chapter 2 systems design: job-order costing. © the mcgraw-hill companies, inc., 2005 mcgraw-hill...

Chapter 2

Systems Design: Job-Order Costing

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Process and Job-Order Costing

ProcessCosting

Job-orderCosting

Produces many units of a single product for long periods.

Products are homogeneous.

Cost are allocated to units.

Will be discussed more in Chapter 3.

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Process and Job-Order Costing

ProcessCosting

Job-orderCosting

Many different products are produced each period.

Products are manufactured to order.

Cost are traced or allocated to jobs.

Cost records must be maintained for each distinct product or job.

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Process and Job-Order Costing

ProcessCosting

Job-orderCosting

Typical job order cost applications: Special-order printing Building construction

Also used in the service industry Hospitals Law firms

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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.

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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.

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Job-Order Costing

THE JOB

Directmaterial

Traced directly to each job

Direct labor

Traced directly

to each job

Manufacturingoverhead (OH)

Applied to eachjob using a

predeterminedrate

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Sequence of Events in a Job-Order Costing System

Receive orders from customers

Schedulejobs

Begin production

Ordermaterials

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Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3

Charge direct

material and direct labor

costs to each job as

work is performed.

Charge direct

material and direct labor

costs to each job as

work is performed.

Sequence of Events in a Job-Order Costing System

Direct MaterialsDirect Materials

Direct LaborDirect Labor

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Apply overhead to

each job using a

predeter-mined rate.

Apply overhead to

each job using a

predeter-mined rate.

Sequence of Events in a Job-Order Costing System

Direct MaterialsDirect Materials

Direct LaborDirect Labor

Job No. 1Job No. 1

Job No. 2Job No. 2

Job No. 3Job No. 3Manufacturing Overhead

Manufacturing Overhead

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Job-Order Cost Accounting

The primary document for tracking the costs associated with a given job is the

job cost sheet.

Let’s investigate

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PearCo Job Cost Sheet

Job Number A - 143 Date Initiated March 3Date Completed

Department B3 Units CompletedItem Wooden cargo crate

Direct Materials Direct Labor Manufacturing OverheadReq. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units ShippedDirect Materials Date Number BalanceDirect LaborManufacturing OverheadTotal CostUnit Cost

Job Cost Sheet

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Job Cost Sheet

PearCo Job Cost Sheet

Job Number A - 143 Date Initiated March 3Date Completed

Department B3 Units CompletedItem Wooden cargo crate

Direct Materials Direct Labor Manufacturing OverheadReq. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units ShippedDirect Materials Date Number BalanceDirect LaborManufacturing OverheadTotal CostUnit Cost

Let’s see one

A materials requisition form is used to

authorize the use of materials on a job.

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Materials Requisition Form

Will E. Delite

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Will E. Delite

Materials Requisition Form

Type, quantity, and total cost of material charged to job A-143.

Cost of material is charged to job A-143.

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Note

Why go to all the trouble to fill out a materials requisition form every time someone needs

materials for a job?

Trace costs of materials to particular

jobs.

Prevent pilferage, loss, and waste.Prevent supervisors from stockpiling materials “just in case the stockroom

runs out.”

Maintain control of assets.

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Job Cost Sheet

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Job Cost Sheet

Workers use time tickets to record the time spent on each

job.

Let’s see one

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Employee Time Ticket

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Job Cost Sheet

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Job Cost Sheet

Now let’s see how to apply manufacturing overhead to jobs.

Let’s do it

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Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

The predetermined overhead rate (POHR) used to apply overhead to jobs

is determined before the period begins.

Application of Manufacturing Overhead

Ideally, the allocation base is a cost driver that causes overhead.

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Application of Manufacturing Overhead

Overhead applied = POHR × Actual activity

Actual amount of the allocation base such as units produced, direct

labor hours, or machine hours incurred during the period.

Based on estimates, and determined before the

period begins.

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The Need for a Predetermined Manufacturing Overhead Rate

Using a predetermined rate makes itpossible to estimate total job costs sooner.

Actual overhead for the period is notknown until the end of the period.

$$

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Note

If we wait until the end of the period, we will know the actual TOTAL overhead cost. However, we still won’t know

the actual overhead cost of a particular job.

Why?

Overhead consists of costs that are either difficult or impossible to trace to particular jobs. Difficult-to-trace costs include the cost of indirect materials like

glue in a furniture factory. Impossible-to-trace costs include fixed common costs like the

property taxes on the factory building and land.

