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Kinds of Production Environments
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LO1: Describe the different kinds of production environments
Production Environments
• Job shops and Job costing
 Customized products in small lots
 Shipyards, custom-built houses
 High traceability of many costs
 Overhead is an exception
• With small batches and make-to-stock
 The batch is the unit of analysis
 Has distinct job number
 All units move as one through the production
process
 Job is either complete or not
 Cost therefore either in COGM or in WIP
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LO1: Describe the different kinds of production environments
Production Environments
• Process shops and process costing
 Similar products in large lots
 Chemicals, fertilizer
 Limited traceability of costs to individual units
 Units in the same batch might be at different levels of
completion
 Need to allocate costs between COGM and WIP
• Operations costing
 Aspects of both job and process costing
 Garment manufacturing
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LO1: Describe the different kinds of production environments
Test Your Knowledge!
The most logical business which would use job
order costing would be:
a) an oil refinery.
b) a paper company.
c) a custom-home builder.
d) a car dealership.
A maker of custom ordered items would most likely use
job order costing.
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Cost Flows Through Accounts
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LO2: Explain the flow of costs in a job shop
•
•
Cost Flows
Regardless of environment, flow of costs through
the inventory accounts is similar
Job shops
 Individual job is the “unit of analysis”
 Can trace materials and labor to individual job
 Have to allocate overhead
 Account balances are sum of costs if individual jobs
Beginning WIP = Value of jobs unfinished at start of accounting period
Ending WIP = Value of jobs unfinished at end of accounting period
COGM = Value of jobs completed during the accounting period
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LO2: Explain the flow of costs in a job shop
Test Your Knowledge!
In a job-order costing system, direct labor costs
are shown as an increase to what account?
a) Finished goods inventory.
b) Work-in-process inventory.
c) Cost of goods manufactured.
d) Raw materials inventory.
Direct labor costs increase work-in-process inventory.
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Cost Flows in a Job Shop: Magna
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LO2: Explain the flow of costs in a job shop
Inventory
Accounts
(12/1):
Magna
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Analyzing Materials
• Materials flow through the inventory
accounts
 Might separate accounts by kind of material
• For direct materials, keep track of which job
materials were issued to
 Examples: Components
• For indirect materials, put into overhead
control account
 Examples: Supplies
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LO2: Explain the flow of costs in a job shop
Analyzing Materials: Magna
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Analyzing Labor Costs
• Accumulated in control account
 Avoids having to deal with salary, bonus, and other
benefits as separate items
 Avoids having to deal with separate wage rates for
different workers (e.g., due to seniority)
• If direct labor, charge out to individual jobs
• If indirect labor, charge out to overhead
control
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LO2: Explain the flow of costs in a job shop
Analyzing Labor: Magna
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LO2: Explain the flow of costs in a job shop
Analyzing Overhead
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LO3: Apply overhead to jobs using predetermined rates
Pre-Determined Overhead Rates
• Calculate Rate at start of accounting period
 Use estimated costs and denominator volume
• Use this rate to apply overhead to individual
jobs
 Overhead applied to Job N = driver units in job N * predetermined rate
 Normal costing
• Triggers end of period adjustments
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LO3: Apply overhead to jobs using predetermined rates
Overhead Costs: Magna
• Suppose:
 Predetermined variable overhead rate = $0.30 per
direct labor dollar.
 Predetermined fixed overhead rate = $1.20 per
direct labor dollar.
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LO3: Apply overhead to jobs using predetermined rates
Analyzing WIP Accounts
We get the data for individual amounts for materials,
labor and overhead for each job from the prior
analyses
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LO3: Apply overhead to jobs using predetermined rates
Flow Through the WIP Account
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LO3: Apply overhead to jobs using predetermined rates
Flow Through The FG Account: COGS
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LO3: Apply overhead to jobs using predetermined rates
Under LIFO, all 2,200 units would be sold from
December’s production. Thus, 2,200 x $68 = $149,600.
