Chapter Two
Manufacturing Costs and
Job-Order Costing Systems
What Does it Cost to Make
Something?
In Accounting 284, all inventory was
purchased from another entity
 In Accounting 285, we will learn how to
cost a product that is manufactured
 All cost associated with the production
process are called product costs and go
through inventory accounts

Product and Period Costs

Product costs are
 Direct
material
 Direct labor
 Manufacturing
Overhead
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Indirect material
Indirect labor
Utilities
Depreciation
Any other
manufacturing cost

Period Costs are
 Selling
cost
 Administrative cost
Product Costs and Period Costs
Product Cost
Period Cost
Balance Sheet
Income
Statement
Inventory
Accounts
Cost of
Goods
Sold
Selling
General and
Administrative
Expense
Three Inventory Accounts
Material inventory includes the cost of
materials purchased but not yet put into
production
 Work in Process (WIP) includes the cost of
material, labor and manufacturing
overhead of goods started but not yet
completed
 Finished goods included the cost of good
completed but not yet sold

Cost Flows Through Inventory
Raw
material
Direct
labor
Overhead
Work
in
Process
Finished
Goods
Cost of
Goods
Sold
Flow Through Accounts
Material
WIP
Beginning Material Beginning WIP
Finished
Goods
Beginning
Finished goods
+ Purchases
+Direct Material + Cost of goods
used + Direct
manufactured
Labor + MOH
= Material Available =Total cost to
=Goods available
account for
for sale
- Ending Material
- Ending WIP
- Ending Finished
Goods
= Cost of material = Cost of goods =Cost of goods
used
manufactured
sold
Job-order versus Process Costing
Job-order costing keeps
track of the cost of
materials and labor used
on each job and then
applies manufacturing
overhead to each job.
Process costing keeps
track of total costs and
divides by output for a
period to get an average
unit cost.
Job Order versus Process Costing
Use Job order costing for non-repetitive,
high cost unique orders
 Use Process costing for large numbers of
homogeneous products
 Which would home builder, tomato
cannery, and automobile manufacturer
use?

Job Order Costing
Keep payroll records according to jobs to
know direct labor cost of each job
 Use material requisitions for all materials
to know the direct material cost for each
job
 Put all overhead (including indirect
materials and indirect labor) into the
overhead account and “apply” it to jobs

Actual versus Normal Overhead
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The big problem in job order costing is relating
overhead to production
To solve this, overhead is applied to production
on the basis of some activity driver
Actual costing waits until the end of the period
and then determines the actual overhead and
the actual level of the driver.
Normal costing estimates the level of the driver
and overhead in advance and then applies it
throughout the period.
Problems with Actual Costing
If done on shorter than an annual period
- say monthly - overhead rates can vary
greatly from month to month.
 If done annually, must wait until end of
year to determine costs of all units
during the year
 No estimates are available for bidding,
which is how job order costers normally
obtain jobs.

Normal Costing
Use a predetermined overhead rate so
that products can be costed as the period
goes along, not at the end
 Rate is developed by using the cost
formula for overhead, estimating activity
and developing a rate
 This is called NORMAL COSTING

Developing Overhead Rate
1)
2)
3)
4)
Determine overhead application basis
Estimate activity level
Estimate overhead costs at that level
Divide estimated costs by activity to get
rate
Rate Example
1)
2)
3)
4)
Activity driver is direct labor hours
Estimated activity level is 25,000 hours
Estimated costs at 25,000 hours is
$250,000
Rate is 250,000/25,000 = $10/DLHr
Applying Overhead
1)
2)
3)
Multiply actual activity by predetermined
overhead rate - this is applied overhead
Compare to the actual overhead - if the
applied is greater overhead is overapplied,
if it is less it is under applied. Being
overapplied is favorable.
The amount of under or overapplied
overhead is assigned to cost of goods sold
or prorated between inventories
Applied Overhead Example
1)
2)
3)
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Assume that actual hours worked were
26,000 and actual overhead was
$257,000
Applied overhead would be 26,000 * $10
or $260,000
Overhead would be overapplied by
$3,000
Why might this be the case?
Causes of Under/overapplied
Assume that overhead was $150,000 +
$4/direct labor hours so that at a volume of
25,000 hours overhead was estimated to
be $250,000 (150,000+(4*25,0000))
 The rate of $10 consists of $6 fixed and $4
variable.
 When we work 26,000 hours, its like more
people coming to the party in that we keep
applying the overhead even though we
shouldn’t still be incurring it.
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More analysis
Overhead was overapplied by $3,000
(Actual overhead was $257,000 and
applied was $260,000)
 Overhead for 26,000 hours should have
been 150,000 + (4)(26,000) = 254,000
 Thus we spent $3,000 more than we
should have, but made up for it by working
1,000 extra hours and applying $6,000 in
fixed overhead that we should not have
incurred
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You Try it
Driver is DL hours
 Overhead is expected to be
$200,000 + $6/DLHr
 Expected hours are 40,000
 Actual hours are 42,000
 Actual overhead is $455,000
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What are the:
the overhead application rate,
 the amount of under/overapplied
overhead,
 the amount of overhead expected for the
volume achieved,
 the deviation from expected overhead
 the impact of missing the volume
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Overhead Application Rate
The rate is:
$200,000 +(6)(40,000) = $11/hour
40,000
Under/overapplied overhead
Actual hours x predetermined rate
42,000 x $11 = $462,000
Actual overhead is $455,000
Overhead is overapplied by $7,000 
The amount of overhead expected
for the volume achieved
The budget formula for overhead was
OH = $200,000 + $6/DLHr
Actual hours were 42,000
Budget for volume achieved was
200,000 + (42,000)(6) = $452,000
The deviation from expected
overhead
The overhead for the actual volume that we
worked was $455,000 and the budget for
that volume was $452,000
Thus, we spent $3,000 more than we should
have 
The impact of missing the volume
The expected volume was 40,000 and the
actual volume was 42,000 direct labor
hours
The extra 2,000 hours times the $5/DLHr
fixed overhead ($200,000/40,000) gives us
$10,000 in extra applied overhead
The overhead was $7,000 overapplied even
though we spent $3,000 more than we
should have because we worked more
that enough extra hours to cover it
Costing Individual Job
Assume Job ANZ used $5,000 worth of
material, 150 labor hours at $15/hour;
what is the cost of this job?
 Direct material
$5,000
 Direct labor
$2,250
 Overhead (150*$10)
$1,500
 Total Cost
$8,750
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Just In Time Production
Goal is to minimize
inventories to allow quicker
response to customer needs
 Requires more frequent
smaller delivers tied to when
the input is needed in
production
 Allows simpler accounting
procedures as there are fewer
inventories
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Total Quality Management
Continuous improvement
 Do it right the first time
 Listen to the needs of customers
 Empowering employees to make good
products or provide good service
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