PRELIM MODULE WEEK 2
CHAPTER 5
ACCOUNTING 16
Management Advisory Services
Job Order Costing
Semester of A.Y. 2021-2022
Introduction
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Product costing plays a critical role in the new manufacturing environment and has become a significant
factor in service industries. Understanding the basics of product costing is an important topic not just for
accountants, but for managers making pricing decisions
Rationale
This chapter has major topics for Differences between job-order costing and process costing, predetermined overhead rate and unit cost in the job-order environment, Source documents: Keeping track of individual
costs, The flow of costs through the accounts, Journal entries for job-order costing, Support department costs and
their allocation to producing departments.
Intended Learning Outcomes
After studying Chapter 5, students should be able to:
A. Describe the differences between job-order costing and process costing and identify the types of firms that would use
each method.
B. Compute the predetermined overhead rate and use the rate to assign overhead to units or services produced.
C. Identify and set up the source documents used in job-order costing.
D. Describe the cost flows associated with job-order costing.
E. (Appendix A) Prepare the journal entries associated with job-order costing.
F. (Appendix B) Allocate support department costs to producing departments.
Discussion
CHARACTERISTICS OF THE JOB-ORDER ENVIRONMENT
Two different systems for tracking costs of products and services are:
1. Job order costing system used by firms producing unique products or services
2. Process costing system used by firms producing very similar products or services.
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A. Job-Order Production and Costing
A job-order costing system accumulates manufacturing costs by job.
Such a system is used when separate jobs are identifiable, such as a furniture manufacturer.
Unit costs in a job-order system are calculated by dividing the total manufacturing cost of the job by the number of
units produced in the job.
B. Process Production and Costing
In a process-costing system, production costs are accumulated by process or by department for a given period of
time.
Unit costs are calculated by dividing the processing department’s costs by the output for the period.
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A comparison of job-order and process costing follows:
NORMAL COSTING AND OVERHEAD APPLICATION
A. Actual Costing versus Normal Costing
Two commonly used ways to measure the costs associated with production are:
• actual costing: uses actual costs to determine unit costs
• normal costing: uses actual costs for direct materials and direct labor. A predetermined overhead rate is
used to apply overhead costs.
A comparison of costs used for actual costing versus normal costing follows:
•
An actual cost system is rarely used because it does not provide accurate cost information on a timely
basis. Although direct materials and direct labor can be traced to the final product, overhead does not have
a direct relationship.
•
Normal costing is widely used. While direct materials and direct labor are actual costs, overhead is
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estimated. A predetermined, or estimated, overhead rate is used to assign overhead to the products
produced throughout the year
B. Importance of Unit Costs to Manufacturing Firms
Unit cost information is needed for:
1. the financial reporting requirements of costing inventory and determining income, and
2. decision making, such as product pricing.
Different cost information is needed for different purposes, such as using the cost information to prepare financial
statements versus using the cost information for decision making.
C. Importance of Unit Costs to Service Firms
Service firms and nonprofit firms do not produce physical products, but must be able to assign costs of services to
each job.
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D. Normal Costing and Estimating Overhead
Using a normal costing system, the total cost of a job is calculated using:
• actual costs for direct materials
• actual costs for direct labor
• a predetermined (estimated) rate to assign (apply) overhead costs to products and services
In normal costing, overhead must be estimated and then applied to production. The three steps to assigning
overhead to products are:
Step 1: Calculate the predetermined overhead rate. (This rate is calculated at the beginning of the year.)
Overhead rate = Estimated annual overhead/Estimated annual activity level
Step 2: Apply overhead to production throughout the year. Overhead is assigned or applied to each job by
multiplying the predetermined overhead rate in Step 1 by the activity for that particular job. For example, if a firm
selected direct labor hours as the activity, applied overhead would be calculated by multiplying the number of hours
worked on the particular job by the predetermined rate.
Applied overhead = Predetermined overhead rate × Actual activity
Step 3: Reconcile the difference between the total actual overhead incurred during the year and the total
overhead applied to production. The difference between actual overhead costs and the applied overhead (from
Step 2) is called an overhead variance.
