Job-Order Costing: Calculating Unit Product Costs

Learning Objectives Identify companies that would use job-order costing system Understand the flow of costs in a job-order system Explain why estimated overhead costs are used Compute predetermined overhead rates and use them to apply overhead cost to jobs Determine the total and unit cost of a job Compute under- or over-applied overhead cost Understand why and how multiple overhead rates are used to determine cost

The Need for Unit Product Cost Data Managers need unit product cost data for: Financial (Cost) accounting Inventory valuation Cost of goods sold calculation Managerial decisions e.g., pricing

Types of Costing (Cost Accounting) Systems Process costing is useful to companies that produce relatively uniform or homogeneous products. e.g., a cement or paint producer Objective is to determine the cost of each unit of product. Job-order costing is useful to companies that produce heterogeneous products, or that produce jobs or orders to customer specifications. e.g., a print shops, a construction company, or a hospital Objective is to determine the cost of each job.

Quick Test 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.

Quick Test 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.

Approaches to Costing Actual (HC) vs. standard costing Absorption (full) vs. variable (direct) costing under absorption costing, all manufacturing costs (fixed and variables) are considered product costs. under variable costing, only variable manufacturing costs are considered product costs. For financial reporting, we use actual absorption costing as required by both GAAP and tax regulations.

Job-Order Costing Overview Manufacturing overhead (OH) Applied to each job using a predetermined rate Direct materials Direct labor Traced directly to each job THE JOB

Sequence of Events in Job-Order Costing Charge direct material and direct labor costs to each job as work is performed Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

Sequence of Events in Job-Order Costing Direct Materials Apply overhead to each job when job is completed and at period end. Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

Accounting for Product Costs (Flow of Costs) in a Job-Order System Costs simply follow the physical flow of the goods. Since costs are traced/allocated to jobs, two options exist: set up one controlling WIP inventory account and a job cost sheet for each job set up one WIP inventory account for each job The next two slides show an example of flow of costs in a job-order system; we will use option # 2.

The Job Cost Sheet Pearl Co Job Cost Sheet Job Number A - 143 Date Initiated 3-4-17 Date Completed Department B3 Units Completed Item Wooden cargo crate Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Rate Cost Summary Units Shipped Date Number Balance Total Cost Unit Product Cost

Accounting for Product Costs (Flow of Costs) in a Job-Order System WIP Inventory DM Inventory Job 1 FG Inventory (1) BI $50,000 (1) BI $30,000 (1) BI 0 (2) Pur 100,000 $110,000 (3) DM 40,000 (7) Cost of (9) EI 40,000 (4) DL 90,000 $205,000 FG $205,000 $205,000 (6) OH 45,000 (9) EI 0 (9) EI 0 WIP Inventory Overhead (Control) Job 2 Cost of Goods Sold (5) OH OH (1) BI 0 (8) CGS incurred applied (3) DM $70,000 $205,000 $140,000 $120,000 (4) DL 150,000 (6) OH 75,000 (9) EI 295,000

Notes to T-Accounts 1) Beginning inventory (one job partially completed) 2) Purchase of materials (DM) 3) DM issued to factory and charged to jobs 4) DL incurred and charged to jobs 5) Overhead incurred 6) Overhead applied (based on predetermined rate) 7) Job 1 was completed and transferred to finished goods 8) Job 1 was shipped to customer 9) Ending inventory (one job partially completed)

Application of Overhead At the beginning of each period, a predetermined overhead rate (POHR) is calculated. POHR = estimated total overhead costs / estimated total activity (cost driver) The activity (cost driver) should be common to all jobs and should result in an equitable allocation. The most widely used bases are DL hours, DL cost, and machine hours.

Application of Overhead Overhead applied to a job (or process) = actual level of activity * predetermined rate Overhead is applied whenever a job is completed, and at the end of each period.

Overhead Application Example Pearl Co. applies overhead based on direct labor hours. Total estimated overhead cost for the year is $640,000. Total estimated labor cost is $1,400,000, and total estimated labor hours are 160,000. What is Pearl Co.’s predetermined overhead rate? If job No. 101 took 50 labor hours to complete, what is the overhead applied/charged to job 101?

Overhead Application Example Estimated total overhead cost for the coming period Estimated total activity (cost driver) for the coming period POHR = $640,000 160,000 direct labor hours (DLH) POHR = POHR = $4.00 per DLH For each direct labor hour worked on a job, $4.00 of factory overhead will be applied to the job. Overhead for job 101 = 50 hours * $4.00 = $200

Determining the Cost of a Job The cost of a job includes direct materials, direct labor and applied overhead. Assuming Job 101 involved 25 units, required $200 of direct materials and labor cost is $15 per hour, the total and unit cost of job 101 would be: Direct materials $ 200 Direct labor (50 * $15) 750 Overhead (50 * $4) 200 Total cost $1,150 Unit cost ($1,150 / 25) $ 46

Overhead Application Example Pearl Co.’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 Pearl Co.’s jobs during the year? Use Pearl Co.’s predetermined overhead rate of $4.00 per direct labor hour. SOLUTION Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 × 170,000 = $680,000 Pearl Co. has overapplied overhead for the year by $30,000. What can Pearl Co. do?

Overhead Allocation In general, overhead costs may be allocated to customers on the basis of: a plant-wide (single) rate departmental (multiple) rates activity rates, the process known as ABC The procedure is essentially the same.

Plant-Wide Overhead Rate Customer 1 Customer 2 Customer 3 Overhead Many Companies tend to use direct labor hours or cost as the overhead allocation base.

Departmental Overhead Rates Finishing Department Shipping Department Painting Department A two stage process: costs are allocated to departments and then to customers.

Departmental Overhead Rates Stage One: Costs assigned to departments (cost pools) Finishing Department Painting Department Shipping Department

Departmental Overhead Rates Stage One: Costs assigned to departments (cost pools) Finishing Department Painting Department Shipping Department Stage Two: Costs applied to customers Customer 1 Customer 2 Customer 3

Activity Overhead Rates Cutting Activity Sanding Activity Joining Activity A two stage process: Costs are allocated to activities and then to customers.

Activity Overhead Rates Stage One: Costs assigned to activities (cost pools) Cutting Activity Joining Activity Sanding Activity Stage Two: Costs applied to customers Customer 1 Customer 2 Customer 3