Chapter 17 Job Order Costing

Chapter 17 Learning Objectives Distinguish between job order costing and process costing Record materials and labor costs in a job order costing system Record actual and allocated overhead costs in a job order costing system © 2018 Pearson Education, Inc.

Chapter 17 Learning Objectives Record the completion and sales of finished goods Adjust for overallocated and underallocated overhead Calculate job costs for a service company © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 1 Distinguish between job order costing and process costing © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. HOW DO MANUFACTURING COMPANIES USE JOB ORDER AND PROCESS COSTING SYSTEMS? Cost accounting systems measure, record, and report product costs. Knowing unit costs helps managers: Determine which products to produce. Set sales prices that will lead to profits. Determine how many products to produce. Compute cost of goods sold for the income statement. Compute the cost of inventory for the balance sheet. A manager’s primary duties include planning and controlling. Cost accounting systems accumulate product cost information so that managers can measure how much it costs to produce each unit of product. Knowing product unit costs helps managers set the selling prices that will generate profits, compute cost of goods sold for the income statement, and compute the cost of inventory for the balance sheet. © 2018 Pearson Education, Inc.

Job Order Costing Job order costing system Unique products Costs accumulated by job Job order costing system A job order costing system is an accounting system that accumulates costs by job. A job is the production of a unique product or specialized service. It may be one unit or a batch of units. There are two types of traditional cost accounting systems: job order costing and process costing.   Job order costing is used by businesses that produce unique products or provide specialized services. Costs are accumulated for each batch, or job. Examples of the types of companies that use job order costing are accounting firms, music studios, health care providers, building contractors, and custom furniture manufacturers. © 2018 Pearson Education, Inc.