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PearCo applies overhead based on direct labor hours. Total estimated overhead

for the year is $640,000. Total estimated labor cost is $1,400,000 and total

estimated labor hours are 160,000.

What is PearCo’s predetermined overhead rate per hour?

Overhead Application Example

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For each direct labor hour worked on a job, $4.00 of factory overhead will be

applied to the job.

Overhead Application Example

POHR = $4.00 per DLH

$640,000

160,000 direct labor hours (DLH)POHR =

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

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Job Cost Sheet

What amount of overhead willPearCo apply to Job A-143?

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Job Cost Sheet

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Quick Check

If the number of wooden crates in the order on the previous page is increased or decreased by one unit, what would you expect to happen to the total spending of PearCo?

a. Total spending would probably change by less than $118.

b. Total spending would probably change by about $118.

c. Total spending would probably change by more than $118.

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If the number of wooden crates in the order on the previous page is increased or decreased by one unit, what would you expect to happen to the total spending of PearCo?

a. Total spending would probably change by less than $118.

b. Total spending would probably change by about $118.

c. Total spending would probably change by more than $118.

Quick Check

Total spending would change by $118 only if all of the costs were variable with respect to the number of units produced. Direct materials is variable, but

much of the overhead and perhaps even direct labor may be fixed.

Total spending would change by $118 only if all of the costs were variable with respect to the number of units produced. Direct materials is variable, but

much of the overhead and perhaps even direct labor may be fixed.

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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.

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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.

Quick Check

Pred. ovhd. rate $760,000/20,000hours $38

Direct materials $200Direct labor $15 x 10 hours $150Manufacturing overhead $38 x 10 hours $380 Total cost $730

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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 19,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $750.

d. $730.

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill /Irwin

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 19,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $750.

d. $730.

Quick Check

Pred. ovhd. rate $760,000/19,000hours $40

Direct materials $200Direct labor $15 x 10 hours $150Manufacturing overhead $40 x 10 hours $400 Total cost $750

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Quick Check

If overhead contains fixed costs, what will happen to the predetermined overhead rate if lower unit sales volume is expected?

a. The predetermined overhead rate will likely increase.

b. The predetermined overhead rate would be unaffected.

c. The predetermined overhead rate will likely decrease.

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If overhead contains fixed costs, what will happen to the predetermined overhead rate if lower unit sales volume is expected?

a. The predetermined overhead rate will likely increase.

b. The predetermined overhead rate would be unaffected.

c. The predetermined overhead rate will likely decrease.

Quick Check

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Quick Check

If overhead contains fixed costs, what will happen to product costs computed by the accounting system if lower unit sales volume is expected?

a. Product costs will likely increase.

b. Product costs would be unaffected.

c. Product costs will likely decrease.

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If overhead contains fixed costs, what will happen to product costs computed by the accounting system if lower unit sales volume is expected?

a. Product costs will likely increase.

b. Product costs would be unaffected.

c. Product costs will likely decrease.

Quick Check

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Quick Check

If overhead contains fixed costs and management set prices by marking up product costs by a preset percentage, what will happen to selling prices if lower unit sales volume is expected?

a. Selling prices will likely increase.

b. Selling prices would be unaffected.

c. Selling prices will likely decrease.

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If overhead contains fixed costs and management set prices by marking up product costs by a preset percentage, what will happen to selling prices if lower unit sales volume is expected?

a. Selling prices will likely increase.

b. Selling prices would be unaffected.

c. Selling prices will likely decrease.

Quick Check

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Quick Check

If selling prices increase, what will happen to unit sales volume?

a. Unit sales volume will likely increase.

b. Unit sales volume would be unaffected.

c. Unit sales volume will likely decrease.

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If selling prices increase, what will happen to unit sales volume?

a. Unit sales volume will likely increase.

b. Unit sales volume would be unaffected.

c. Unit sales volume will likely decrease.

Quick Check

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Let’s summarize the document flow we have

been discussing in a job-order

costing system.

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Job-Order CostingDocument Flow Summary

Job Cost Sheets

MaterialsRequisition

Manufacturing Overhead Account

Direct materials

Indirect materials

Materials usedmay be either

direct orindirect.

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Job-Order CostingDocument Flow Summary

Job Cost Sheets

Employee Time Ticket

Manufacturing Overhead Account

Direct Labor

Indirect Labor

An employee’stime may be eitherdirect or indirect.

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Job-Order CostingDocument Flow Summary

Manufacturing Overhead Account

OtherActual OHCharges

Job Cost Sheets

AppliedOverhead

MaterialsRequisition

IndirectMaterial

EmployeeTime Ticket

IndirectLabor

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Let’s examine the cost flows in a

job-order costing system. We will use T-accounts and start with

materials.

