Systems Design:
Job-Order Costing
Chapter Three
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-2
Learning Objective 1
Distinguish between
process costing and joborder costing and identify
companies that would use
each costing method.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-3
Types of Product Costing Systems
Process
Costing
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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-4
Types of Product Costing Systems
Process
Costing
Job-order
Costing

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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-5
Learning Objective 2
Identify the documents
used in a job-order costing
system.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-6
Measuring Direct Materials Cost
Will E. Delite
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-7
Measuring Direct Materials Cost
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-8
Measuring Direct Labor Costs
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-9
Job-Order Cost Accounting
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-10
Learning Objective 3
Compute predetermined
overhead rates and
explain why estimated
overhead costs (rather
than actual overhead
costs) are used in the
costing process.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-11
Why Use an Allocation Base?
Manufacturing overhead is applied to jobs that
are in process. An allocation base, such as
direct labor hours, direct labor dollars, or
machine hours, is used to assign
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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-12
Manufacturing Overhead Application
The predetermined overhead rate (POHR)
used to apply overhead to jobs is
determined before the period begins.
POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
Ideally, the allocation base
is a cost driver that causes
overhead.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-13
The Need for a POHR
Using a predetermined rate makes it
possible to estimate total job costs sooner.
$
Actual overhead for the period is not
known until the end of the period.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-14
Application of Manufacturing Overhead
Based on estimates, and
determined before the
period begins.
Overhead applied = POHR × Actual activity
Actual amount of the allocation
based upon the actual level of
activity.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-15
Overhead Application Rate
POHR =
POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
$640,000
160,000 direct labor hours (DLH)
POHR = $4.00 per DLH
For each direct labor hour worked on a
particular job, $4.00 of factory overhead
will be applied to that job.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-16
Job-Order Cost Accounting
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-17
Job-Order Cost Accounting
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-18
Learning Objective 4
Understand the flow of
costs in a job-order
costing system and
prepare appropriate
journal entries to record
costs.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
Job-Order Costing
Document Flow Summary
3-19
A sales order is the
basis of issuing a
production order.
McGraw-Hill/Irwin
A production
order initiates
work on a job.
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-20
Job-Order Costing
Document Flow Summary
Materials used
may be either
direct or
indirect.
Direct
materials
Job Cost
Sheets
Materials
Requisition
Indirect
materials
McGraw-Hill/Irwin
Manufacturing
Overhead
Account
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-21
Job-Order Costing
Document Flow Summary
An employee’s
time may be either
direct or indirect.
Direct
Labor
Job Cost
Sheets
Employee Time
Ticket
Indirect
Labor
McGraw-Hill/Irwin
Manufacturing
Overhead
Account
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-22
Job-Order Costing
Document Flow Summary
Employee
Time Ticket
Other
Actual OH
Charges
Materials
Requisition
McGraw-Hill/Irwin
Indirect
Labor
Manufacturing Applied
Overhead
Overhead
Account
Job Cost
Sheets
Indirect
Material
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-23
Learning Objectives 4 & 7
Understand the flow of costs
in a job-order costing system
and prepare appropriate
journal entries to record costs.
Use T-accounts to show the
flow of costs in a job-order
costing system.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-24
The Purchase and Issue of Raw Materials
Raw Materials
Material Direct
Purchases Materials
Indirect
Materials

Work in Process
(Job Cost Sheet)
Direct
Materials

Mfg. Overhead
Actual Applied
Indirect
Materials
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-25
The Recording of Labor Costs
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor

Mfg. Overhead
Actual
Indirect
Materials
Indirect
Labor
McGraw-Hill/Irwin
Applied
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-26
Recording Actual Manufacturing Overhead
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor

Mfg. Overhead
Actual Applied
Indirect
Materials
Indirect
Labor
Other
Overhead
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-27
Learning Objective 5
Apply overhead cost to
Work in Process using a
predetermined overhead
rate.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-28
Applying Manufacturing Overhead
Salaries and
Wages Payable
Direct
Labor
Indirect
Labor

Mfg. Overhead
Actual Applied
Indirect
Materials Overhead
Indirect
Applied to
Labor
Work in
Other
Process
Overhead
McGraw-Hill/Irwin
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor
Overhead
Applied

If actual and applied
manufacturing overhead
are not equal, a year-end
adjustment is required.
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-29
Accounting for Nonmanufacturing Cost
Nonmanufacturing 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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-30
Learning Objective 6
Prepare schedules of cost
of goods manufactured
and cost of goods sold.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-31
Transferring Completed Units
Work in Process
(Job Cost Sheet)
Direct
Materials
Direct
Labor
Overhead
Applied

McGraw-Hill/Irwin
Finished Goods
Cost of
Goods
Mfd.

