Chapter 4 Job Costing

Building-Block Concepts of Costing Systems Cost Object: anything of interest for which a cost is desired (product, service, department). Direct cost: can be conveniently and economically traced (tracked) to a cost object. Indirect cost: cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner

Building-Block Concepts of Costing Systems (contd.) Cost Pool: a grouping of individual cost items (cost objects). Examples: All manufacturing costs, The costs of operating metal cutting machines. Cost-allocation base: a cost driver is used as a basis upon which to build a systematic method of distributing indirect costs (cause-and-effect relation) For example, let’s say that direct labor hours cause indirect costs to change. Accordingly, direct labor hours will be used to distribute or allocate costs among objects based on their usage of that cost driver.

Costing Systems Job-Costing: system accounting for distinct cost objects called Jobs. Each job may be different from the next, and consumes different resources Construction project, aircraft, advertising Process-Costing: system accounting for mass production of identical or similar products Oil refining, orange juice, soda pop Many companies have costing systems that are neither pure job costing nor pure process costing but have elements of both. Example: Kellogg Corporation (Corn Flakes, Crispix, Froot Loops)

Costing Approaches Actual Costing – allocates: Indirect costs based on the actual indirect-cost rates times the actual activity consumption Normal Costing – allocates: Indirect costs based on the budgeted indirect-cost rates times the actual activity consumption Both methods allocate Direct costs to a cost object the same way: by using actual direct-cost rates times actual consumption

Seven-step Job Costing Identify the Job to be costed Identify the Direct Costs of the Job Select the Cost-Allocation base(s) to use for allocating Indirect Costs to the Job Match Indirect Costs to their respective Cost-Allocation base(s) Calculate an Overhead Allocation Rate Allocate Overhead Costs to the Job Compute Total Job Costs by adding all direct and indirect costs together

Seven-step Job Costing (contd.) Identify the Job to be costed: Example: Robinson company: Job WPP 298 (manufacturing a machine) Information gathering through source documents (material-Requisition Record, Labor-Time Record, a Job-Cost Record).

Seven-step Job Costing (contd.) Identify the Direct Costs of the Job: Direct materials: on the basis of engineering specifications and drawings a manufacturing engineer orders materials from storeroom. Materials-requisition record contains information about the cost of direct materials used on a specific job. Direct Manufacturing Labor: Labor-time record

Seven-step Job Costing (contd.) Select the Cost-Allocation base(s) to use for allocating Indirect Costs to the Job: Different jobs require different quantities of indirect resources. The objective is to allocate the costs of indirect resources in a systematic way to their related jobs. Examples of Cost-allocation basis used for manufacturing overhead: Direct labor, Machine-hours, Direct material cost, Units of production. For example, some indirect costs such as depreciation and repairs of machines are more closely related to machine-hours. Supervision and production support are more closely related to direct manufacturing labor-hours.

Seven-step Job Costing (contd.) Match Indirect Costs to their respective Cost-Allocation base(s): Robinson company believes that a single cost-allocation base – direct manufacturing labor-hours- can be used to allocate indirect manufacturing costs to jobs. Consequently, Robinson creates a single cost pool called manufacturing overhead costs.

Seven-step Job Costing (contd.) Calculate an Overhead Allocation Rate: The actual overhead cost rate is calculated by dividing the total indirect costs in the pool by the total quantity of the cost allocation base. Actual Overhead Allocation Rate = Actual OH Costs ÷ Actual total OH Allocation Base (for all jobs) Example: Robinson company: Actual Overhead Allocation Rate = $1,215,000/27,000 hr Actual Overhead Allocation Rate = $45 per direct manufacturing labor-hour

Seven-step Job Costing (contd.) Allocate Overhead Costs to the Job: The indirect costs of each job are computed by multiplying the actual quantity of each different allocation base ( direct labor-hour for each job, in this example) by the indirect cost rate of each allocation base. Robinson company: manufacturing overhead costs allocated to this machine (job) = $45 per direct manufacturing labor-hour X 88 hours (out of the 27,000 total direct manufacturing labor-hours for all jobs in 2006)= $3,960

