College
Accounting,
by Heintz and Parry
Chapter 27:
Manufacturing Accounting:
The Job Order Cost
System
When Eddie entered on Monday, he headed
straight for Nick’s office. “How did your meeting with Rick
Swagger go this weekend? Did he like your idea of selling
videos as well as CD’s?”
“Eddie, he said my idea wasn’t bad, but he had an idea that was
really intriguing. If we take back the whole building, we could
open a recording studio. Rick says we can afford the machine
that actually stamps out the recorded CD’s. That means we can
offer local bands recording and mixing services and multiple
copies of their CD, all for one price. With my connections as a
promoter and Rick’s recording expertise, it’s a logical fit for us.
In fact, Forever Run could make their next CD here, which would
create great publicity.”
“Wow, that’s exciting. Of course, it means you’ll be venturing
into the exciting world of cost accounting. In a strange way,
making the CD would be a manufacturing operation for us.”
“Manufacturing? Eddie, we’ll be making art! How will we be like
a manufacturer?”
“Manufacturers produce a product,
and they incur three types of manufacturing costs:
1) Materials: Direct materials are the physical pieces that end
up in the finished product. With CD’s, it seems like it’s a lot of
plastic, and maybe a thin film of some other material in the
middle. Indirect materials are items the company uses that
aren’t part of the final product, like the digital master copy of the
tape that the studio produces.
2) Labor: Direct labor is the pay for people who make the
product, like the mixing engineer and the person who runs the
CD stamping machine. Indirect labor would include everyone
involved in the process who doesn’t actually participate in
assembling the product, like supervisors, janitors in the
production area, or product testers.
3) Factory overhead: This category includes all indirect costs
needed to support production, including indirect materials,
indirect labor, utility expenses, and depreciation and repairs on
the equipment.”
“Manufacturers also have three types of inventories:
1) Materials Inventory: Direct and indirect materials that the
company has purchased but that haven’t yet been used in the
production process. These are usually kept in a materials
storeroom.
2) Work in Process Inventory: Items that have been started but
not completed. These are usually found somewhere along an
assembly or production line.
3) Finished Goods Inventory: This category includes all items
ready for sale. These are usually found in a warehouse or in a
storeroom near the shipping dock or customer pick-up area.
“The flow of costs looks like this:
Materials
Indirect Direct
Labor
Work in Process
Finished Goods
Indirect Direct
Inventory
Inventory
Factory
Overhead
“A manufacturer’s financial statements are pretty
much like ours, except that cost of goods sold is calculated in a
different way. The calculation would look like this (differences
in red).”
The CD Side of Town
Partial Income Statement
For Year Ended Dec. 31, 2001
Cost of Goods Sold:
Finished Goods Inventory, Jan. 1, 2001
Cost of Goods Manufactured
Goods Available for Sale
Finished Goods Inventory, Dec. 31, 2001
Cost of Goods Sold
$ 20,000
85,000
$105,000
18,000
$ 87,000
“A separate statement or schedule is used to
calculate cost of goods manufactured. The cost of goods
manufactured is calculated by totaling manufacturing costs
(direct materials, direct labor, and factory overhead) and
subtracting any increase (or adding any decrease) in work in
process. The statement looks like this.”
The CD Side of Town
Statement of Cost of Goods Manufactured
For Year Ended Dec. 31, 2001
Work in Process, Jan. 1, 2001
Materials inventory, Jan. 1, 2001
Materials purchases
Materials available for use
Materials inventory, Dec. 31, 2001
Direct labor
Overhead
Total manufacturing costs
Total work in process during the period
Work in process, Dec. 31, 2001
Cost of Goods Manufactured
$ 9,000
21,000
$30,000
7,000
$23,000
31,000
34,000
$ 14,000
88,000
$102,000
17,000
$ 85,000
“Of course, the entries made are impacted by which
type of cost accounting you use:
Job order cost accounting keeps separate records of the cost of
individual batches or orders prepared to customer
specifications. We would use this method, because each band’s
order might involve different numbers of studio and mixing
hours, and a different quantity of CD’s as well.
Process cost accounting accumulates costs by process. For
example, a chair company might accumulate costs in the
cutting, routing, sanding, assembling, and staining departments.
This system is generally used when the product is standardized
and produced in high volumes, like toothpaste, televisions, or
notebooks.
The entries in cost accounting follow the flow of costs
through the inventory accounts. For example, the first entry
would be to purchase the materials the company uses. If they’re
purchased on account, the entry is pretty simple:
#1
Materials
Work in Process
Indirect Direct
Finished Goods
Inventory
Inventory
Factory
Overhead
Date
Description
2001
Sept.10 Materials
Accounts Payable
P. R.
Debit
370.00
Credit
370.00
A document called a materials requisition is used to
report the transfer of materials from the materials storeroom to
the production floor. When the transfer involves direct
materials, the requisition is the source document for this entry:
#1
Materials
Indirect Direct
#2
Work in Process
Finished Goods
Inventory
Inventory
Factory
Overhead
Date
Description
2001
Sept.15 Work in Process (Job 45)
Materials
P. R.
Debit
127.00
Credit
127.00
When the materials storeroom issues
indirect materials instead, the materials requisition is the source
document for this entry:
#1
Materials
Indirect Direct
#3
#2
Work in Process
Finished Goods
Inventory
Inventory
Factory
Overhead
Date
Description
2001
Sept.17 Factory Overhead
Materials
P. R.
Debit
76.00
Credit
76.00
Time sheets or time tickets are the source
document that is used to allocate direct labor to the jobs worked
on. The entry looks like this:
#1
Materials
Indirect Direct
Labor
Indirect Direct
#3
#2
Work in Process
Finished Goods
Inventory
Inventory
#4
Factory
Overhead
Date
Description
2001
Sept.20 Work in Process (Job 45)
Wages Payable
P. R.
Debit
215.00
Credit
215.00
Time sheets or time tickets are also used to
summarize indirect labor and place it in the factory overhead
account like this:
#1
Materials
Indirect Direct
Labor
Indirect Direct
#5
#3
Factory
Overhead
#2
Work in Process
Finished Goods
Inventory
Inventory
#4
Date
Description
2001
Sept.20 Factory Overhead
Wages Payable
P. R.
Debit
86.00
Credit
86.00
Factory overhead also occurs when bills for
utilities, rent, property taxes, and various other costs are
received:
#1
Materials
Indirect Direct
Labor
#6 Indirect Direct
#5
#3 Factory
Overhead
#2
Work in Process
Finished Goods
Inventory
Inventory
#4
Date
Description
2001
Sept.20 Factory Overhead
Accounts Payable
P. R.
Debit
118.00
Credit
118.00
“To apply factory overhead
to production, a
predetermined overhead rate is developed so that a reasonable
amount of overhead is applied to each job. The rate is set at
the start of the fiscal year based on estimates of annual factory
overhead and production activity.
Production activity can be measured in many ways. Three of
the most common measures are direct labor hours, direct labor
costs, and machine hours (the last one is appropriate if the
production process is highly automated).
For example, if factory overhead is expected to be $20,000 and
direct labor costs are expected to be $50,000, the rate would be
estimated factory overhead 20,000
estimated direct labor costs = 50,000 = 40% of dir. labor $
Question: If direct labor for Job 45 was $215, how
much factory overhead would be applied to that job?
Answer: Factory overhead applied to that job would be
$215 direct labor X 40% rate = $86.00
The entry would look like this:
#1
Materials
Indirect Direct
Labor
#6 Indirect Direct
#5
#3 Factory
Overhead
#2
Work in Process
Finished Goods
Inventory
Inventory
#4
#7
Date
Description
2001
Sept.22 Work in Process (Job 45)
Factory Overhead
P. R.
Debit
86.00
Credit
86.00
A job cost sheet is prepared for Job 45 accumulating the
direct materials ($127), direct labor ($215), and factory overhead
($86) costs of the job. When the job is completed, the job cost
sheet is the source document for the entry to transfer the job to
finished goods:
#1
Materials
Indirect Direct
Labor
#6 Indirect Direct
#5
#3 Factory
Overhead
#2
Work in Process #8 Finished Goods
Inventory
Inventory
#4
#7
Date
Description
PR Debit
2001
Sept.29 Finished Goods (Job 45)($127 + 215 + 86)
428.00
Work in Process (Job 45)
Credit
428.00
When the job is sold (or shipped), two entries are needed:
one for the sale, and one to remove the finished goods from
inventory and expense it as cost of goods sold. The entry for
Job 45 is:
#1
Materials
Indirect Direct
Labor
#6 Indirect Direct
#5
#3 Factory
Overhead
#2
Work in Process #8 Finished Goods
Inventory
#4
#7
Date
Description
2001
Oct. 5 Cash (or Accounts Rec.-Joe Shmoe)
Sales
Cost of Goods Sold
Finished Goods (Job 45)
Inventory
#9 Cost of Goods
Sold
PR
Debit
600.00
428.00
Credit
600.00
428.00
At the end of the year, factory overhead is likely
to have a balance. This is due to the fact that we have been
debiting it for actual costs, and crediting it at a rate based on
estimates of factory overhead costs and production activity. If
the balance is a debit, factory overhead has been underapplied:
Factory Overhead
Actual Applied
19,900
19,090
Bal. 810
Although some of this balance theoretically belongs in Work in
Process and Finished Goods, it is easiest and reasonably
accurate to close the balance to Cost of Goods Sold:
Date
Description
2001
Dec. 31 Cost of Goods Sold
Factory Overhead
P. R.
Debit
810.00
Credit
810.00
Of course, factory overhead is equally likely to have a
credit balance. When this is true, factory overhead has been
overapplied:
Factory Overhead
Actual
Applied
19,900
20,873
Bal. 973
Although the accounts would be reversed and we would be
reducing our expenses, we would still close the balance to Cost
of Goods Sold:
Date
Description
2001
Dec. 31 Factory Overhead
Cost of Goods Sold
P. R.
Debit
973.00
Credit
973.00
“I’ll have to recommend a grade of ‘A’ to your cost
accounting professor, Eddie. That will be your first one since
you showed you could ’play well with others’ in kindergarten,
right? Actually, I did want to ask how process cost accounting
is different.”
“Good question, Mister ‘C- for Humor.’ The biggest difference is
that each processing department has it’s own work in process
account. Department 2’s work in process account might get
debits and credits like this (assuming no beginning or ending
inventories in Department 2):
Work in Process (WIP) - Dept. 2
WIP from Dept. 1
1,200 WIP sent on to Dept. 3 2,900
Dept. 2 Materials added 600
Dept. 2 Labor incurred
700
Dept. 2 Fact. Overhead 400
Total debits
2,900
Each department would also have its own:
1) overhead application rate, and
2) cost per unit calculations for materials, labor, and overhead.
“By the way, Nick, let’s see what kind of a grade you
get on my review quiz:
Questions: 1) What are the the two types of cost
accounting systems?
2) What are the three types of manufacturing costs?
3) What are the three types of inventory for a
manufacturer, and in what order do costs flow these
three inventory accounts?
4) What are the accounts debited and credited when
factory overhead is applied to jobs?
Answers:
1) The the two types of cost accounting
systems are job order cost accounting and process cost
accounting.
2) The three types of manufacturing costs are direct
materials, direct labor, and factory overhead.
3) The three types of inventory for a manufacturer (in
the order that the costs flow) are materials inventory,
work in process inventory, and finished goods
inventory.
4) The accounts debited and credited when factory
overhead is applied to jobs are work in process (debit)
and factory overhead (credit).