types of product costing systems

Types of Product Costing Systems

ProcessCosting

Job-orderCosting

A company produces many units of a single A company produces many units of a single product. product.

One unit of product is indistinguishable One unit of product is indistinguishable from other units of product. from other units of product.

The identical nature of each unit of product The identical nature of each unit of product enables assigning the same average cost enables assigning the same average cost

per unit. per unit.

A company produces many units of a single A company produces many units of a single product. product.

One unit of product is indistinguishable One unit of product is indistinguishable from other units of product. from other units of product.

The identical nature of each unit of product The identical nature of each unit of product enables assigning the same average cost enables assigning the same average cost

per unit. per unit.

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Types of Product Costing Systems

ProcessCosting

Job-orderCosting

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.

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.

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Comparing Process and Job-Order Costing

Job-Order Process

Number of jobs worked Many Single Product

Cost accumulated byIndividual

Job Department

Average cost computed by Job Department

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Job-Order Costing—An Overview

Manufacturing Overhead

Manufacturing Overhead

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.

Direct MaterialsDirect Materials

Direct LaborDirect Labor

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Job-Order Costing—An Overview

Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, ,

are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.

Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect

materialsmaterials and and indirect laborindirect labor, ,

are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.

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 Cost Sheet

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Materials Requisition Form

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Job Cost Sheet

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Employee Time Ticket

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Job Cost Sheet

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Application of Manufacturing OverheadManufacturing overhead is applied to jobs that Manufacturing overhead is applied to jobs that

are in process. An allocation base, such as are in process. An allocation base, such as direct labor hours, direct labor dollars, or direct labor hours, direct labor dollars, or

machine hours, is used to assign machine hours, is used to assign manufacturing overhead to individual jobs.manufacturing overhead to individual jobs.

Manufacturing overhead is applied to jobs that Manufacturing overhead is applied to jobs that are in process. An allocation base, such as are in process. An allocation base, such as

direct labor hours, direct labor dollars, or direct labor hours, direct labor dollars, or machine hours, is used to assign machine hours, is used to assign

manufacturing overhead to individual jobs.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 a production manager’s salary.

3. Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

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

determined before the period begins.

Application of Manufacturing Overhead

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

Ideally, the allocation base is a cost driver that causes

overhead.

Ideally, the allocation base is a cost driver that causes

overhead.

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Using a predetermined overhead rate (POHR)makes it possible to estimate total job costs sooner.

Actual overhead for the period is notknown until sometime after the period has ended. Actual overhead costs can fluctuate seasonally,

thus misleading decision makers. It simplifies record keeping.

Application of Manufacturing Overhead

$

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Application of Manufacturing Overhead

Actual amount of the allocation based upon the actual level of activity (this is called a normal

costing system).

Actual amount of the allocation based upon the actual level of activity (this is called a normal

costing system).

Based on estimates, and determined before the

period begins.

Based on estimates, and determined before the

period begins.

Overhead applied = POHR × Actual activity

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Application of Manufacturing Overhead

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

will be applied to that job.

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

will be applied to that job.

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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Application of Manufacturing Overhead

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Completing the Job Cost Sheet

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Interpreting the Average Unit Cost

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional unit were produced.

Fixed overhead would not change if another unitwere produced, so the incremental cost of another unit is something less than $118.

The average unit cost should not be interpretedas the costs that would actually be incurred if an

additional unit were produced.

Fixed overhead would not change if another unitwere produced, so the incremental cost of another unit is something less than $118.

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Raw MaterialsMaterial

Purchases

Mfg. Overhead

Work in Process(Job Cost Sheet)

Actual Applied

Direct Materials Direct

Materials

Indirect Materials

Indirect Materials

Summary of Cost Flows

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Journal Entry – Material Purchases

Raw material purchases are recorded in an inventory account.

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Journal Entry – 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 decrease Raw Materials.

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Mfg. Overhead

Salaries and Wages Payable

Work in Process(Job Cost Sheet)

Direct

Materials

Direct Labor

Direct Labor

IndirectLabor

Indirect Materials

Actual Applied

IndirectLabor

Summary of Cost Flows

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Journal Entry – Labor Costs

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

cost of indirect labor increases Manufacturing Overhead.

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Mfg. Overhead

Indirect Materials

Actual Applied

IndirectLabor

Summary of Cost Flows

OtherOverhead

In addition to indirect materials and indirect

labor, other actual manufacturing

overhead costs are debited to the Manufacturing

Overhead account.

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Journal Entry – 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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Mfg. OverheadWork in Process(Job Cost Sheet)

Direct

Materials

Overhead Applied

OverheadApplied to

Work inProcess

Direct Labor

Indirect Materials

Actual Applied

If 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.

IndirectLabor

Summary of Manufacturing Overhead Cost Flows

OtherOverhead

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Journal Entry – Overhead Applied

Work in Process is increasedwhen Manufacturing Overhead

is applied to jobs.