Process Costing Process costing system Identical units Costs accumulated by process Process costing system A process costing system is an accounting system that accumulates costs by process. It is used when companies manufacture identical units. There are two types of traditional cost accounting systems: job order costing and process costing.   Process costing is used by businesses that manufacture large quantities of identical units. A process costing system accumulates the costs of each process needed to complete the product. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 2 Record materials and labor costs in a job order costing system © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. HOW DO MATERIALS AND LABOR COSTS FLOW THROUGH THE JOB ORDER COSTING SYSTEM? Companies use a job cost record to document the product costs for each job. A job order costing system tracks costs as raw materials move from the storeroom to the production floor, where they are converted into finished products. Smart Touch Learning uses a job cost record to document the product costs for each job: direct materials, direct labor, and manufacturing overhead. Exhibit 17-1 provides an example of a completed job cost record for Job 27. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. HOW DO MATERIALS AND LABOR COSTS FLOW THROUGH THE JOB ORDER COSTING SYSTEM? In a job order costing system, companies must accumulate costs and then assign costs to each job. Costs are accumulated when the company purchases raw materials, incurs direct labor, and incurs manufacturing overhead. The company starts the job cost record when work begins on the job. As Smart Touch Learning incurs costs, the company adds costs to the job cost record, and the costs are added to the Work-in-Process Inventory (WIP). When Smart Touch Learning finishes a job, the company totals the costs and transfers the costs from Work-in-Process Inventory to Finished Goods Inventory (FG). The costs transferred to Finished Goods Inventory are called Cost of Goods Manufactured (COGM). When the job’s units are sold, the costing system moves the costs from Finished Goods Inventory, an asset, to Cost of Goods Sold (COGS), an expense. Exhibit 17-2 diagrams the flow of costs for three jobs (Job 27, Job 28, and Job 29) that were worked on during the accounting period at Smart Touch Learning. Smart Touch Learning worked on many jobs in addition to these three jobs during the year. In Exhibit 17-2, notice that Jobs 27 and 28 were completed, and their costs were transferred from WIP to FG. Job 27 was delivered to the customer, so those costs were transferred from FG to COGS. Job 29 is the only job that is not complete and still in process. Job 28 is complete but not delivered to the customer, and Job 27 is the only job completed and sold. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Materials Purchasing materials: Often stored for later usage Using materials in production: Direct materials Indirect materials Materials purchased and materials used in production are usually different amounts. There are two aspects to accounting for raw materials: purchasing materials and using materials in production. Raw materials do not have to be used immediately when purchased and can be stored for later use. Materials purchased and materials used in production are usually two different amounts. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Purchasing Materials December 31, 2019 Balances: Transaction 1—Materials Purchased: During 2020, Smart Touch Learning purchases raw materials of $367,000 on account. During 2020, Smart Touch Learning purchases raw materials of $367,000 on account. This is a product cost that accumulates in the Raw Materials Inventory account. Smart Touch Learning records the journal entry for the entire year rather than showing each individual purchase to simplify the recording process. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Purchasing Materials The raw materials subsidiary ledger includes a separate record for each type of material that Smart Touch Learning uses to produce its tablets. So, Smart Touch Learning would have separate pages in the ledger for the batteries, processors, cases, and other materials used.   Exhibit 17-3 shows an example of Smart Touch Learning’s raw materials subsidiary ledger for batteries. A subsidiary ledger allows for better control of inventory because it helps track each type of material used in production. Remember that the balance of the Raw Materials Inventory account in the general ledger should always equal the sum of the balances in the raw materials subsidiary ledger. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Using Materials A materials requisition is a request to transfer materials to the production floor. Below is the materials requisition from when Smart Touch Learning starts Job 27 on January 14, 2020. When Smart Touch starts Job 27 on January 14, 2020, the production team requests materials for the job by filling out a materials requisition, as shown in Exhibit 17-4. A materials requisition is a request for the transfer of raw materials to the production floor.   Note that the subsidiary ledger previously shown in Exhibit 17-3 records the materials requisition number (342) along with the number of units requisitioned and their cost. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Using Materials When materials are received on the production floor, the direct materials are recorded on the job cost record. When the raw materials are received on the production floor, they are recorded on the job cost record. Exhibit 17-5 shows the job cost record for Job 27 after materials requisition 342 has been recorded.   The raw materials added to Job 27 from this materials requisition are considered direct materials because the batteries can be easily and cost-effectively traced directly to the finished tablet. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Using Materials Transaction 2—Materials Used: In 2020, Smart Touch Learning uses direct materials costing $355,000 and indirect materials costing $17,000. The $17,000 of indirect materials are transferred from Raw Materials Inventory to Work-in-Process through the Manufacturing Overhead account. Smart Touch Learning records a summary journal entry at the end of the period for all materials used. To produce the tablets, both direct and indirect materials are used.   Remember that direct materials can be easily and cost-effectively traced directly to the finished product. Indirect materials cannot be easily and cost-effectively traced directly to the finished product. In 2020, Smart Touch Learning uses direct materials costing $355,000 and indirect materials of $17,000. Work-in-Process Inventory has a beginning balance of $80,000. To record the use of direct materials, the cost of the direct materials is transferred out of Raw Materials Inventory and assigned to Work-in-Process Inventory. The amount debited to Work-in-Process Inventory is the total of the individual job cost records. To record the use of indirect materials, the cost of the indirect materials is also transferred out of the Raw Materials Inventory account. However, these costs are accumulated in the Manufacturing Overhead account with a debit. Manufacturing Overhead is a temporary account used to accumulate indirect production costs during the accounting period. Because it is a temporary account, it is classified as an equity account. We will show how Manufacturing Overhead is adjusted later in this presentation. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Labor Most companies use electronic labor/time to track labor costs. If a manual system is used, each employee completes a labor time record to track and assign direct labor to jobs. Exhibit 17-6 shows the job cost record for Job 27. Direct labor costs are assigned to the job based on labor time records. Most companies use electronic labor/time records to streamline the tracking of labor costs. Employees use ID cards to swipe and enter job information. The time is automatically added to the appropriate job cost records. If a manual system is used, each employee completes a labor time record that indicates the amount of time spent on each job. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Labor Transaction 3—Labor Costs Incurred: During 2020, Smart Touch Learning incurs total labor costs of $197,000, of which $169,000 is direct labor and $28,000 is indirect labor. During 2020, Smart Touch Learning incurs total labor costs of $197,000, of which $169,000 is direct labor and $28,000 is indirect labor.   Recall that direct labor costs can be easily and cost-effectively traced directly to the finished product. Indirect labor costs cannot. Indirect labor consists of labor costs for employees working in the factory but not directly on the products, including employees in supervision, maintenance, and janitorial positions. The total cost of direct labor is debited to Work-in-Process Inventory. The indirect labor costs are accumulated in Manufacturing Overhead by debiting that account. This is the same treatment as for the direct and indirect materials illustrated in Transaction 2. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 3 Record actual and allocated overhead costs in a job order costing system © 2018 Pearson Education, Inc.

HOW DO OVERHEAD COSTS FLOW THROUGH THE JOB ORDER COSTING SYSTEM? Transactions 4–7—Actual Overhead Costs Incurred: In addition to indirect materials and indirect labor, other overhead costs are incurred: Depreciation on manufacturing plant and equipment of $20,000 Plant utilities of $7,000 Plant insurance of $6,000 Plant property taxes incurred but not yet paid of $5,000 Smart Touch Learning has already accumulated the costs of indirect materials (Transaction 2) and indirect labor (Transaction 3) to Manufacturing Overhead. In addition to indirect materials and indirect labor, Smart Touch Learning also incurs depreciation expense, utilities expense on the plant, insurance expense on the plan, and plant property taxes.   © 2018 Pearson Education, Inc.

