Chapter 17 Job Order Costing

Learning Objectives Distinguish between job order costing and process costing Record materials and labor costs in a job order costing system Calculate the predetermined overhead allocation rate and allocate overhead costs

Learning Objectives Record the completion and sales of finished goods Adjust for overallocated and underallocated overhead Calculate job costs for a service company

Learning Objective 1 Distinguish between job order costing and process costing

How Do Manufacturing Companies Use Job Order and Process Costing Systems? Product costs are accumulated in cost accounting systems. Knowing unit costs help managers: Set selling prices that will lead to profits 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.

How Do Manufacturing Companies Use Job Order and Process Costing Systems? Exhibit 17-1 illustrates that cost accounting systems are not just for manufacturing companies. Managers of merchandising and service organizations need to know how must it costs to provide goods and services in order to determine the sales price that will generate profits.

Job Order Costing 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. 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.

Process Costing A process costing system is an accounting system that accumulates costs by process. It is used when companies manufacture identical units. Identical units Costs accumulated by process Process costing system 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 product costing system accumulates the costs of each process needed to complete the product.

Learning Objective 2 Record materials and labor costs in a job order costing system

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. Exhibit 17-2 shows the flow of product costs through a job order costing system. 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. A job cost record is a document that shows the direct materials, direct labor, and manufacturing overhead costs for an individual job.

Materials Purchasing materials: Using materials in production: Often stored for later usage Using materials in production: Direct materials Indirect materials Note: 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.

Purchasing Materials Transaction 1—Materials Purchased: During 2018, Smart Touch Learning purchased raw materials of $367,000 on account. During 2018, Smart Touch Learning purchased raw materials of $367,000 on account. This is a product cost that accumulates in the Raw Materials Inventory account. The journal entry is recorded for the entire year rather than showing each individual purchase to simplify the recording process.

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, 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.

Using Materials A materials requisition is a request to transfer materials to the production floor. When Smart Touch started Job 27 on January 14, 2018, the production team requested 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.

Using Materials 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.

Using Materials Transaction 2—Materials Used: In 2018, Smart Touch Learning used 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 will record 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, 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 2018, Smart Touch Learning used direct materials costing $355,000 and indirect materials of $17,000. Work-in-Process Inventory had 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 is 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.

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.

Labor Transaction 3—Labor Costs Incurred: During 2018, Smart Touch Learning incurred total labor costs of $197,000, of which $169,000 was direct labor and $28,000 was indirect labor. During 2018, Smart Touch Learning incurred total labor costs of $197,000, of which $169,000 was direct labor and $28,000 was 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.

Learning Objective 3 Calculate the predetermined overhead allocation rate and allocate overhead costs

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 We have 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 incurred depreciation expense, utilities expense on the plant, insurance expense on the plan, and plant property taxes.  

How Do Overhead Costs Flow Through the Job Order Costing System? We have already accumulated the costs of indirect materials (Transaction 2) and indirect labor (Transaction 3) to manufacturing overhead. We will see that all manufacturing overhead costs are accumulated as debits to the Manufacturing Overhead account.  

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. 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.

Before the Period—Calculating 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.

During the Period—Allocating Overhead Exhibit 17-7 shows the completed cost record for Job 27. The actual direct material costs of $2,750, actual direct labor costs of $1,250, and allocated overhead of $500 are recorded for Job 27. As a result, the total cost to produce 15 tablets is $4,500, for a unit cost of $300 per tablet.

During the Period—Allocating Overhead Transaction 8—Overhead Allocation: Smart Touch Learning’s total direct labor cost for 2018 was $169,000. Using an overhead allocation rate of 40%, Manufacturing Overhead is $67,600. Smart Touch Learning’s total direct labor cost for 2018 was $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.

At the End of the Period—Adjusting for Overallocated and Underallocated Overhead Overhead costs are allocated based on a predetermined overhead allocation rate. Manufacturing Overhead is a temporary account and must have a zero balance at the end of the period. A debit signifies actual overhead was greater than allocated overhead. A credit signifies actual overhead was less than the allocated overhead. After allocation manufacturing overhead to jobs for 2018, a $15,400 debit balance remains in the Manufacturing Overhead account. This means that Smart Touch Learning’s actual overhead costs of $83,000 were greater than the overhead allocation to jobs in Work-in-Process Inventory of $67,600.

Learning Objective 4 Record the completion and sales of finished goods

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.

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 2018. 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 2018 is $644,600.

Transferring Costs to Cost of Goods Sold Transaction 10—Jobs Sold: During 2018, sales on account were $1,200,000. Transaction 10 records $1,200,000 of sales on account. Smart Touch Learning records Sales Revenue and Accounts Receivable for the transaction.

Transferring Costs to Cost of Goods Sold Transaction 11—Cost of Jobs Sold: The cost of all jobs that Smart Touch Learning sold during 2018 was $584,600. The goods have been shipped to customers. Assuming Smart Touch Learning uses a perpetual inventory system, the company must decrease the Finished Goods Inventory account and increase Cost of Goods Sold. Transaction 11 records the $584,600 cost of all jobs that were sold in 2018.

Learning Objective 5 Adjust for overallocated and underallocated overhead

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 up 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.

How Is the Manufacturing Overhead Account Adjusted? Transaction 12—Adjusting Manufacturing Overhead: 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 up estimates, an adjustment is required to Manufacturing Overhead at the end of the period. The Manufacturing Overhead accounts 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.

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.

Summary 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, with notations on the four steps.

Summary

Summary

Summary Exhibit 17-9 shows 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.

Summary Exhibit 17-10 shows the schedule of cost of goods manufactured for Smart Touch Learning for 2018.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.

Summary 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.

Learning Objective 6 Calculate job costs for a service company

How Do Service Companies Use a Job Order Costing System? Service companies do not have inventory or manufacturing costs. Trace direct labor to jobs. Allocate overhead costs to jobs: Compute the predetermined overhead allocation rate. Allocate indirect costs to jobs, using the predetermined overhead allocation rate. 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: Total expected indirect costs / Expected direct labor hours = Predetermined overhead allocation rate. This rate is used to apply indirect costs to each job.