Systems Design: Job-Order Costing Chapter 3 © 2010 The McGraw-Hill Companies, Inc. Learning Objective 1 Distinguish between process costing and joborder costing and identify companies that would use each costing method. McGraw-Hill/Irwin Slide 2 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 Slide 3 Types of Product Costing Systems Process Costing Job-order Costing A company produces many units of a single product.companies: Example 1.One Weyerhaeuser (paper manufacturing) from unit of product is indistinguishable units Aluminum of product.(refining aluminum ingots) 2.other Reynolds 3.The Coca-Cola bottling identical(mixing nature and of each unit beverages) of product enables assigning the same average cost per unit. McGraw-Hill/Irwin Slide 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 Slide 5 Types of Product Costing Systems Process Costing Job-order Costing Many different products are produced each period. Example companies: are manufactured to order. 1.Products Boeing (aircraft manufacturing) unique nature of each order requires tracing or 2.The Bechtel International (large scale construction) costs to each job, and maintaining cost 3.allocating Walt Disney Studios (movie production) records for each job. McGraw-Hill/Irwin Slide 6 Comparing Process and Job-Order Costing Job-Order Number of jobs worked Cost accumulated by Average cost computed by McGraw-Hill/Irwin Process Many Individual Job Single Product Job Department Department Slide 7 Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels. McGraw-Hill/Irwin Slide 8 Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels. McGraw-Hill/Irwin Slide 9 Learning Objective 2 Identify the documents used in a job-order costing system. McGraw-Hill/Irwin Slide 10 Job-Order Costing – An Overview Direct Materials Job No. 1 Direct Labor Manufacturing Overhead McGraw-Hill/Irwin Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed. Slide 11 Indirect Manufacturing Costs Direct Materials Job No. 1 Direct Labor Manufacturing Overhead McGraw-Hill/Irwin Job No. 2 Job No. 3 Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job. Slide 12 The Job Cost Sheet PearCo Job Cost Sheet Job Number A - 143 Department B3 Item Wooden cargo crate Direct Materials Req. No. Amount Direct Labor Manufacturing Overhead Ticket Hours Amount Hours Rate Amount Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Product Cost McGraw-Hill/Irwin Date Initiated 3-4-09 Date Completed Units Completed Units Shipped Date Number Balance Slide 13 Measuring Direct Materials Cost Will E. Delite McGraw-Hill/Irwin Slide 14 Measuring Direct Materials Cost McGraw-Hill/Irwin Slide 15 Measuring Direct Labor Costs McGraw-Hill/Irwin Slide 16 Job-Order Cost Accounting McGraw-Hill/Irwin Slide 17 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 Slide 18 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 Slide 19 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 Slide 20 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 Slide 21 Determining Predetermined Overhead Rates Predetermined overhead rates are calculated using a three-step process. Estimate the level of production for the period. Estimate total amount of the allocation base for the period. Estimate total manufacturing overhead costs. POHR = ÷ McGraw-Hill/Irwin Slide 22 Application of Manufacturing Overhead Based on estimates, and determined before the period begins. Overhead applied = POHR × Actual activity Actual amount of allocation is based upon the actual level of activity (normal costing system). McGraw-Hill/Irwin Slide 23 Overhead Application Rate POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period $640,000 POHR = 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 Slide 24 Job-Order Cost Accounting McGraw-Hill/Irwin Slide 25 Job-Order Cost Accounting McGraw-Hill/Irwin Slide 26 Interpreting the Average Unit Cost The average unit cost should not be interpreted as the costs that would actually be incurred if an additional unit was produced. Fixed overhead would not change if another unit was produced, so the incremental cost of another unit is something less than $118. McGraw-Hill/Irwin Slide 27 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730. McGraw-Hill/Irwin Slide 28 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730. McGraw-Hill/Irwin POHR = $760,000/20,000 hours $38 Direct materials $200 Direct labor $15 x 10 hours $150 Manufacturing overhead $38 x 10 hours $380 Total cost $730 Slide 29 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 Slide 30 Job-Order Costing Document Flow Summary A sales order is the basis of issuing a production order. McGraw-Hill/Irwin A production order initiates work on a job. Slide 31 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 Slide 32 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 Slide 33 Job-Order Costing Document Flow Summary Materials Requisition Other Actual OH Charges Employee Time Ticket McGraw-Hill/Irwin Indirect Material Manufacturing Overhead Account POHR rate used to apply overhead Job Cost Sheets Indirect Labor Slide 34 Learning Objectives 4 and 7 Understand the flow of costs in a joborder 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 Slide 35 Job-Order Costing: The Flow of Costs The transactions (in Taccount and journal entry form) that capture the flow of costs in a job-order costing system are illustrated on the following slides. McGraw-Hill/Irwin Slide 36 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 Slide 37 Cost Flows – Material Purchases Raw material purchases are recorded in an inventory account. McGraw-Hill/Irwin Slide 38 Cost Flows – Material Usage Direct materials issued to a job increase Work in Process and decrease Raw Materials. Indirect materials used are charged to Manufacturing Overhead and also decrease Raw Materials. McGraw-Hill/Irwin Slide 39 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 Slide 40 The Recording of Labor Costs The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead. McGraw-Hill/Irwin Slide 41 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 Slide 42 Recording Actual Manufacturing Overhead In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred. McGraw-Hill/Irwin Slide 43 Learning Objective 5 Apply overhead cost to Work in Process using a