HOW DO OVERHEAD COSTS FLOW THROUGH THE JOB ORDER COSTING SYSTEM? All manufacturing overhead costs are accumulated as debits to the Manufacturing Overhead account.   © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Before the Period—Calculating the Predetermined Overhead Allocation Rate Actual manufacturing overhead costs are not known until the end of the period. Managers use a predetermined overhead allocation rate to allocate costs to jobs before the end of the period. An allocation base links the overhead costs to jobs. The primary cost driver causes an increase or a decrease in the cost. The most accurate allocation of Manufacturing Overhead can be made only when total overhead costs are known, which is not until the end of the period. But managers cannot wait that long for product cost information. Therefore, the predetermined overhead allocation rate is calculated before the period begins. Companies use the predetermined overhead allocation rate to allocate estimated overhead costs to individual jobs. The predetermined overhead allocation rate is the estimated overhead cost per unit of the allocation base, calculated at the beginning of the accounting period: Total estimated overhead costs / Total estimated quantity of the overhead allocation base. The key to allocating indirect manufacturing costs to a job is to identify a workable manufacturing overhead allocation base. The allocation base is a denominator that links indirect costs to cost objects. Ideally, the allocation base is the primary cost driver of the indirect costs. A cost driver is the primary factor that causes a cost to increase or decrease. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Before the Period—Calculating the Predetermined Overhead Allocation Rate Common manufacturing company cost drivers are: Direct labor hours (for labor-intensive production environments) Direct labor cost (for labor-intensive production environments) Machine hours (for machine-intensive production environments) Three cost drivers are commonly used by manufacturers. Direct labor hours or direct labor cost are appropriate cost drivers for companies whose production is labor intensive. Machine hours are used when production is machine intensive. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Before the Period—Calculating the Predetermined Overhead Allocation Rate At the end of 2019, Smart Touch Learning estimated that total overhead costs for 2020 would be $68,000 and direct labor costs would total $170,000. Using this information, the predetermined overhead allocation rate is calculated as follows: At the end of 2019, Smart Touch Learning estimated that total overhead costs for 2020 would be $68,000 and direct labor costs would total $170,000. The predetermined overhead allocation rate = Total estimated overhead costs / Total estimated quantity of the overhead allocation base The predetermined overhead allocation rate = $68,000 / $170,000 = 40% of direct labor costs. © 2018 Pearson Education, Inc.

During the Period—Allocating Overhead As jobs are completed in 2020, Smart Touch Learning will allocate overhead costs using the predetermined overhead allocation rate. The total direct labor cost for Job 27 is $1,250, and the predetermined overhead allocation rate is 40% of direct labor costs. Job 27 produced 15 tablets. As jobs are completed in 2020, Smart Touch Learning will allocate overhead costs using the predetermined overhead allocation rate and assign 40% of each direct labor dollar incurred for the job as manufacturing overhead costs. Smart Touch Learning uses the same predetermined overhead rate to allocate manufacturing overhead to all jobs worked on throughout the year, including jobs still in process at the end of the accounting period. Let’s use Job 27 as an example. The total direct labor cost for Job 27 is $1,250, and the predetermined overhead allocation rate is 40% of direct labor costs. Job 27 produced 15 tablets. © 2018 Pearson Education, Inc.

During the Period—Allocating Overhead Exhibit 17-7 shows the allocated manufacturing overhead costs of $500 on the job cost record. The Cost Summary section of the completed job cost record for the Central College Bookstore order shows that Job 27 cost Smart Touch Learning a total of $4,500, composed of $2,750 for direct materials, $1,250 for direct labor, and $500 of allocated manufacturing overhead. © 2018 Pearson Education, Inc.

During the Period—Allocating Overhead Transaction 8—Overhead Allocation: Smart Touch Learning’s total direct labor cost for 2020 is $169,000. Using an overhead allocation rate of 40%, Manufacturing Overhead is $67,600. Smart Touch Learning’s total direct labor cost for 2020 is $169,000, so total overhead allocated to all jobs is 40% of the $169,000 direct labor costs, or $67,600. The journal entry to record the allocation of overhead is a debit to Work-in-Process Inventory of $67,600 and a credit to Manufacturing Overhead of $67,600. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 4 Record the completion and sales of finished goods © 2018 Pearson Education, Inc.

