Cornerstones of Managerial Accounting 2e Chapter Five Job-Order Costing Mowen/Hansen Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Job-Order Production and Costing Firms operating in job-order industries produce a wide-variety of services or products that are quite distinct from each other. Example industries: Printing Furniture making Automobile repair Medical and dental services Beautician services Construction

Job-Order Production and Costing The key feature is that the cost of one job differs from that of another job and must be kept track of separately.

Process Production and Costing Firms in process industries mass-produce large quantities of similar or homogeneous products. Example industries: Food Cement Petroleum Chemicals

Process Production and Costing The key feature is that the cost of one unit of a product is identical to the cost of another.

Production Costs in Job-Order Costing Direct Materials Direct Labor Job #1 Job #2 Job #3 Direct materials and direct labor are fairly easy to trace to individual jobs.

Production Costs in Job-Order Costing Overhead Overhead is not so easy to trace to individual jobs. Instead overhead is applied to production.

Actual overhead can be hard to track Actual Costing Actual costs of direct materials, direct labor, and overhead are used to determine unit cost. Actual overhead can be hard to track

Problems With Actual Costing and Overhead Many overhead costs are not incurred uniformly through the year Uneven production levels Give rise to fluctuating unit overhead costs

Virtually all firms use normal costing. Determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead. Virtually all firms use normal costing.

Importance of Unit Costs to Manufacturing Firms Unit costs are essential for: Valuing inventory Determining income Making important decisions

Importance of Unit Costs to Service Firms Unit costs are used to determine: profitability Feasibility of introducing new services

Normal Costing and Estimating Overhead Applying overhead is a three step process: Calculate the predetermined overhead rate. Apply overhead to production throughout the year. Reconcile the difference between the total actual overhead incurred during the year and the total overhead applied to production.

Calculate the Predetermined Overhead Rate Formula: Estimated Annual Overhead Overhead Rate = Firm’s best estimate of manufacturing-related costs, such as factory-related costs, indirect materials, and indirect labor.

Calculate the Predetermined Overhead Rate Formula: Estimated Annual Overhead Overhead Rate = Estimated Annual Activity Level Also called the “Cost Driver”

Calculate the Predetermined Overhead Rate Formula: Estimated Annual Overhead Overhead Rate = Estimated Annual Activity Level Both overhead and activity level are estimated because the overhead rate must be calculated at the beginning of the year.

Applying Overhead to Production Formula: Applied Overhead Predetermined overhead rate Actual activity level = x

Over or Underapplied Overhead Actual Overhead Applied Overhead Underapplied Overhead > = Actual Overhead Applied Overhead Overapplied Overhead < =

Disposition of Overhead Variance At year end, costs reported on the financial statements must be actual, not estimated, amounts. Overhead Variance is assigned to Cost of Goods Sold

Disposition of Under and Overapplied Overhead Actual Overhead Applied Overhead Underapplied Overhead > = The amount of the underapplied overhead would be ADDED to Cost of Goods Sold

Disposition of Under and Overapplied Overhead Actual Overhead Applied Overhead Underapplied Overhead > = Actual Overhead Applied Overhead Overapplied Overhead < = The amount of the overapplied overhead would be SUBTRACTED from Cost of Goods Sold

Departmental Overhead Rates Plantwide Overhead Rate A single overhead rate calculated using all estimated overhead for a factory and dividing by the estimated activity for the entire plant Departmental Overhead Rate Estimated overhead for a department divided by the estimated activity level for that same department

Overhead Rates Machining Dept. overhead rate Estimated Overhead = Estimated Machine Hours Machining Department’s overhead is applied on the basis of machine hours

Unit Costs in the Job-Order System Unit cost of a job is the total cost of: Materials used on the job (Direct Materials) Labor worked on the job (Direct Labor) Applied overhead

Job-Order Cost Sheet Contains all information pertinent to a job Job description Cost of materials, labor, and overhead Jobs are named or numbered Total of all unfinished job-order cost sheets should equal the ending balance of the Work in Process account

Materials Requisition Form Provides information for assigning direct materials costs to jobs Useful for maintaining proper control over a firm’s inventory of direct materials

Job Time Tickets Employees fill out a time ticket that identifies: His or her name Wage rate Hours worked on each job Cost accounting department posts the cost of direct labor to individual jobs

Source Documents as Sources for Account Balances Work in Process Total of all the job-order cost sheets for the unfinished jobs. Finished Goods Total of all the job-order cost sheets for the finished but unsold jobs. Cost of Goods Sold Total of all the job-order cost sheets for the sold jobs.

Accounting for Materials Purchases are added to Raw Materials Inventory account As they are used in production, direct materials are moved from Raw Materials to Work in Process Materials used in production are classified by job and recorded in job-order cost sheets Raw Materials Purchases Direct Materials used in production

Accounting for Direct Labor Cost Time tickets indicate the amount of labor spent on each job These labor costs are added to the job-order cost sheets Total of all the direct labor from all the jobs is recorded as a debit in the Work in Process account Work in Process Direct Materials Direct Labor

Accounting for Overhead Normal costing is used Actual overhead is not assigned directly to jobs Overhead is applied to each job using a predetermined rate. Work in Process Direct Materials Direct Labor Applied Overhead

Accounting for Actual Overhead Costs Never enters the Work in Process account Costs are recorded as debits in the Manufacturing Overhead control account At the end of the period, actual overhead is reconciled with applied overhead

Accounting for Finished Goods Costs of completed jobs are transferred from the Work in Process account to the Finished Goods account Work in Process Finished Goods Direct Materials Completed jobs Completed jobs Direct Labor Applied Overhead

Accounting for Sold Goods Once the job is sold, it is added to the cost of goods sold which is reported on the Income Statement Finished Goods Cost of Goods Sold Completed jobs Sold jobs Sold jobs

Cost of Goods Manufactured Statement To ensure the accuracy in computing these costs, a cost of goods manufactured statement is prepared

Accounting for Cost of Goods Sold When jobs are sold, Finished Goods inventory is decreased Cost of Goods Sold is increased The selling price is recognized by: Increasing (crediting) Sales Revenue Increasing (debiting) Accounts Receivable (or Cash)

Normal and Adjusted Cost of Goods Sold Normal Cost of Goods Sold Cost of Goods Sold before an adjustment for an overhead variance Adjusted Cost of Goods Sold Cost of Goods Sold after adjusting for an overhead variance

Accounting for Nonmanufacturing Costs Manufacturing costs are not the only costs incurred by a firm Selling and general administrative are period costs These period costs are shown on the Income Statement