectives:
5.
6.
7.
Explain the relation between the
cost of jobs and the Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts.
Describe how direct material,
direct labor, and manufacturing
overhead are assigned to jobs.
Explain the role of a
predetermined overhead rate in
applying overhead to jobs.
Eliminating Overapplied or
Underapplied Overhead
Recording
Manufacturing Overhead
is a two-step process.
First, actual costs are
accumulated in the
Manufacturing Overhead
Account and second,
overhead is applied to
production based on the
Predetermined Overhead
Rate.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs
using a predetermined rate is
closed to Cost of Goods Sold
or apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
More
Eliminating Overapplied or
Underapplied Overhead
As a result, unless estimates
are perfect, there will be
either a debit or credit
balance in the Manufacturing
Overhead account. If actual
costs are more than
estimates applied, a debit
balance will result and we
have underapplied overhead.
If applied overhead is more
than actual overhead, the
result is overapplied
overhead.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs
using a predetermined rate is
closed to Cost of Goods Sold
or apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
More
Eliminating Overapplied or
Underapplied Overhead
So what happens to this
underapplied or overapplied
amount at the end of the
year? Since the
Manufacturing Overhead
account should have a zero
balance at year-end, we often
close it out to Cost of Goods
Sold. Theoretically, though, it
should be allocated to Work
in Process, Finished Goods
and Cost of Goods Sold.
Materiality is the key here.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs
using a predetermined rate is
closed to Cost of Goods Sold
or apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Job-Order Costing for Service
Companies
Although we have used
primarily manufacturing
examples so far, JobOrder Costing is also
used by service
companies. Examples
include hospitals
(patients) and
automobile repair firms.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs
using a predetermined rate is
closed to Cost of Goods Sold
or apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Changes in Manufacturing Practices
and Product Costing Systems
In an effort to become more
globally competitive, U.S.
companies have made
fundamental changes in
their operations and
philosophies. Here are
some examples:
1.
2.
3.
Just-in-Time (JIT)
Production
Computer-Controlled
Manufacturing
Total Quality Management
(TWM)
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs using a
predetermined rate is closed to
Cost of Goods Sold or
apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Just-in-Time (JIT) Production
In JIT, physical inventories
(Direct Materials and Work in
Process) are kept to a
minimum. In the case of
Direct Materials,
manufacturers rely on
suppliers to deliver raw
materials “Just-in-Time” for
production. The home builder
is a good example of this,
usually waiting until nearly
the day of building to take
delivery of various materials
such as lumber and shingles.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs using a
predetermined rate is closed to
Cost of Goods Sold or
apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Computer-Controlled
Manufacturing
Companies also rely
heavily on ComputerControlled
Manufacturing systems.
Computers are used to
control equipment and
robots and to increase
flexibility and accuracy
of the production
process.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs using a
predetermined rate is closed to
Cost of Goods Sold or
apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
Total Quality Management
Total Quality Management
(TQM) has to do with
ensuring that products and
processes are of the highest
quality. It is also a matter of
continuous improvement.
This is achieved by listening
to the needs of customers,
making products right the
first time, reducing the
number of defective products
that must be reworked and
encouraging workers to
continuously improve their
production processes.
Related Learning Objectives:
5.
8.
Explain why the difference
between actual overhead and
overhead allocated to jobs using a
predetermined rate is closed to
Cost of Goods Sold or
apportioned among Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold.
Discuss changes in the
manufacturing environment of
U.S. companies and how they
affect product costing.
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