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End of Period Adjustments
•
Use of estimated rates means a difference between the inflows
and outflows into the overhead control account
Actual overhead = Amount of overhead costs
Applied overhead = Allocate to products by a pre-determined rate
•
We can charge out too much or too little. IF
Actual Rate < Pre-determined Rate
Actual Rate > Pre-determined Rate
Under-applied overhead
Over-applied overhead
•
Generally,
Under or
Over-applied
Overhead
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=
Actual
–
Overhead
Applied
Overhead
LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
Calculations for Magna
Actual fixed overhead costs
$76,582
(Given)
Applied fixed overhead cost
$83,544
(120% of $69,620)
Overapplied fixed overhead
$ 6,962
Check To See Why
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Actual labor cost
$69,620
Actual fixed overhead rate for the month
___________
Predetermined overhead rate
$1.20 per labor $
Error in rate
___________
Error in rate × actual labor cost
___________
LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
$69,620
$78,582
$1.10 / labor $
$83,544
$6,962 (over-applied)
$0.10 higher
$6,962
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Disposition
• Three methods permitted
 Write off entire amount to COGS
 Prorate (i.e., allocate) among WIP, FG and
COGS accounts
 Re-compute the rates
• All three methods comply with GAAP
 All methods essentially allocate the
under- / over-applied overhead
 Differ in the accounts charged for the error
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LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
$4,623,800
1 $4,629,450
1 Add under-applied overhead and subtract overapplied overhead to determine the
adjusted COGS as $4,629,450.
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Disposition: Comparison
WIP
Inventory
FG
Inventory
COGS
Write off to COGS
X
Proration (allocation)
X
X
X
Actual rates (assignment)
X
X
X
•
Write off is least correct
 Assumes entire error relates to COGS
•
Proration is better
 Assumes error is proportional to end of period value
 Should be proportion to current period overhead in the
account
•
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Correcting rates is most accurate
LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
Which Method To Use?
• Write off to COGS is the easiest method. OK
if amount is not large
 Easy to implement. Most inaccurate.
• Proration (i.e., allocating among) is common.
Uses of end of year balances as the basis
 Most commonly used
• Re-computing rates is most accurate.
 Easy if system is computerized
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LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
Examples
•
If overhead is under-applied, we have used “smaller
than actual” rates. Thus, inventory accounts are undervalued. The adjustment therefore increases inventory
values and cost of goods sold.
 Opposite reasoning of over-applied overhead. The adjustment
decreases inventory values and COGS.
Unadjusted cost of goods sold (Jan-Nov)
Cost of goods sold
Total unadjusted cost of goods sold
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$4,245,000
378,000
$4,263,800
-
Over-applied variable overhead for the year
25,689
+
Under-applied fixed overhead for the year
15,963
=
Adjusted cost of goods sold
$4,614,074
LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
Example: Proration
•
•
Proration allocates the under- or over-applied
overhead to WIP, FG and COGS accounts
Uses end of year balances as the allocation basis
WIP
Inventory
FG
Inventory
COGS
Unadjusted balance as of 12/31
% of total
Unadjusted balance as of 12/31
- Over-applied variable overhead
+ Under-applied fixed overhead
$21,000.00 $285,500.00 $4,623,600.00
0.4%
5.8%
93.8%
$21,000.00 $285,500.00 $4,623,600.00
1,014.42
1,487.58
24,092.00
67.99
924.37
14,970.63
= Adjusted values
$20,958.57 $284,936.79 $4,614,648.63
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LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.
Exercise 14.26
Basic job costing (LO2)
Tubbs and Company manufactures custom motorcycles. Tubbs uses a jobcost system and provides the following information related to the work-inprocess account for the month of January:
January 1 balance
$22,500
Direct material used
25,000
Direct labor incurred
24,000
Manufacturing overhead applied
36,000
Tubbs applies manufacturing overhead based on direct labor cost. Job No.
232 was the only job still in process at the end of January. As of January 31,
this job, which was started in January, contains direct materials of $4,250
and direct labor of $2,500.
Required:
Determine the cost of goods manufactured during January.
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Exercise 14.26 (Continued)
Determine the cost of goods manufactured during January.
We can use the inventory equation for the WIP account to answer
the question.
Beginning WIP + (materials + labor + applied overhead) = COGM +
Ending WIP.
We know the items on the left hand side. But, we need to calculate
Ending WIP, which will be the costs charged to job 232.
Direct materials
$4,250
Direct labor
$2,500
Mfg. overhead
$3,750
Ending WIP
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$10,500
$2,500 × $1.50 per labor $
Exercise 14.26 (Concluded)
Determine the cost of goods manufactured during January.
Direct materials
$4,250
Direct labor
$2,500
Mfg. overhead
$3,750
Ending WIP
$2,500 × $1.50 per labor $
$10,500
(We use the total amounts charged to WIP to calculate the overhead
rate as $36,000 applied overhead /$24,000 labor $ = $1.50 per labor
dollar.)
Thus, we have:
COGM = $22,500 + (25,000+24,000 + 36,000) - $10,500 = $97,000.
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