REVIEW of Chapter 14 We begin this chapter by describing a cost accounting system. We then explain the procedures used to determine costs using a job order costing system. We conclude with a discussion of over and underapplied overhead.

Balance Sheet of a Manufacturer Goods in Process Raw Materials Finished Goods Partially complete products. Material to which some labor and/or overhead have been added. Completed products for sale. Materials waiting to be processed. Can be direct or indirect. Raw materials can be direct or indirect. Direct materials are used directly in a product. Materials not clearly identified with a specific units or batches of product are indirect materials. Remember that merchandisers typically have only one type of inventory, whereas manufacturers generally have at least three types of inventory accounts. 14-17

Income Statement of a Manufacturer Merchandiser Manufacturer Beginning Finished Goods Inventory Beginning Merchandise Inventory + + The major difference Cost of Goods Purchased Cost of Goods Manufactured _ _ The finished goods inventory of a manufacturer is the equivalent of a merchandiser’s merchandise inventory account. Items in this inventory account are complete and awaiting sale. The major difference is that the manufacturer manufactures the items in the finished goods account, while the merchandiser buys the items in the merchandise inventory account. When items are sold from these inventory accounts, the cost of inventory, whether purchased or manufactured, becomes cost of goods sold on the income statement. Ending Merchandise Inventory Ending Finished Goods Inventory Cost of Goods Sold = = 14-18

Income Statement of a Manufacturer P1 Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers. The inventory cost flows are similar for both merchandisers and manufacturers. Beginning inventory plus additions equals goods available for sale. Subtracting ending inventory from goods available for sale results in cost of goods sold. 14-19

Manufacturing Statement P2 Manufacturing Statement Summarizes the types and amounts of costs Incurred in a company’s manufacturing process. Direct Materials Used + Direct Labor + Factory Overhead = Total Manufacturing Costs + Beginning Work in Process – Ending Work in Process = Cost of Goods Manufactured The production activities in the center portion of the preceding flow chart can be summarized in a manufacturing statement. The three product costs are totaled and added to the beginning balance of the goods in process inventory account. Subtracting the ending balance of the goods in process account from this total results in the cost of goods manufactured for the period. 14-25

Job Order Costing and Analysis Chapter 15 Job Order Costing and Analysis We begin this chapter by describing a cost accounting system. We then explain the procedures used to determine costs using a job order costing system. We conclude with a discussion of over and underapplied overhead.

Job Order Manufacturing Process Costing Job Costing Chapter 16 Soda Cereal Gravel Cement Soap Car repair Custom home Custom suit Home repair Airplane maker Here you see some examples where job order costing is used. Another example familiar to many of us is an automobile repair shop. When you take your car in for an inexpensive job like an oil change, you expect to be charged the cost of an oil change instead of an expensive engine repair. The shop’s accounting system must be able to handle multiple jobs with differing amounts of materials and labor costs that are incurred each day. 15-7

Job Order Production Process Costing Job Costing Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job. Job order costing is typically used by manufacturers of custom products or providers of custom services. The jobs must be large enough in scope and value to justify the accounting effort to trace costs to the jobs. Job order production can apply to both manufacturing and service companies. 15-8

Job Order Manufacturing Process Costing Job Costing Typical job order cost applications: Special-order printing Building construction Also used in service industry Hospitals Law firms Here you see some examples where job order costing is used. Another example familiar to many of us is an automobile repair shop. When you take your car in for an inexpensive job like an oil change, you expect to be charged the cost of an oil change instead of an expensive engine repair. The shop’s accounting system must be able to handle multiple jobs with differing amounts of materials and labor costs that are incurred each day. 15-9

Job Order Manufacturing Process Costing Job Costing Soda Cereal Gravel Cement Soap Car repair Custom home Custom suit Home repair Airplane mfg Here you see some examples where job order costing is used. Another example familiar to many of us is an automobile repair shop. When you take your car in for an inexpensive job like an oil change, you expect to be charged the cost of an oil change instead of an expensive engine repair. The shop’s accounting system must be able to handle multiple jobs with differing amounts of materials and labor costs that are incurred each day. 15-10

Events in Job Order Costing Receive order from customers Schedule the production of job The initial event in a job order system is receipt of a customer order. A less common case is to begin work on a job before the company has a signed contract. This is referred to as jobs produced on speculation. The sales price of the job may be a cost-plus, such as with a government contract, or may be determined by market factors. The company may then decide whether the price will provide a reasonable profit. The job is then scheduled, necessary materials are obtained, and the work is begun. Negotiate a sales price and decide whether to pursue the job. Predict cost to complete job 15-11

Job Order Production Activities Direct Materials Indirect Factory Overhead Allocate Goods in Process Finished Goods Cost of Goods Sold Direct materials and direct labor are traced directly to jobs in the goods in process inventory account. Indirect materials and indirect labor, along with other factory overhead costs flow through the factory overhead account into goods in process. Completed jobs are transferred from the goods in process inventory account to the finished goods inventory account. When the finished jobs are delivered to customers, the cost of these jobs becomes an expense on the income statement called cost of goods sold. Indirect Direct Labor 15-12

Job Cost Sheet C 2 A job cost sheet is a separate record maintained for each job that is used to account for material, labor, and factory overhead costs for each job. The job cost sheet may be a paper record, but most likely it is a computerized file. Here’s an example of a job cost sheet showing customer identification, job number, relevant dates, along with materials, labor, and overhead expenditures for the job. 15-13

Materials Requisition P1 C. Luther When materials are need for a job, the production manager, C. Luther, prepares a materials requisition and sends it to the materials manager. The materials manager, M. Bateman, will not release materials from the materials storage facility without this authorization. In addition to the proper signature authorizing the transfer of materials, the job number of the job where the material is to be used is noted on the requisition. Materials requisitions are sequentially numbered just like checks in a checkbook This feature enhances the control of materials use. The requisition also contains a description of the material along with the inventory stock number. When material is transferred from the materials storage facility, an accounting entry is made to reduce the material inventory balance. The materials requisition is the source document supporting the accounting entry, which we will see in a subsequent slide. M. Bateman C. Luther 15-14

Materials Ledger Card P1 The materials ledger card is a perpetual inventory record of the material M-347. This record may be a paper record, but most likely it is a computerized file. Here we see that two hundred twenty five dollars of material M-347 has been issued on materials requisition R4705. This entry on the ledger card reduces the inventory balance from six hundred seventy five dollars to four hundred fifty dollars. 15-15

Job Cost Sheet P1 Here we see the summary information for the material used on job B15 entered on the job cost sheet. If additional information about this material is needed, it can be found on materials requisition R4705. 15-16

Job Cost Sheet P2 Accumulate direct labor costs by means of a work record, such as a time ticket, for each employee. Let’s see one Labor cost entered on the job cost sheet is summarized from an employee’s time ticket. 15-17

Labor Time Ticket C. Luther P2 Production managers use labor time tickets to assign labor costs to individual jobs. In addition to the proper signature authorizing the labor cost assignment, the time ticket includes labor time, rate, job number, date, and employee identification. Labor time tickets are the source documents supporting the payroll accounting entries. C. Luther 15-18

Job Cost Sheet P2 Here we see the summary information for the labor cost of job B15 entered on the job cost sheet. If additional information about the labor cost is needed, it can be found on time ticket L3479. This will generate an accounting entry (to be shown later). 15-19

Job Cost Sheet P3 Allocate manufacturing overhead to jobs using a predetermined overhead rate Let’s do it Overhead is an indirect manufacturing cost that includes all production costs other than direct materials and direct labor. Entries for various overhead items will be shown on a subsequent slide. Unlike labor and materials, overhead cannot be traced directly to individual jobs. We must use a predetermined overhead rate to allocate overhead to jobs. The predetermined overhead rate may be based on such production factors as direct labor hours, direct labor cost, or machine hours 15-20

Job Cost Sheet P3 Road Warriors assigns overhead to jobs using a predetermined overhead rate of one hundred sixty percent of direct labor cost. In other words, for each dollar of direct labor incurred on a job, one dollar and sixty cents of overhead will be charged to the job. For job B15, the labor cost was sixty dollars; so multiplying one dollar and sixty cents times sixty dollars yields ninety six dollars of overhead assigned to the job. 15-21

Predetermined Overhead Allocation Rate Formula Road Warriors uses a predetermined overhead rate (POHR) based on direct labor cost to apply overhead to jobs. Estimated total manufacturing overhead cost for the coming period Estimated total direct labor costs for the coming period POHR = POHR = = 160% of direct labor $ $200,000 $125,000 The term predetermined means that the overhead rate is computed before the operating period begins. Overhead costs and labor costs are estimated for the coming period as a part of the company’s budgeting process. The activity chosen for the denominator is known as an allocation base. Overhead and the allocation base are linked such that as the allocation base increases, overhead increases. For Road Warriors, we could say that overhead supports direct labor costs, or that incurrence of direct labor costs causes additional overhead costs. 15-22

Factory Overhead Account Cost Flows and Documents P1 The materials requisition indicates the cost of direct materials to charge to jobs and the cost of indirect materials to charge to overhead. Direct materials Job Cost Sheets Factory Overhead Account Materials Ledger Cards Materials Ledger Cards Materials Ledger Cards Materials Requisition Let’s look at two flow diagrams that will help us put job order document flows into perspective. Materials used are classified as either direct or indirect. We place direct materials’ costs on the job cost sheet. We place indirect materials costs in the factory overhead account. Later the overhead will be applied to the job using a predetermined overhead rate. Indirect materials 15-23

Factory Overhead Account Cost Flows and Documents P3 Direct Labor Employee time tickets indicate the cost of direct labor to charge to jobs and the cost of indirect labor to charge to overhead. Job Cost Sheets Job Cost Sheets Job Cost Sheets Job Cost Sheets Employee Time Ticket Employee Time Ticket Employee Time Ticket Employee Time Ticket Labor costs are also classified as either direct or indirect. We place direct labor costs on the job cost sheet. We place indirect labor costs in the factory overhead account. Later, factory overhead will be applied to the job using a predetermined overhead rate. Factory Overhead Account Indirect Labor 15-24