WHAT HAPPENS WHEN PRODUCTS ARE COMPLETED AND SOLD? After accumulating, assigning, and allocating the costs of direct materials, direct labor, and overhead to jobs, a company: Accounts for the completion of jobs Accounts for the sale of jobs Adjusts Manufacturing Overhead at the end of the period Once you know how to accumulate, assign, and allocate the costs of direct materials, direct labor, and overhead to jobs, the process must be completed by accounting for the completion of jobs, accounting for the sale of jobs, and adjusting Manufacturing Overhead. © 2018 Pearson Education, Inc.

Transferring Costs to Finished Goods Inventory Transaction 9—Jobs Completed: The $644,600 Cost of Goods Manufactured is the cost of all jobs Smart Touch Learning completed during 2020. Normally, journal entries would be made as each individual job is completed, but we are showing it as one summary journal entry, Transaction 9.   The Cost of Goods Manufactured is transferred from Work-in-Process Inventory to Finished Goods Inventory as jobs are completed and moved into the finished goods storage area. The cost of goods completed during 2020 is $644,600. © 2018 Pearson Education, Inc.

Transferring Costs to Cost of Goods Sold Transactions 10 and 11—Jobs Sold: During 2020, Smart Touch Learning sells jobs with a sales price of $1,200,000 and a cost of $584,600. Transactions 10 and 11 records $1,200,000 of sales on account for jobs with a cost of $584,600. Smart Touch Learning records two entries, one for the sale and the other to recognize the Cost of Goods Sold. © 2018 Pearson Education, Inc.

Transferring Costs to Cost of Goods Sold The T-accounts for Smart Touch Learning’s manufacturing costs now show: As jobs are completed, their costs are transferred to Finished Goods Inventory. We end the period with other jobs started but not finished, which are represented by the $27,000 ending balance of Work-in-Process Inventory. We also have jobs completed and not sold, which are represented by the $60,000 ending balance of Finished Goods Inventory. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 5 Adjust for overallocated and underallocated overhead © 2018 Pearson Education, Inc.

HOW IS THE MANUFACTURING OVERHEAD ACCOUNT ADJUSTED? Companies must adjust the Manufacturing Overhead account for any over- or underallocation of overhead. Underallocated overhead occurs when actual manufacturing overhead costs are more than allocated manufacturing overhead costs. Overallocated overhead costs occur when the actual manufacturing overhead costs are less than allocated manufacturing overhead costs. Because Smart Touch Learning allocates overhead to jobs using a predetermined overhead allocation rate based on estimates, an adjustment is required to Manufacturing Overhead at the end of the period. At the end of the accounting period, the underallocated and overallocated overhead is adjusted by closing the manufacturing overhead account. Overhead is underallocated when the company allocates less cost to jobs than actual costs incurred. Overhead is overallocated when the company allocates more costs to jobs than actual costs incurred. © 2018 Pearson Education, Inc.

HOW IS THE MANUFACTURING OVERHEAD ACCOUNT ADJUSTED? Transaction 12—Adjust Manufacturing Overhead: During the year, the Manufacturing Overhead account is debited for actual overhead costs incurred and credited for overhead costs allocated to jobs. A credit to Manufacturing Overhead of $15,400 is needed to bring the account balance to zero. Because Smart Touch Learning allocates overhead to jobs using a predetermined overhead allocation rate based on estimates, an adjustment is required to Manufacturing Overhead at the end of the period. The Manufacturing Overhead account needs to be adjusted because a debit of $15,400 exists. At the end of the accounting period, the underallocated and overallocated overhead is adjusted by closing the Manufacturing Overhead account. A credit to Manufacturing Overhead of $15,400 is required to bring the account balance to zero. The Cost of Goods Sold expense is increased for the overhead costs not allocated previously. © 2018 Pearson Education, Inc.

HOW IS THE MANUFACTURING OVERHEAD ACCOUNT ADJUSTED? The T-accounts for Smart Touch Learning now show: The Manufacturing Overhead account balance is now zero, and the Cost of Goods Sold account reflects the actual cost of producing the product. © 2018 Pearson Education, Inc.

HOW IS THE MANUFACTURING OVERHEAD ACCOUNT ADJUSTED? If actual overhead costs were less than allocated overhead costs, Manufacturing Overhead is overallocated, and Cost of Goods Sold is overcosted. To close Manufacturing Overhead, the Manufacturing Overhead account is increased with a debit, and Cost of Goods Sold is decreased with a credit. © 2018 Pearson Education, Inc.

Summary of Journal Entries As costs flow through the job order costing system, we go through a four-step process of accumulating, assigning, allocating, and adjusting. Exhibit 17-9 lists all journal entries illustrated in the chapter (Transactions 1-3 are shown on this slide). © 2018 Pearson Education, Inc.