Seven-step Job Costing (contd.) Compute Total Job Costs by adding all direct and indirect costs together: The total manufacturing costs for Robinson company regarding this job (machine) (see job-cost record on slide # 8): Direct material = $4,606 Direct manufacturing labor = $1,579 Manufacturing overhead costs = $3,960 Total manufacturing costs of job = $10,145

Job Costing Overview Example:

A Normal Job-Costing System in Manufacturing Track the flow of costs in a job-costing system from purchase of material to sale of finished goods. Purchases of Materials and Other Manufacturing inputs Conversion Into Work-in-process inventory Finished Goods Inventory Sale of Finished Goods (a) (d) (c) (b)

A Normal Job-Costing System in Manufacturing-contd. Journal Entries: Journal entries are made at each step of the production process General Ledger and Subsidiary Ledgers: General Ledger: T-account relationships that gives a “bird’s-eye view” of the costing system Contains all the assets, liabilities, and owner’s equity accounts for all jobs. Subsidiary Ledgers: Contain additional details; “worm’s-eye view” The sum of all entries in underlying subsidiary ledgers equals the total amounts in the corresponding general ledger.

Journal Entries All Product Costs are accumulated in the Work-in-Process Control account Direct Materials used Direct Labor incurred Factory Overhead allocated or applied Actual Indirect Costs (overhead) are accumulated in the Manufacturing Overhead Control account

Journal Entries, continued Purchase of Materials on credit: Materials Control 89000 Accounts Payable Control 89000 Requisition of Direct and Indirect Materials (OH) into production: Work-in-Process Control 81000 Manufacturing Overhead Control 4000 Materials Control 85000

Journal Entries, continued Incurred Direct and Indirect (OH) Labor Wages Work-in-Process Control 39000 Manufacturing Overhead Control 15000 Wages Payable Control 54000 Incurring or recording of various actual Indirect Costs: Manufacturing Overhead Control 75000 Salaries Payable Control 44000 Accounts Payable Control (utilities) 11000 Accumulated Depreciation Control 18000 Prepaid Insurance Control 2000

Journal Entries, continued Allocation or application of Indirect Costs (overhead) to the Work-in-Process account is based on a predetermined overhead rate ($40 per labor-hour X 2,000 direct manufacturing labor for all jobs) Work-in-Process Control 80000 Manufacturing Overhead Allocated 80000 Note: actual overhead costs are never posted directly into Work-in-Process

Journal Entries, continued Products are completed and transferred out of production in preparation for being sold Finished Goods Control 188800 Work-in-Process Control 188800

Journal Entries, continued Products are sold to customers on credit Accounts Receivable Control 270000 Sales (Revenues) 270000 And the associated costs are transferred to an expense (cost) account Cost of Goods Sold 180000 Finished Goods Control 180000 Note: The difference between the sales and cost of goods sold amounts represents the gross margin (profit) on this particular transaction

Budgeted Indirect Costs and End-of-Accounting-Year Adjustment Recall that two different overhead accounts were used in the preceding journal entries: Manufacturing Overhead Control was debited for the actual overhead costs incurred ($94,000) Manufacturing Overhead Allocated ($80,000) was credited for estimated (budgeted) overhead applied to production through the Work-in-Process account.

Budgeted Indirect Costs and End-of-Accounting-Year Adjustment (contd.) Actual costs will almost never equal budgeted costs. Accordingly, an imbalance situation exists between the two overhead accounts If Overhead Control > Overhead Allocated, this is called Underallocated Overhead If Overhead Control < Overhead Allocated, this is called Overallocated Overhead This difference will be eliminated in the end-of-period adjusting entry process, using one of three possible methods

Three Methods for Adjusting the Over/Underapplied Situations Adjusted Allocation Rate Approach All allocations are recalculated with the actual, exact allocation rate. The result is that at year-end, every job-cost record as well as finished goods control, work-in-process control, and cost of goods sold - accurately represent actual manufacturing overhead costs incurred. Computerized accounting systems has greatly reduced the cost of using this approach.

Three Methods for Adjusting the Over/Underapplied Situations (contd.) Proration Approach The difference is allocated between Cost of Goods Sold, Work-in-Process, and Finished Goods based on their relative sizes (i.e. the allocated Overhead included in each account balance) Write-Off Approach The difference is simply written off to Cost of Goods Sold (because gross margin equal Revenues minus Cost of goods sold)

Example: