SYSTEMS DESIGN: JOB-ORDER COSTING Chapter 5 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

5-22 Learning Objective 1 Distinguish between process costing and job- order costing and identify companies that would use each costing method.

5-3 Types of Product Costing Systems Process Costing Job-order Costing  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.

5-4 Types of Product Costing Systems Process Costing Job-order Costing  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit. Example companies: 1. Weyerhaeuser (paper manufacturing) 2. Reynolds Aluminum (refining aluminum ingots) 3. Coca-Cola (mixing and bottling beverages) Example companies: 1. Weyerhaeuser (paper manufacturing) 2. Reynolds Aluminum (refining aluminum ingots) 3. Coca-Cola (mixing and bottling beverages)

5-5 Types of Product Costing Systems Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

5-6 Types of Product Costing Systems Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job. Example companies: 1. Boeing (aircraft manufacturing) 2. Bechtel International (large scale construction) 3. Walt Disney Studios (movie production) Example companies: 1. Boeing (aircraft manufacturing) 2. Bechtel International (large scale construction) 3. Walt Disney Studios (movie production)

5-77 Comparing Process and Job-Order Costing

5-8 Quick Check 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.

5-9 Quick Check 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.

Learning Objective 2 Identify the documents used in a job-order costing system.

Manufacturing Overhead Job No. 1 Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed. Job-Order Costing – An Overview Direct Materials Direct Labor

Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job. Direct Materials Direct Labor Job No. 1 Job No. 2 Job No. 3 Manufacturing Overhead Job-Order Costing – An Overview

PearCo Job Cost Sheet Job Number A - 143Date Initiated Date Completed Department B3Units Completed Item Wooden cargo crate Direct MaterialsDirect LaborManufacturing Overhead Req. No.AmountTicketHoursAmountHoursRateAmount Cost SummaryUnits Shipped Direct MaterialsDateNumberBalance Direct Labor Manufacturing Overhead Total Cost Unit Product Cost The Job Cost Sheet

5-14 Measuring Direct Materials Cost Will E. Delite

Measuring Direct Materials Cost

Measuring Direct Labor Costs PearCo Employee Time Ticket Time Ticket No.36 Date EmployeeI. M. Skilled Station42 StartingEndingHoursHourly Time CompletedRateAmountJob No $ 88.00$ A-143 Totals $ 88.00$ A-143 Supervisor C. M. Workman

Job-Order Cost Accounting

Learning Objective 3 Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

Why Use an Allocation Base? Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to individual jobs. We use an allocation base because: 1.It is impossible or difficult to trace overhead costs to particular jobs. 2.Manufacturing overhead consists of many different items ranging from the grease used in machines to the production manager’s salary. 3.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

5-20 The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Ideally, the allocation base is a cost driver that causes overhead. Application of Manufacturing Overhead

5-21 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. $ Application of Manufacturing Overhead

Application of Manufacturing Overhead  Estimate the level of production for the period.  Estimate the total amount of the allocation base in the denominator that would be required for that level of production.  Estimate the total manufacturing overhead cost in the numerator that would be incurred for the estimated amount of the allocation base. Predetermined overhead rates are calculated using a three-step process.

5-23 Application of Manufacturing Overhead The predetermined overhead rate (POHR) is based on estimates and determined before the period begins. Actual amount of the allocation is based upon the actual level of activity.

5-24 For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job. POHR = $4.00 per DLH $640, ,000 direct labor hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = Application of Manufacturing Overhead

Job-Order Cost Accounting

Job-Order Cost Accounting

Interpreting the Average Unit Cost The average unit cost should not be interpreted as the cost that would actually be incurred if an additional unit were produced. Fixed overhead would not change if another unit were produced, so the incremental cost of another unit is something less than $118. The average unit cost should not be interpreted as the cost that would actually be incurred if an additional unit were produced. Fixed overhead would not change if another unit were produced, so the incremental cost of another unit is something less than $118.

