Indirect costs

Job Costing
Basic Costing Terminology…
• Several key points from prior chapters:
 Cost Objects
• including responsibility centers, departments, customers,
products, etc.
 Direct Costs and Tracing
• materials and labor
 Indirect Costs and Allocation
• overhead
…logically extended
• Cost Pool
 any logical grouping of related cost objects
• Cost-allocation Base
 A cost driver is used as a basis upon which to build a
systematic method of distributing indirect costs
• For example, let’s say that direct labor hours cause
indirect costs to change. Accordingly, direct labor hours
will be used to distribute or allocate costs among objects
based on their usage of that cost driver
Costing Systems
• Job-Costing (what this chapter is about)
 A system accounting for distinct cost objects called
Jobs. Each job may be different from the next, and
consumes different resources
 Wedding announcements, aircraft, advertising
• Process-Costing (we’ll do this one next)
 A system accounting for mass production of identical
or similar products
• Oil refining, orange juice, soda pop
Costing Approaches
• Actual Costing – allocates:
 Indirect costs based on the actual indirect-cost rates
times the actual activity consumption
• Normal Costing – allocates:
 Indirect costs based on the budgeted indirect-cost
rates times the actual activity consumption
• Both methods allocate Direct costs to a cost
object the same way: by using actual direct-cost
rates times actual consumption
Seven-step Job Costing
1. Identify the Job to be costed
2. Identify the Direct Costs of the Job
3. Select the Cost-Allocation base(s) to use for
allocating Indirect Costs to the Job
4. Match Indirect Costs to their respective CostAllocation base(s)
5. Calculate an Overhead Allocation Rate:
Actual OH Costs ÷ Actual OH Allocation Base
6. Allocate Overhead Costs to the Job:
OH Allocation Rate x Actual Base Activity For the Job
7. Compute Total Job Costs by adding all direct and
indirect costs together
Job Costing Overview
Imagine a factory making airplanes!
• Materials
• Inventory
Identify the costs of your products
• Direct material
 Tires, Windshields, Body panels, Engines,
Dashboards etc.
• Direct labor
 Wages of line workers in the factory
• Overhead
 Supervisor salaries, utilities, insurance on
factory, miscellaneous supplies
Overhead costs
• We can have one pool or multiple pools of
overhead cost
• In any event, we must choose an allocation
base and then apply the costs to various
 Rate = actual costs in the pool
actual quantity of AB
 or rate = estimated costs in pool
estimated quantity of AB
Allocate the cost
• The indirect costs for a job are calculated as
 (units of allocation base)X(allocation rate)
 If you have multiple OH pools, then you will
make multiple applications of overhead
 Allocation rates are based on annual periods
to get a better sense of activity for the entire
• Summarize costs
 DM + DL + allocated indirect costs
What kinds of accounts do we use?
• Costs flow through the inventory accounts
and ultimately end up on the income
• Inventory Accounts
 DM - subsidiary accounts for each DM
 WIP - subsidiary accounts for each Job
 FG - subsidiary accounts for each product
Direct materials inventory
• Increased for purchases of materials
• Decreased by the use of materials
• Materials used will result in the following
 WIP inventory
DM inventory
 DM, used = DM, beg + purchases - DM, end
Work in Process
• As direct costs are incurred, you increase the
WIP inventory
• As indirect costs are incurred, you increase
Manufacturing Overhead Control
• As overhead costs are allocated to jobs you
increase the WIP and decrease the MO
Allocated account.
Finished Goods
• As jobs are completed, you transfer the costs
from WIP inventory to Finished Goods
 COGM = WIP, beg + manufacturing costs incurred WIP, end
• As jobs are sold you take the costs out of FG
and transfer them to COGS
 COGS = FG, beg + COGM - FG, end
Tracking Costs
Job 1
Job 2
Job 3
Job Costs
Tracking Costs
• Documents:
 Job Cost Record - accumulates costs by job, these
serve as the sub ledger of WIP
• Entries to WIP-Job A from DM, Wages Payable, OH
 Materials requisition - releases materials from
inventory to factory floor
• Entries from DM to WIP-Job A
 Labor time record - workers track time by job
• Entries to WIP-Job A and Wages payable
• For example, public accountants fill out time sheets to keep
track of how long they work on each client.
Tracking Costs
• Documents:
 Labor time record - workers track time by job
• Entries to WIP-Job A and Wages payable
 For example, public accountants fill out time sheets
to keep track of how long they work on each client.
Journal Entries
• Journal entries are made at each step of the
production process
• The purpose is to have the accounting system
closely reflect the actual state of the business, its
inventories and its production processes
Flow of Costs Illustrated
Accounting for Overhead
• Recall that two different overhead accounts are
used in the journal entries:
 Manufacturing Overhead Control is debited for
the actual overhead costs incurred.
 Manufacturing Overhead Allocated was
credited for estimated (budgeted) overhead applied
to production through the Work-in-Process
Accounting for Overhead
• Actual costs will almost never equal
budgeted costs.
• Accordingly, an imbalance situation exists
between the two overhead accounts
 If Overhead Control > Overhead Allocated, this is
called Underallocated Overhead
 If Overhead Control < Overhead Allocated, this is
called Overallocated Overhead
Accounting for Overhead
• This difference will be eliminated in the end-ofperiod adjusting entry process, using one of
three possible methods
• The choice of method should be based on such
issues as materiality, consistency, and industry
Three Methods for Adjusting the Over/Underapplied
• Adjusted Allocation Rate Approach
 all allocations are recalculated with the actual, exact
allocation rate
• Proration Approach
 the difference is allocated between Cost of Goods
Sold, Work-in-Process, and Finished Goods based
on their relative sizes
• Write-Off Approach
 the difference is simply written off to Cost of Goods
End of Chapter 4
• That’s three chapters (nearly) done!