Overhead variance = Applied overhead – Actual overhead
•
•
•
Overapplied overhead results when applied overhead exceeds actual overhead for the period, (overhead
was overapplied).
Underapplied overhead results when applied overhead is less than actual overhead for the period,
(overhead was underapplied).
If immaterial, underapplied or overapplied overhead may be treated as an adjustment to cost of goods sold.
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How to Calculate the Predetermined Overhead Rate and Apply Overhead to Production (Steps 1 and 2 above)
How to Reconcile Actual Overhead with Applied Overhead (Step 3 above)
BREAK-EVEN POINT IN UNITS AND SALES
The break-even point is the point where total revenue equal total cost, the point of zero profit.
A. Using Operating Income in CVP Analysis
A functional income statement was used that classified expenses by function as:
1. manufacturing costs (both fixed and variable)
2. selling and administrative costs (both fixed and variable)
To help review these concepts, this exhibit illustrates the concepts of over- and underapplied overhead
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E. Departmental Overhead Rates
Overhead can be applied using:
1. Plantwide overhead rate: a single overhead rate using all estimated overhead for a factory divided by the
estimated activity level for the entire factory.
Predetermined plantwide overhead rate = Estimated factory overhead/ Estimated activity for factory
2. Departmental overhead rate: different overhead rates are used for different departments. A departmental
overhead rate is calculated as estimated overhead for a department divided by the estimated activity for that
department.
Predetermined departmental overhead rate = Estimated departmental overhead/ Estimated
departmental activity
How to
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Calculate Predetermined Departmental Overhead Rates and Apply Overhead to Production
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How to Convert Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production
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See the summary below for a comparison of plantwide versus departmental overhead rates:
KEEPING TRACK OF JOB COSTS WITH SOURCE DOCUMENTS
It is important for students to understand the different documents that are used in a job-order system. The document for
collecting all costs that belong to a job is the job-order cost sheet, which identifies the job and collects the materials, labor,
and overhead costs for the job. It serves as a subsidiary ledger to the work-in-process account. The total of the costs for all
job-cost sheets must equal the total for the controlling work-in-process account.
If a firm has underestimated the costs in a job and begin losing money, accountants could post costs from the under-priced
job to other profitable jobs. Ethical issues arise when firms manipulate and inappropriately record of costs from one job to the
job-order sheet of another job. Also, owners of small businesses may purchase materials or use labor for their own personal
use and charge a job. Customers rely on professionalism and honest in job-order firm in record keeping.
A. Job-Order Cost Sheet
A job-order cost sheet is prepared for every job; it used to accumulate the manufacturing costs (direct materials,
direct labor, and overhead) associated with a job.
JOB ORDER COST SHEET
Direct Materials
Actual Cost
Direct Labor
Actual Cost
Applied Overhead
Predetermined Overhead Rate x Activity used on the job
Total Cost
Total Cost for the Job
Number of Units
Divided by the number of units in the job
Unit Cost
Unit Cost of the Job
The job-order cost sheets are the subsidiary ledgers to the Work-in-Process account.
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B. Materials Requisitions
The cost of materials is traced to each job through the use of a materials requisition form. When materials are issued
to production, the materials requisition form identifies the job, the quantity and type of materials, and the cost of
materials. This document is the source document for assigning materials costs to individual job orders
C. Job Time Tickets
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Job time tickets are the source documents used to assign labor costs to jobs. When direct laborers work on a job,
they fill out a time ticket indicating the time spent on the job, along with their wage rate.
D. Accounting for Actual Overhead Costs
Actual overhead costs are recorded in the Overhead Control account.
Actual overhead costs include:
1. indirect materials
2. indirect labor, overtime premium, and idle time
3. invoices received from outside suppliers for utilities, rent, repairs, property taxes, etc.
4. internal transfers of costs, such as depreciation and the expiration of prepaid insurance.
E. Other Source Documents
Job-order cost sheets for jobs that are complete but not yet sold serve as subsidiary ledgers for Finished Goods
inventory.
Job-order cost sheets for unfinished jobs serve as subsidiary ledgers for Work in Process inventory.