Cost of
Goods
Mfd.

Copyright © 2008, The McGraw-Hill Companies, Inc.
3-32
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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-33
Learning Objective 8
Compute underapplied or
overapplied overhead cost
and prepare the journal
entry to close the balance
in Manufacturing
Overhead to the
appropriate accounts.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-34
Problems 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.
McGraw-Hill/Irwin
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.
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-35
Overhead Application Example
PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor
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 labor hour.
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-36
Disposition of Under- or Overapplied Overhead
PearCo’s Method
$30,000
may be allocated
to these accounts.
$30,000 may be
closed directly to
cost of goods sold.
OR
Work in
Process
Finished
Goods
Cost of
Goods Sold
McGraw-Hill/Irwin
Cost of
Goods Sold
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-37
Disposition of Under- or Overapplied Overhead
PearCo’s Cost
of Goods Sold
Actual Overhead
overhead applied
costs
to jobs
Unadjusted
Balance
$30,000
Adjusted
Balance
McGraw-Hill/Irwin
PearCo’s
Mfg. Overhead
$650,000
$30,000
$680,000
$30,000
overapplied
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-38
Overapplied and Underapplied Manufacturing
Overhead - Summary
PearCo’s
Method
If Manufacturing
Overhead is . . .
UNDERAPPLIED
Alternative 1
Close to Cost
of Goods Sold
Alternative 2
INCREASE
Cost of Goods Sold
INCREASE
Work in Process
Finished Goods
Cost of Goods Sold
DECREASE
Cost of Goods Sold
DECREASE
Work in Process
Finished Goods
Cost of Goods Sold
(Applied OH is less
than actual OH)
OVERAPPLIED
(Applied OH is greater
than actual OH)
McGraw-Hill/Irwin
Allocation
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-39
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.
McGraw-Hill/Irwin
May be more
complex but . . .
May be more accurate
because it reflects
differences across
departments.
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-40
Job-Order Costing in Service Companies
Job-order costing is used in many
different types of service companies.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-41
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 webbased programming language called
Extensible Markup Language (XML), bar
coding eliminates the inefficiencies and
inaccuracies associated with manual clerical
processes.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
The Predetermined
Overhead Rate & Capacity
Appendix 3A
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-43
Learning Objective 9
(Appendix 3A)
Understand the implications of
basing the predetermined
overhead rate on activity at
capacity rather than on
estimated activity for the
period.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-44
Predetermined Overhead Rate and Capacity
Calculating predetermined overhead rates using
an estimated, or budgeted amount of the
allocation base has been criticized because:
1. Basing the predetermined overhead rate upon
budgeted activity results in product costs that
fluctuate depending upon the activity level.
2. Calculating predetermined rates based upon
budgeted activity charges products for costs that
they do not use.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-45
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?
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-46
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?
McGraw-Hill/Irwin
Traditional
=
Method
$100,000
40,000
= $2.50 per unit
Capacity
Method
$100,000
50,000
= $2.00 per unit
=
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-47
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.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-48
Income Statement Preparation
Actual volume
Selling price
Variable production cost
Fixed manufacturing overhead
Capacity
Predetermined overhead rate
Fixed selling and admin. expense
Revenue
Cost of goods sold
Gross margin
Cost of idle capacity
Selling and admin. expense
Net operating income
McGraw-Hill/Irwin
40,000
$40.00
$24.00
$100,000
50,000
$2.00
$500,000
cases
per case
per case
per year
cases
per case
per year
$ 1,600,000
1,040,000
560,000
20,000
500,000
$
40,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-49
Income Statement Preparation
Actual volume
Selling price
Variable production cost
Fixed manufacturing overhead
Capacity
Predetermined overhead rate
Fixed selling and admin. expense
Revenue
Cost of goods sold
Gross margin
Cost of idle capacity
Selling and admin. expense
Net operating income
McGraw-Hill/Irwin
40,000
$40.00
$24.00
$100,000
40,000
$2.50
$500,000
cases
per case
per case
per year
cases
per case
per year
$ 1,600,000
1,060,000
540,000
500,000
$
40,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
3-50
End of Chapter 3
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.