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Raw MaterialsMaterial

Purchases

Mfg. Overhead

Work in Process(Job Cost Sheet)

Direct Materials

Direct Materials

Indirect Materials

Indirect Materials

Actual Applied

Job-Order System Cost Flows

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Next let’s add labor costs and

applied manufacturing overhead to the job-order cost flows. Are you

with me?

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Mfg. Overhead

Salaries and Wages Payable

Work in Process(Job Cost Sheet)

Direct

Materials

Overhead Applied

OverheadApplied to

Work inProcess

Direct Labor

Direct Labor

Indirect Materials

Actual AppliedIf actual and applied

manufacturing overheadare not equal, a year-end adjustment is required.

If actual and applied manufacturing overheadare not equal, a year-end adjustment is required.

Job-Order System Cost Flows

IndirectLabor

IndirectLabor

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Now let’s complete the

goods and sell them. Still with

me?

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Finished Goods

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Cost of Goods Sold

Work in Process(Job Cost Sheet)

Direct

MaterialsDirect Labor

Overhead Applied

Job-Order System Cost Flows

Cost ofGoodsSold

Cost ofGoodsSold

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Let’s return to PearCo and see

what we will do if actual and

applied overhead are not equal.

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Overhead Application Example

PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours.

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.

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Overhead Application Example

SOLUTIONApplied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours.

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.

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SOLUTIONApplied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours.

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 Application Example

PearCo has overappliedoverhead for the yearby $30,000. What will

PearCo do?

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Work inProcess

FinishedGoods

Cost of Goods Sold

$30,000may be allocated

to these accounts.

Overapplied and Underapplied Manufacturing Overhead

$30,000 may beclosed directly to

cost of goods sold.

Cost of Goods Sold

PearCo’s Method

OR

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Overapplied and Underapplied Manufacturing Overhead

PearCo’sMfg. Overhead

Actualoverhead

costs

$650,000$30,000

overapplied

PearCo’s Costof Goods Sold

Unadjusted Balance

$30,000

$30,000

AdjustedBalance

Overhead Appliedto jobs

$680,000

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Quick Check

What effect will the overapplied overhead have on PearCo’s cost of goods sold?

a. Cost of goods sold will increase.

b. Cost of goods sold will be unaffected.

c. Cost of goods sold will decrease.

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What effect will the overapplied overhead have on PearCo’s cost of goods sold?

a. Cost of goods sold will increase.

b. Cost of goods sold will be unaffected.

c. Cost of goods sold will decrease.

Quick Check

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Quick Check

What effect will the overapplied overhead have on PearCo’s net income?

a. Net income will increase.

b. Net income will be unaffected.

c. Net income will decrease.

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What effect will the overapplied overhead have on PearCo’s net income?

a. Net income will increase.

b. Net income will be unaffected.

c. Net income will decrease.

Quick Check

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If ManufacturingOverhead is . . .

UNDERAPPLIED INCREASECost of Goods Sold

(Applied OH is lessthan actual OH)

OVERAPPLIED DECREASECost of Goods Sold

(Applied OH is greaterthan actual OH)

Overapplied and Underapplied Manufacturing Overhead - Summary

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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.

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.

Quick Check

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill /Irwin

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.

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.

Quick Check

Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000

Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

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Let’s look at summary journal entries for a job-

order costing system. We’ll omit

the numbers so that we can focus

on accounts.

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Cost Flows – Material Purchases

Raw material purchases are recorded in aninventory account.

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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.

Cost Flows – Material Usage

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Cost Flows – Labor

The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases

Manufacturing Overhead.

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Cost Flows – Actual Overhead

In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they

are incurred.

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Cost Flows – Overhead Applied

Work in Process is increased when Manufacturing Overhead is applied to jobs.

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Cost Flows – Period Expenses

Nonmanufacturing costs (period expenses) are charged to expense as they are incurred.

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Cost Flows – Cost of Goods Manufactured

As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods

from Work in Process.

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Cost Flows – Sales

When finished goods are sold, two entries are required: (1) to record the sale; and (2) to record Cost of Goods Sold and reduce Finished Goods.

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Job-Order Costing in Service Companies

Job-order costing is a versatile and widely used costing method that may be encountered in virtually

any organization.

In an accounting firm, each client

is a “job.”

In a movie studio, each file produced

is a “job.”

In a law firm, each client is a

“job.”

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End of Chapter 2