CHAPTER 4 Job Costing Chapter 18 Spoilage, Rework, and Scrap © 2012 Pearson Education. All rights reserved.

Basic Costing Terminology… Several key points from prior chapters: Cost objects—including responsibility centers, departments, customers, products, and so on Direct costs and tracing—materials and labor Indirect costs and allocation—overhead

…logically extended Cost pool—any logical grouping of related cost objects Cost-allocation base—a cost driver is used as a basis upon which to build a systematic method of distributing indirect costs. 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. Wedding announcements, aircraft, advertising Process-costing—system accounting for mass production of identical or similar products. Oil refining, orange juice, soda pop

Costing Systems Illustrated

Costing Approaches Actual costing—allocates: Normal 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.

Costing Approaches Summarized

Seven-Step Job Costing Identify the job that is the chosen cost object. 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).

Seven-Step Job Costing Calculate an overhead allocation rate: Allocate overhead costs to the job: Budgeted Allocation Rate x Actual Base Activity For the Job Compute total job costs by adding all direct and indirect costs together. Budgeted Manufacturing Overhead Rate = Budgeted Manufacturing Overhead Costs Budgeted Total Quantity of Cost-Allocation Base

Sample Job Cost Document

Sample Job Cost Source Documents

Job Costing Overview

Journal Entries Journal entries are made at each step of the production process. The purpose is to have the accounting system closely reflect the actual state of the business, its inventories, and its production processes.

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 Purchase of materials on mredit: Materials Control XX Accounts Payable Control XX Requisition of direct and indirect materials (OH) into production: Work-in-Process Control X Manufacturing Overhead Control Y Materials Control Z

Journal Entries Incurred direct and indirect (OH) labor wages Work-in-Process Control X Manufacturing Overhead Control Y Cash Control Z

Journal Entries Incurring or recording of various actual indirect costs: Manufacturing Overhead Control X Salaries Payable Control A Accounts Payable Control B Accumulated Depreciation Control C Prepaid Expenses Control D

Journal Entries Allocation or application of indirect costs (overhead) to the work-in-process account is based on a predetermined overhead rate. Work-in-Process Control X Manufacturing Overhead Allocated X Note: Actual overhead costs are never posted directly into work-in-process.

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

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

Flow of Costs Illustrated

Illustrated General Ledger in a Job Cost Environment

Illustrated Subsidiary Ledger in a Job Cost Environment

Accounting for Overhead Recall that two different overhead accounts were used in the preceding journal entries: Manufacturing overhead control was debited for the actual overhead costs incurred. Manufacturing overhead allocated was credited for estimated (budgeted) overhead applied to production through the work-in-process account.

Accounting for Overhead 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

Accounting for Overhead This difference will be eliminated in the end-of-period adjusting entry process, using one of three possible methods. The choice of method should be based on such issues as materiality, consistency, and industry practice.

Three Methods for Adjusting Over/Underapplied Overhead Adjusted allocation rate approach—all allocations are recalculated with the actual, exact allocation rate. Proration approach—the difference is allocated between cost of goods sold, work-in-process, and finished goods based on their relative sizes. Write-off approach—the difference is simply written off to cost of goods sold.

Spoilage, Rework, and Scrap CHAPTER 18 Spoilage, Rework, and Scrap

Basic Terminology Spoilage—units of production, either fully or partially completed, that do not meet the specifications required by customers for good units and that are discarded or sold for reduced prices

Basic Terminology Rework—units of production that do not meet the specifications required by customers but which are subsequently repaired and sold as good finished goods. Scrap—residual material that results from manufacturing a product. Scrap has low total sales value compared with the total sales value of the product.

Accounting for Spoilage Accounting for spoilage aims to determine the magnitude of spoilage costs and to distinguish between costs of normal and abnormal spoilage. To manage, control, and reduce spoilage costs, they should be highlighted, not simply folded into production costs.

Types of Spoilage Abnormal spoilage is spoilage that is not inherent in a particular production process and would not arise under normal operating conditions. Abnormal spoilage is considered avoidable and controllable. Units of abnormal spoilage are calculated and recorded in the loss from abnormal spoilage account, which appears as a separate line item no the income statement.

Job Costing and Spoilage Job-costing systems generally distinguish between normal spoilage attributable to a specific job from normal spoilage common to all jobs.

Job Costing and Accounting for Spoilage Normal spoilage attributable to a specific job: when normal spoilage occurs because of the specifications of a particular job, that job bears the cost of the spoilage minus the disposal value of the spoilage.

Job Costing and Accounting for Spoilage Normal spoilage common to all jobs: in some cases, spoilage may be considered a normal characteristic of the production process. The spoilage is costed as manufacturing overhead because it is common to all jobs. The budgeted manufacturing overhead rate includes a provision for normal spoilage.

Job Costing and Accounting for Spoilage Abnormal spoilage: if the spoilage is abnormal, the net loss is charged to the loss from abnormal spoilage account. Abnormal spoilage costs are not included as a part of the cost of good units produced.

Job Costing and Rework Three types of rework: Normal rework attributable to a specific job—the rework costs are charged to that job. Normal rework common to all jobs—the costs are charged to manufacturing overhead and spread, through overhead allocation, over all jobs. Abnormal rework is charged to loss from abnormal rework account that appears on the income statement.

Accounting for Scrap No distinction is made between normal and abnormal scrap because no cost is assigned to scrap. The only distinction made is between scrap attributable to a specific job and scrap common to all jobs.

Aspects of Accounting for Scrap Planning and control, including physical tracking Inventory costing, including when and how it affects operating income NOTE: Many firms maintain a distinct account for scrap costs.

Accounting for Scrap Scrap attributable to a specific job—job-costing systems sometime trace the scrap revenues to the jobs that yielded the scrap. Done only when the tracing can be done in an economic feasible way No cost assigned to scrap

Accounting for Scrap Scrap common to all jobs—all products bear production costs without any credit for scrap revenues except in an indirect manner Expected scrap revenues are considered when setting is lower than it would be if the overhead budget had not been reduced by expected scrap revenues

Accounting for Scrap Recognizing scrap at the time of its production—sometimes the value of the scrap is material, and the time between storing and selling it can be long. The firm assigns an inventory cost to scrap at a conservative estimate of its net realizable value so that production costs and related scrap revenues are recognized in the same accounting period.