F. Accounting for Cost of Goods Sold
If the overhead variance is immaterial, it is treated as an adjustment to cost of goods sold at the end of the year.
Normal cost of goods sold is the amount of cost of goods sold before adjustment for an overhead variance.
Adjusted cost of goods sold is normal cost of goods sold after adjustment for an overhead variance.
G. Accounting for Nonmanufacturing Costs
Selling and general administrative costs (nonmanufacturing costs) are considered period costs and are not assigned
to the product.
Selling and administrative expenses appear on the income statement.
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How to Prepare Brief Job-Order Cost Sheets
Required:
1. Calculate the overhead rate based on direct labor cost.
2. Prepare a brief job-order cost sheet for the four jobs. Show the balance as of June 1 as well as direct materials and
direct labor added in June. Apply overhead to the four jobs for the month of June, and show the ending balances.
3. Calculate the ending balances of Work in Process and Finished Goods as of June 30.
4. Calculate Cost of Goods Sold for June.
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APPENDIX 5A: JOURNAL ENTRIES ASSOCIATED WITH JOB-ORDER COSTING
A. JOURNAL ENTRIES
When using a job-order costing system transactions are entered into the accounting system by making journal
entries and posting them to the accounts.
Typical transactions include:
1. The purchase of raw materials.
2. Materials are requisitioned from the storeroom and transferred into production.
3. Direct labor is recognized.
4. Overhead is applied to production using the predetermined overhead rate.
5. Actual overhead costs are incurred.
6. Completed production and transferred to Finished Goods.
7. Sold a job at cost plus determined markup percentage.
8. Close over(under)applied overhead to Cost of Goods Sold
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The following diagram summarizes the flow of manufacturing cost.
APPENDIX 5B: SUPPORT DEPARTMENT COST ALLOCATION
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1. Types of Departments
If departments are the cost objects, departments are classified as either producing departments or support
departments.
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2. CHOOSING A SUPPORT DEPARTMENT COST ALLOCATION METHOD
There are three methods commonly used to allocate support costs: (1) the direct method; (2) the sequential (or step)
method; and (3) the reciprocal method. Many instructors choose to defer coverage of the reciprocal method to cost
accounting. It is important for students to realize that no matter which method of support department cost allocation
is used, total factory overhead costs remain unchanged. That is, the different allocation methods simply split up the
costs differently among the producing departments.
Three methods used to allocate support-department costs to producing departments are:
a. direct method
b. sequential method, and
c. reciprocal method.
A. Direct Method of Allocation
The direct method allocates support-department costs directly to the producing departments based on relative use.
This method ignores reciprocal services (services provided by one support department to another support
department). For example, this method would ignore service provided by the data processing department to other
support departments, such as personnel or maintenance.
If a firm has two support departments (power and maintenance) and two producing departments (grinding and
assembly), the allocation of support-department costs using the direct method could be diagramed as follows:
How to Assign Support Department Costs Using the Direct Method
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B. Sequential Method of Allocation
The sequential (or step) method allocates support-department costs to the producing departments and to some
support departments. Thus, the sequential method partially recognizes reciprocal services.
The sequential method is applied in the following manner:
1. Select a support department and allocate its costs to the producing departments and support departments to
which it provides services. (The support department with the greatest total costs is allocated first.)
2. Select another support department and allocate its cost to the producing departments and the remaining support
departments.
3. Proceed in this manner until all of the support-department costs have been allocated to the producing
departments.
Notice that once the costs of a support department are allocated, no further allocations are made to that support
department.
The allocation of support department costs under the sequential method can be diagramed as follows:
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How to Assign Support Department Costs Using the Sequential Method
C. Reciprocal Method of Allocation
The reciprocal method fully recognizes the reciprocal services provided by support departments to other support
departments.
The reciprocal method requires the use of simultaneous equations.
The allocation of support-department costs under the reciprocal method can be diagramed as follows:
The reciprocal
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method fully recognizes the reciprocal services provided by support departments to other support departments.
This method is not widely used due to its complexity.