Summary of Journal Entries Exhibit 17-9 lists all journal entries illustrated in the chapter (Transactions 4-7 are shown on this slide). © 2018 Pearson Education, Inc.

Summary of Journal Entries Exhibit 17-9 lists all journal entries illustrated in the chapter (Transactions 8-12 are shown on this slide). © 2018 Pearson Education, Inc.

Summary of Journal Entries Exhibit 17-9 shows that the Manufacturing Overhead account has a zero balance after the adjusting entry. The materials from the Raw Materials Inventory account were allocated to Work-in-Process Inventory of $355,000 and to Manufacturing Overhead of $17,000, as shown in Transaction 2. The goods transferred from Work-in-Process Inventory to Finished Goods Inventory represent the goods completed during the period. The goods sold were removed from Finished Goods Inventory and appear as a debit to Cost of Goods Sold. © 2018 Pearson Education, Inc.

Cost of Goods Manufactured and Cost of Goods Sold Exhibit 17-10 shows the schedule of cost of goods manufactured for Smart Touch Learning for 2020. The Cost of Goods Manufactured total of $644,600 is the same value shown as a debit in the Finished Goods Inventory T-account in Exhibit 17-9. © 2018 Pearson Education, Inc.

Cost of Goods Manufactured and Cost of Goods Sold Exhibit 17-11 shows the income statement for the same period. Notice on the income statement that the underallocated overhead is added in the cost of goods sold calculation so that the cost of goods sold on the income statement matches the amount on the T-account. If overhead had been overallocated, the adjustment amount would have been subtracted. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc. Learning Objective 6 Calculate job costs for a service company © 2018 Pearson Education, Inc.

HOW DO SERVICE COMPANIES USE A JOB ORDER COSTING SYSTEM? Service companies do not have inventory or manufacturing costs. They trace direct labor to jobs. They allocate overhead costs to jobs: Computing the predetermined overhead allocation rate Allocating indirect costs to jobs, using the predetermined overhead allocation rate They use the costing information to make pricing decisions. Service firms have no inventory but still incur operating costs that need to be allocated to jobs. The hourly rate is found by taking the total salary paid to a particular employee for the year and dividing by available work hours per year. The predetermined overhead allocation rate is calculated using an allocation base, such as direct labor hours. The formula is the same as before: Estimated indirect costs / Estimated direct labor hours = Predetermined overhead allocation rate. This rate is used to apply indirect costs to each job based on the actual direct hours used on the job. © 2018 Pearson Education, Inc.

HOW DO SERVICE COMPANIES USE A JOB ORDER COSTING SYSTEM? Fox’s salary and benefits total $100,000 per year. Assuming a 40-hour workweek and 50 workweeks in each year, Fox has 2,000 available work hours per year. Fox’s hourly pay rate is as follows: The following indirect costs are estimated for 2018: Fox’s salary and benefits total $100,000 per year. Assuming a 40-hour workweek and 50 workweeks in each year, Fox has 2,000 available work hours per year. Fox’s hourly pay rate = $100,000 / 2,000 hours = $50 per hour. © 2018 Pearson Education, Inc.

HOW DO SERVICE COMPANIES USE A JOB ORDER COSTING SYSTEM? Direct labor hours are used as the allocation base. Walsh attorneys will work an estimated 10,000 direct labor hours in 2018. Step 1: Compute the predetermined overhead allocation rate. Step 2: Allocate indirect costs to jobs. Direct labor hours are used as the allocation base. Walsh attorneys will work an estimated 10,000 direct labor hours in 2018. Step 1: Compute the predetermined overhead allocation rate. As the slide shows, the predetermined overhead allocation rate = $30 per direct labor hour. Step 2: Allocate indirect costs to jobs. As the slide shows, a job with 14 direct labor hours would be allocated $420 at the rate of $30 per hour from step 1. © 2018 Pearson Education, Inc.

HOW DO SERVICE COMPANIES USE A JOB ORDER COSTING SYSTEM? To summarize, the total costs assigned and allocated to Client 367 are as follows: The total hourly rate for the company is $80, which is $50 per hour for direct labor plus $30 per hour for indirect costs. If the firm desires a profit equal to 75% of the firm’s cost, then the price would be calculated as follows: The slide shows the total costs assigned and allocated to Client 367. The total hourly rate for the company is $80, which is $50 per hour for direct labor plus $30 per hour for indirect costs. If the firm desires a profit equal to 75% of the firm’s cost, then the slide shows that the price would equal $140. © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc.