CHAPTER 4 © 2008 McGraw-Hill Ryerson Limited.

Types of Costing Systems Used to Determine Product Costs Process Costing Job-order Costing Chapter 5

© 2008 McGraw-Hill Ryerson Limited. Types of Costing Systems Used to Determine Product Costs Process Costing Job-order Costing Job production Car repair after major accident Custom built-in library shelves Wedding Cake Continuous production original production of the automobile mass produced book shelves bought at Wal Mart Cakes made at a commercial bakery

© 2008 McGraw-Hill Ryerson Limited. Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

© 2008 McGraw-Hill Ryerson Limited. Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

© 2008 McGraw-Hill Ryerson Limited. Job-Order Costing THE JOB Direct material Traced directly to each job Direct labour Traced directly to each job Manufacturing overhead (OH) Applied to each job using a predetermined rate

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting The primary document for tracking the costs associated with a given job is the job cost sheet. Let’s investigate

© 2008 McGraw-Hill Ryerson Limited. PearCo Job Cost Sheet Job Number A - 143Date Initiated March 2 Date Completed Department B3Units Completed Item Wooden cargo crate Direct MaterialsDirect LaborManufacturing Overhead Req. No.AmountTicketHoursAmountHoursRateAmount Cost SummaryUnits Shipped Direct MaterialsDateNumberBalance Direct Labour Manufacturing Overhead Total Cost Unit Cost Job-Order Cost Accounting

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting

© 2008 McGraw-Hill Ryerson Limited. Materials Requisition Form Will E. Delite

© 2008 McGraw-Hill Ryerson Limited. Materials Requisition Form Will E. Delite Type, quantity, and total cost of material charged to job A-143. Cost of material is charged to job A-143.

© 2008 McGraw-Hill Ryerson Limited. Note materials requisition form –Maintain control of assets. Prevent pilferage, loss, and waste. Prevent supervisors from stockpiling materials “just in case the stockroom runs out.” –Trace costs of materials to particular jobs. –The materials requisition form, like all the others illustrated today, can be electronic rather than hardcopy.

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting Workers use time tickets to record the time spent on each job. Let’s see one

© 2008 McGraw-Hill Ryerson Limited. Employee Time Ticket

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting Apply manufacturing overhead to jobs using a predetermined overhead rate of $4 per direct labour hour (DLH). Let’s do it

© 2008 McGraw-Hill Ryerson Limited. Job-Order Cost Accounting

© 2008 McGraw-Hill Ryerson Limited. Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Application of Manufacturing Overhead Ideally, the allocation base is a cost driver that causes overhead.

© 2008 McGraw-Hill Ryerson Limited. Application of Manufacturing Overhead Overhead applied = POHR × Actual activity Actual amount of the allocation base such as units produced, direct labour hours, or machine hours incurred during the period. Based on estimates, and determined before the period begins.

© 2008 McGraw-Hill Ryerson Limited. Application of Manufacturing Overhead Recall the wooden crate example where: Overhead applied = $4 per DLH × 8 DLH = $32 Overhead applied = POHR × Actual activity

© 2008 McGraw-Hill Ryerson Limited. The Need for a Predetermined Manufacturing Overhead Rate Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period.

© 2008 McGraw-Hill Ryerson Limited. Note If we wait until the end of the period, we will know the actual TOTAL overhead cost. However, still we won’t know the actual overhead cost of a particular job. Why? –Overhead consists of costs that are either difficult or impossible to trace to particular jobs. Difficult-to-trace costs include the cost of indirect materials like glue in a furniture factory. Impossible-to-trace costs include fixed common costs like the property taxes on the factory building and land.

© 2008 McGraw-Hill Ryerson Limited. PearCo applies overhead based on direct labour hours. Total estimated overhead for the year is $640,000. Total estimated labour cost is $1,400,000 and total estimated labour hours are 160,000. What is PearCo’s predetermined overhead rate per hour? Overhead Application Example

© 2008 McGraw-Hill Ryerson Limited. For each direct labour hour worked on a job, $4.00 of factory overhead will be applied to the job. Overhead Application Example POHR = $4.00 per DLH $640, ,000 direct labour hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR =

© 2008 McGraw-Hill Ryerson Limited. Overhead Application Example What amount of overhead will PearCo apply to Job X-32?

© 2008 McGraw-Hill Ryerson Limited. Overhead Application Example

© 2008 McGraw-Hill Ryerson Limited. Overhead Application Example

© 2008 McGraw-Hill Ryerson Limited. Job-Order Costing Document Flow Summary Job Cost Sheets Materials Requisition Manufacturing Overhead Account Direct material s Indirect materials Materials used may be either direct or indirect.

© 2008 McGraw-Hill Ryerson Limited. Job-Order Costing Document Flow Summary Job Cost Sheets Employee Time Ticket Manufacturing Overhead Account Direct Labour Indirect Labour An employee’s time may be either direct or indirect.