Activity:
Activity 1. Read on Job Order Costing.
Exercise:
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Exercise 1: True/False
1. Manufacturing and service firms producing unique products or services require process-costing accounting systems.
2. The difference between actual overhead and applied overhead is the overhead variance.
3. If actual overhead is greater than applied overhead, the variance is called overapplied overhead.
4. Costs reported on the financial statements must be estimated costs.
5. If the overhead variance is immaterial, it is allocated among the ending balances of Work in Process, Finished
Goods, and Cost of Goods Sold.
Exercise 2: Multiple Choice
1. Which of the following is not a characteristic of job-order costing?
a. Wide variety of distinct products
b. Unit cost is computed by dividing process costs of the period by the units produced in the period
c. Unit cost computed by dividing total job costs by units produced on that job
d. Costs accumulated by job
e. typically, the cost of one job is different from that of another job
2. How are unit costs calculated?
a. by dividing total cost associated with the units produced by the unit cost
b. by adding all variable costs per unit associated with the units produced
c. by dividing total fixed costs by the number of units produced
d. by dividing total cost associated with the units produced by the number of units produced
e. by adding unit variable costs to total fixed costs
3. Production costs do not include:
a. direct materials
b. direct labor
c. variable overhead
d. fixed overhead
e. all of these are production costs.
4. Which of the following are easy to trace to individual jobs?
a. direct materials and overhead
b. direct materials and direct labor
c. direct labor and overhead
d. overhead and indirect labor
e. depreciation on machinery and indirect labor
5. Which of the following is the assignment process used with normal costing?
a. Actual direct materials, actual direct labor and actual overhead cost are assigned to products.
b. Actual direct materials cost is assigned to products, but direct labor and overhead costs are assigned using
predetermined rates.
c. Actual direct labor cost is assigned to products, but direct material and overhead costs are assigned using
predetermined rates.
d. Actual direct material and direct labor costs are assigned to products, but overhead costs are assigned
using predetermined rates.
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e. all manufacturing costs are assigned using predetermined rates
Exercise 3: Computations
Figure 5-1.
Jones Company applies overhead based on direct labor hours. At the beginning of the year, Jones estimates overhead to be
$480,000, machine hours to be 120,000, and direct labor hours to be 80,000. During January, Jones has 6,700 direct labor
hours and 11,000 machine hours.
1. Refer to Figure 5-1. What is the predetermined overhead rate?
a. $6 per direct labor hour
b. $40,200
c. $4 per machine hour
d. $44,000
e. none of these
2. Refer to Figure 5-1. What is the amount of overhead applied for January?
a. $40,200
b. $66,000
c. $44,000
d. $26,800
e. $480,000
3. Refer to Figure 5-1. If the actual overhead for January is $41,000, what is the overhead variance and is it overapplied
or underapplied?
a. $3,000 overapplied
b. $800 overapplied
c. $3,000 underapplied
d. $800 underapplied
e. none of these
Figure 5-2.
Smith has applied overhead of $73,000 and actual overhead of 87,600 for the month of November. It applies overhead based
on direct labor hours and those equaled 14,600 in November. Overhead for the year was estimated to be $900,000. How
many direct labor hours were estimated for the year?
a. 175200
b. 180,000
c. $5
d. 150,000
e. $6
Figure 5-3.
At the beginning of the year, Wilson Company estimated the following:
Overhead
$360,000
Direct labor hours 60,000
Wilson used normal costing and applies overhead on the basis of direct labor hours. For the month of September, direct labor
hours equaled 9,350 and actual overhead equaled $46,750.
Calculate the overhead applied to production in September.
a. $56,100
b. $30,000
c. $46,750
d. $5 per direct labor hour
e. none of these
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Reflection
Wisteria Company provided the following data:
Budgeted overhead
Budgeted direct labor hours
Actual overhead
Actual direct labor hours
A.
B.
$80,000
10,000
$86,000
10,860
What is applied overhead?
What is the overhead variance? Is it overapplied or underapplied?
Resources
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Main Resources:
1. Hansen, M. et.al (4th edition), Managerial Accounting
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