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Journal Entry – Accounting for Nonmanufacturing Costs

Nonmanufacturing Cost Examples:Nonmanufacturing Cost Examples:1.1. Salary expense of employees that work in Salary expense of employees that work in a marketing, selling, or administrative capacity. a marketing, selling, or administrative capacity.2.2. Advertising expenses are expensed in the Advertising expenses are expensed in the period incurred. period incurred.

Nonmanufacturing Cost Examples:Nonmanufacturing Cost Examples:1.1. Salary expense of employees that work in Salary expense of employees that work in a marketing, selling, or administrative capacity. a marketing, selling, or administrative capacity.2.2. Advertising expenses are expensed in the Advertising expenses are expensed in the period incurred. period incurred.

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Finished Goods

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Work in Process(Job Cost Sheet)

Direct

MaterialsDirect Labor

Overhead Applied

Summary of Goods Manufactured Cost Flows

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Journal Entry – 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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Summary of Job-Order System Cost Flows

Finished Goods

Cost of Goods Sold

Work in Process(Job Cost Sheet)

Direct

MaterialsDirect Labor

Overhead Applied

Cost ofGoodsMfd.

Cost ofGoodsMfd.

Cost ofGoodsSold

Cost ofGoodsSold

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Journal Entry – Sales

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

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Defining Under- and Overapplied Overhead

The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is termed 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.

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.

Overapplied overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.

Overapplied overheadOverapplied overhead exists when the amount of exists when the amount of overhead applied to jobs overhead applied to jobs

during the period using the during the period using the predetermined overhead predetermined overhead

rate is rate is greater thangreater than the total the total amount of overhead actually amount of overhead actually incurred during the period.incurred during the period.

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PearCo’s PearCo’s actual overheadactual overhead for the year was for the year was $650,000$650,000 with a total of with a total of 170,000170,000 direct direct

labor hours worked on jobs.labor hours worked on jobs.How much total overhead was applied to How much total overhead was applied to

PearCo’s jobs during the year? Use PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of PearCo’s predetermined overhead rate of

$4.00 per direct labor hour. $4.00 per direct labor hour.

PearCo’s PearCo’s actual overheadactual overhead for the year was for the year was $650,000$650,000 with a total of with a total of 170,000170,000 direct direct

labor hours worked on jobs.labor hours worked on jobs.How much total overhead was applied to How much total overhead was applied to

PearCo’s jobs during the year? Use PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of PearCo’s predetermined overhead rate of

$4.00 per direct labor hour. $4.00 per direct labor hour.

Overhead Application Example

Overhead Applied During the PeriodApplied Overhead = POHR × Actual Direct Labor Hours

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

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PearCo’s PearCo’s actual overheadactual overhead for the year for the year was was $650,000$650,000 with a total of with a total of 170,000170,000

direct labor hours worked on jobs.direct labor hours worked on jobs.How much total overhead was applied How much total overhead was applied

to PearCo’s jobs during the year? to PearCo’s jobs during the year? Use PearCo’s predetermined Use PearCo’s predetermined

overhead rate of $4.00 per direct overhead rate of $4.00 per direct labor hour. labor hour.

PearCo’s PearCo’s actual overheadactual overhead for the year for the year was was $650,000$650,000 with a total of with a total of 170,000170,000

direct labor hours worked on jobs.direct labor hours worked on jobs.How much total overhead was applied How much total overhead was applied

to PearCo’s jobs during the year? to PearCo’s jobs during the year? Use PearCo’s predetermined Use PearCo’s predetermined

overhead rate of $4.00 per direct overhead rate of $4.00 per direct labor hour. labor hour.

Overhead Applied During the PeriodApplied Overhead = POHR × Actual Direct Labor Hours

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

Overhead Application Example

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

PearCo do?

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

PearCo do?

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Disposition of Under- or Overapplied Overhead

PearCo’sMfg. Overhead

Actualoverhead

costs

$650,000$30,000

overapplied

Overhead appliedto jobs

$680,000

PearCo’s Costof Goods Sold

Unadjusted Balance

AdjustedBalance

$30,000

$30,000

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Multiple Predetermined Overhead RatesTo this point, we have assumed that there is a single predetermined overhead rate called a

plantwide overhead rate.

To this point, we have assumed that there is a single predetermined overhead rate called a

plantwide overhead rate.

Large companies Large companies often use multiple often use multiple

predetermined predetermined overhead rates.overhead rates.

Large companies Large companies often use multiple often use multiple

predetermined predetermined overhead rates.overhead rates.

May be more May be more complex but . . .complex but . . .

May be more May be more complex but . . .complex but . . .

May be more accurate because it reflects differences

across departments.

May be more accurate because it reflects differences

across departments.

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Job-Order Costing in Service CompaniesJob-order costing is used in many

difference types of service companies.

Job-order costing is used in many difference types of service

companies.

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