© 2008 McGraw-Hill Ryerson Limited. Job-Order Costing Document Flow Summary Manufacturing Overhead Account Other Actual OH Charges Job Cost Sheets Applied Overhead Materials Requisition Indirect Material Employee Time Ticket Indirect Labour

© 2008 McGraw-Hill Ryerson Limited. Let’s examine the cost flows in a job-order costing system. We will use T-accounts and start with materials. Job-Order System Cost Flows

© 2008 McGraw-Hill Ryerson Limited. Raw Materials Material Purchases Mfg. Overhead Job-Order System Cost Flows Work in Process (Job Cost Sheet) Direct Materials Indirect Materials ActualApplied

© 2008 McGraw-Hill Ryerson Limited. Job-Order System Cost Flows Mfg. Overhead Salaries and Wages Payable Work in Process (Job Cost Sheet) Direct Materials Overhead Applied Overhead applied to Work in Process Direct Labour Indirect Labour Indirect Materials ActualApplied If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.

© 2008 McGraw-Hill Ryerson Limited. Finished Goods Cost of Goods Mfd. Cost of Goods Sold Job-Order System Cost Flows Work in Process (Job Cost Sheet) Direct Materials Direct Labour Overhead Applied

© 2008 McGraw-Hill Ryerson Limited. Overhead Application Example PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labour hour.

© 2008 McGraw-Hill Ryerson Limited. Overhead Application Example SOLUTION Applied Overhead = POHR × Actual Direct Labour Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labour hour.

© 2008 McGraw-Hill Ryerson Limited. SOLUTION Applied Overhead = POHR × Actual Direct Labour Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labour hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labour hour, Overhead Application Example PearCo has overapplied overhead for the year by $30,000. What will PearCo do?

© 2008 McGraw-Hill Ryerson Limited. Work in Process Finished Goods Cost of Goods Sold $30,000 may be allocated to these accounts. Overapplied and Underapplied Manufacturing Overhead $30,000 may be closed directly to cost of goods sold. Cost of Goods Sold PearCo’s Method OR

© 2008 McGraw-Hill Ryerson Limited. Overapplied and Underapplied Manufacturing Overhead PearCo’s Mfg. Overhead Actual overhead costs $650,000 $30,000 overapplied PearCo’s Cost of Goods Sold Unadjusted Balance $30,000 Adjusted Balance Overhead Applied to jobs $680,000

© 2008 McGraw-Hill Ryerson Limited. Quick Check What effect will the overapplied overhead have on PearCo’s cost of goods sold? a. Cost of goods sold will increase. b. Cost of goods sold will be unaffected. c. Cost of goods sold will decrease.

© 2008 McGraw-Hill Ryerson Limited. Quick Check What effect will the overapplied overhead have on PearCo’s cost of goods sold? a. Cost of goods sold will increase. b. Cost of goods sold will be unaffected. c. Cost of goods sold will decrease.

© 2008 McGraw-Hill Ryerson Limited. Quick Check What effect will the overapplied overhead have on PearCo’s net income? a. Net income will increase. b. Net income will be unaffected. c. Net income will decrease.

© 2008 McGraw-Hill Ryerson Limited. Quick Check What effect will the overapplied overhead have on PearCo’s net income? a. Net income will increase. b. Net income will be unaffected. c. Net income will decrease.

© 2008 McGraw-Hill Ryerson Limited. Overapplied and Underapplied Manufacturing Overhead: Summary

© 2008 McGraw-Hill Ryerson Limited. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Quick Check

© 2008 McGraw-Hill Ryerson Limited. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Quick Check Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000 Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

© 2008 McGraw-Hill Ryerson Limited. Let’s look at summary journal entries for a job- order costing system. We’ll omit the numbers so that we can focus on accounts. Job-Order Costing: Typical Accounting Entries

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Material Purchases Raw material purchases are recorded in an inventory account.

© 2008 McGraw-Hill Ryerson Limited. Direct materials issued to a job increase Work in Process and decrease Raw Materials. Indirect materials used are charged to Manufacturing Overhead and also decrease Raw Materials. Cost Flows: Material Usage

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Labour The cost of direct labour incurred increases Work in Process and the cost of indirect labour increases Manufacturing Overhead.

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Actual Overhead In addition to indirect materials and indirect labour, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Overhead Applied Work in Process is increased when Manufacturing Overhead is applied to jobs.

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Period Expenses Non-manufacturing costs (period expenses) are charged to expense as they are incurred.

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Cost of Goods Manufactured As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.

© 2008 McGraw-Hill Ryerson Limited. Cost Flows: Sales When finished goods are sold, two entries are required: (1) to record the sale; and (2) to record Cost of Goods Sold and reduce Finished Goods.