predetermined overhead rate. McGraw-Hill/Irwin Slide 44 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. Slide 45 Applying Manufacturing Overhead Work in Process is increased when Manufacturing Overhead is applied to jobs. McGraw-Hill/Irwin Slide 46 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 Slide 47 Accounting for Nonmanufacturing Cost Nonmanufacturing costs (period expenses) are charged to expense as they are incurred. McGraw-Hill/Irwin Slide 48 Learning Objective 6 Prepare schedules of cost of goods manufactured and cost of goods sold. McGraw-Hill/Irwin Slide 49 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. Slide 50 Transferring Completed Units As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process. McGraw-Hill/Irwin Slide 51 Transferring Units Sold Work in Process (Job Cost Sheet) Direct Materials Direct Labor Overhead Applied Finished Goods Cost of Goods Mfd. Cost of Goods Mfd. Cost of Goods Sold Cost of Goods Sold Cost of Goods Sold McGraw-Hill/Irwin Slide 52 Transferring Units Sold When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record the Cost of Goods Sold. McGraw-Hill/Irwin Slide 53 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 Slide 54 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. Slide 55 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 Slide 56 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 PearCo has overapplied $4.00 per direct labor hour. overheadrate forofthe year by $30,000. What will PearCo Applied do? Overhead During the Period Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 McGraw-Hill/Irwin Slide 57 Quick Check Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. McGraw-Hill/Irwin Slide 58 Quick Check Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 andOverhead a predetermined overhead Applied rate of $4.00 per machine$4.00 hour. Inc. worked per Tiger, hour × 290,000 hours = $1,160,000 290,000 machine hours during the period. Tiger’s Underapplied Overhead manufacturing overhead is a. $50,000 overapplied. $1,210,000 - $1,160,000 = $50,000 b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. McGraw-Hill/Irwin Slide 59 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 Slide 60 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 Slide 61 Allocating Under- or Overapplied Overhead Between Accounts Assume the overhead applied in ending Work in Process Inventory, ending Finished Goods Inventory, and Cost of Goods Sold is shown below: Work in process Finished Goods Cost of Goods Sold Total McGraw-Hill/Irwin Amount $ 68,000 204,000 408,000 $ 680,000 Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000 Slide 62 Allocating Under- or Overapplied Overhead Between Accounts We would complete the following allocation of $30,000 overapplied overhead: Work in process Finished Goods Cost of Goods Sold Total Amount $ 68,000 204,000 408,000 $ 680,000 Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000 10% × $30,000 McGraw-Hill/Irwin Slide 63 Allocating Under- or Overapplied Overhead Between Accounts Work in process Finished Goods Cost of Goods Sold Total McGraw-Hill/Irwin Amount $ 68,000 204,000 408,000 $ 680,000 Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000 Slide 64 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) Allocation More accurate but more complex to compute. McGraw-Hill/Irwin Slide 65 Quick Check What effect will the overapplied overhead have on PearCo’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease. McGraw-Hill/Irwin Slide 66 Quick Check What effect will the overapplied overhead have on PearCo’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease. McGraw-Hill/Irwin Slide 67 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. May be more complex but . . . May be more accurate because it reflects differences across departments. McGraw-Hill/Irwin Slide 68 Job-Order Costing in Service Companies Job-order costing is used in many different types of service companies. McGraw-Hill/Irwin Slide 69 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 web-based programming language called Extensible Markup Language (XML), bar coding eliminates the inefficiencies and inaccuracies associated with manual clerical processes. McGraw-Hill/Irwin Slide 70 The Predetermined Overhead Rate and Capacity Appendix 3A © 2010 The McGraw-Hill Companies, Inc. 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 Slide 72 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 Slide 73 Capacity-Based Overhead Rates Criticisms can be overcome by using estimated total units in the allocation base at capacity in the denominator of the predetermined overhead rate calculation. Let’s look at the difference! McGraw-Hill/Irwin Slide 74 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 Slide 75 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. McGraw-Hill/Irwin Traditional = Method $100,000 40,000 = $2.50 per unit Capacity Method $100,000 50,000 = $2.00 per unit = Slide 76 Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case. McGraw-Hill/Irwin Slide 77 Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case. McGraw-Hill/Irwin Slide 78 Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case. McGraw-Hill/Irwin Slide 79 Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. At full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case. McGraw-Hill/Irwin Slide 80 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 because it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down. McGraw-Hill/Irwin Slide 81 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 because it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down. McGraw-Hill/Irwin Slide 82 Quick Check When estimated activity 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 because it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down. McGraw-Hill/Irwin Slide 83 Quick Check When estimated activity 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 because it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down. McGraw-Hill/Irwin Slide 84 Income Statement Preparation – Capacity 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 $ Slide 85 Income Statement Preparation – Traditional 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 Slide 86 End of Chapter 3 McGraw-Hill/Irwin Slide 87