Summary of Cost Flows Material Purchases Direct Material Dr Cr Dr Cr Material Purchases Direct Material Actual Overhead Costs Indirect Material Dr Cr T-accounts for a job order system are helpful in visualizing the cost flows. Material purchases are entered as debits (left side) in the raw materials inventory account. A credit entry (right side) in the materials inventory account is recorded when material is withdrawn. Direct materials usage is recorded in the goods in process inventory account and on the job cost sheet for an individual job. Indirect material usage is recorded in the factory overhead account. 15-25

/ Summary of Cost Flows = Direct Labor Direct Material Incurred P4 Direct Labor Direct Material Incurred Indirect Labor Actual Overhead Costs Overhead Overhead Applied to Work in Process Actual Applied factory factory overhead overhead = / an adjustment is needed. We will look at how to accomplish this later. When Direct labor and applied factory overhead are the remaining product costs that we must record. Direct labor cost is recorded in the goods in process inventory account and on the job cost sheet for an individual job. Indirect labor cost is recorded in the factory overhead account. Factory overhead is applied to jobs in the goods in process inventory account using a predetermined overhead rate. Because of the estimating process used in calculating the predetermined overhead rate, the amount of overhead assigned to all jobs in an operating period may differ from the actual overhead costs incurred in the same period. 15-26

Direct Material Direct Labor Overhead Summary of Cost Flows P4 Direct Material Direct Labor Overhead Cost of Goods Mfd. Cost of Goods Sold Direct material, direct labor, and factory overhead are combined in goods in process. As jobs are completed, they are transferred to finished goods and then sold (delivered to customers). The dollar amount of the transfer from the goods in process inventory account to the finished goods inventory account is called cost of goods manufactured. 15-27

Tell me again how we use the POHR to assign overhead to jobs. Overhead Application P4 Tell me again how we use the POHR to assign overhead to jobs. We multiply the POHR times the number of activity units (direct labor cost for Road Warriors) incurred for the job. Overhead is an indirect manufacturing cost. Unlike labor and material, overhead cannot be traced directly to individual jobs. We must use a predetermined overhead rate to assign overhead to jobs. Road Warriors uses an overhead rate of one hundred sixty percent of direct labor cost. For each dollar of direct labor incurred on a job, Road Warriors will assign one dollar and sixty cents of overhead to the job. 15-28

Reasons for using a predetermined overhead rate Overhead Application P4 Reasons for using a predetermined overhead rate Overhead is not incurred uniformly during the year. Actual overhead rate might vary from month to month. Predetermined rate makes it possible to estimate job costs sooner. We cannot wait until the end of the period when all actual overhead costs are known to charge overhead costs to jobs. Jobs are completed continually during the year. Perpetual inventory records must be updated in a timely manner, not at the end of the period. Customers expect to know the total cost of jobs at the time jobs are delivered, not at the end of the period. Using a predetermined overhead rate allows us to assign overhead in a timely and consistent fashion to accomplish these objectives. 15-29

Adjusting of Overapplied or Underapplied Overhead The POHR is based on estimates. What happens if actual results differ from the estimates? The result will be either underapplied or overapplied overhead and we will adjust Cost of Goods Sold at the end of the period. Here, let me show you. Because of the estimating process used in calculating the predetermined overhead rate, the amount of overhead assigned to all jobs in an operating period may differ from the actual overhead costs incurred in the same period. The difference between actual and applied overhead is referred to as either overapplied or underapplied overhead. Cost of goods sold is adjusted for these amounts at the end of the period. 15-30

Adjusting of Overapplied and Underapplied Overhead Overhead is overapplied. Overhead applied to Work in Process (POHR × Activity) Actual overhead costs incurred When the amount of overhead applied to all jobs in a period is greater than the actual amount of overhead incurred, overhead is overapplied. 15-31

Adjusting of Overapplied and Underapplied Overhead Overhead is underapplied. Actual overhead costs incurred Overhead applied to Work in Process (POHR × Activity) When the amount of overhead applied to all jobs in a period is less than the actual amount of overhead incurred, overhead is underapplied. 15-32

Adjusting of Overapplied and Underapplied Overhead Adjusting Cost of Goods Sold for underapplied or overapplied overhead If overhead is underapplied, the cost of goods sold does not include all production costs incurred. Therefore, the end-of-period adjustment for underapplied overhead increases cost of goods sold. If overhead is overapplied, the cost of goods sold includes more costs than were incurred. The end-of-period adjustment for overapplied overhead decreases cost of goods sold. 15-33

Apply Job Order Costing to Pricing Services Estimate the cost of any supplies (shampoo/conditioner) Estimate the cost of the labor (stylist’s rate X time of service) Estimate the amount of overhead to be allocated to all customers Add a mark up The same concepts used in a manufacturing environment can be used in a service setting. For each job, one must estimate the materials or supplies needed, charge out the necessary labor time, include an allocation of overhead and then apply some type of a mark up. Of course, other information also needs to be considered. This would include, among other things, how much competitors charge. A typical haircut 15-34