5-28 Quick Check Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.

5-29 Quick Check Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.

Job-Order Costing Document Flow Summary A sales order is the basis of issuing a production order. A production order initiates work on a job.

Job-Order Costing Document Flow Summary Job Cost Sheets Materials Requisition Manufacturing Overhead Account Direct materials Indirect materials Materials used may be either direct or indirect.

Job-Order Costing Document Flow Summary Job Cost Sheets Employee Time Ticket Manufacturing Overhead Account An employee’s time may be either direct or indirect. Direct Labor Indirect Labor

Job-Order Costing Document Flow Summary Other Actual Overhead Charges Job Cost Sheets Applied Overhead Materials Requisition Employee Time Ticket Indirect Labor Manufacturing Overhead Account Indirect Material

An Extended Example of Job-Order Costing Rand Company produces gold and silver commemorative medallions. At the beginning of April, Rand company had no finished goods inventory and one job (Job A) in process, a special minting of 1,000 gold medallions commemorating the invention of motion pictures. Manufacturing costs incurred to date on Job A total $30,000. Job A will be completed in April and Job B, an order for 10,000 sliver medallions commemorating the fall of the Berlin Wall, will be started in April and finished in a subsequent month. Rand Company produces gold and silver commemorative medallions. At the beginning of April, Rand company had no finished goods inventory and one job (Job A) in process, a special minting of 1,000 gold medallions commemorating the invention of motion pictures. Manufacturing costs incurred to date on Job A total $30,000. Job A will be completed in April and Job B, an order for 10,000 sliver medallions commemorating the fall of the Berlin Wall, will be started in April and finished in a subsequent month.

An Extended Example of Job-Order Costing Given this information, we will now track the flow of Rand Company’s raw materials, direct labor, and overhead costs for April and prepare an income statement for the month.

An Extended Example of Job-Order Costing

An Extended Example of Job-Order Costing

An Extended Example of Job-Order Costing

Learning Objective 4 Apply overhead costs to jobs using a predetermined overhead rate.

An Extended Example of Job-Order Costing Let’s assume the following: Rand’s predetermined overhead rate is $6 per machine hour. During April, 10,000 machine hours were worked on Job A. During April, 5,000 machine hours were worked on Job B. Let’s assume the following: Rand’s predetermined overhead rate is $6 per machine hour. During April, 10,000 machine hours were worked on Job A. During April, 5,000 machine hours were worked on Job B.

An Extended Example of Job-Order Costing

Learning Objective 5 Determine underapplied or overapplied overhead.

Underapplied or Overapplied Overhead The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is referred to as either underapplied or overapplied overhead. Underapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period. Overapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.

Recall the following facts for Rand Company: Underapplied or Overapplied Overhead

5-45 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 Quick Check

5-46 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 Quick Check Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000 Underapplied Overhead $1,210,000 - $1,160,000 = $50,000 Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000 Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

5-47 $5,000 can be closed directly to cost of goods sold. Cost of Goods Sold Rand’s Method Work in Process Finished Goods Cost of Goods Sold $5,000 can be allocated to these accounts. OROR Disposition of Underapplied or Overapplied Overhead

Disposition of Under- or Overapplied Overhead We will always assume that underapplied or overapplied overhead is closed out to Cost of Goods Sold. Overapplied deducted Overapplied overhead is deducted from Cost of Goods Sold. Underapplied added Underapplied overhead is added to Cost of Goods Sold.

5-49 Quick Check Quick Check What effect will the underapplied overhead have on Rand’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease.

5-50 What effect will the underapplied overhead have on Rand’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease. Quick Check Quick Check

Learning Objective 6 Use the direct method to determine cost of goods sold.

Prepare an Income Statement Let’s recall some key facts from the Rand Company example: Job A, which consisted of 1,000 gold medallions, was completed during April, but Job B was not completed. The unit product cost for each of the 1,000 gold medallions included in Job A was $158 ($158,000 ÷ 1,000 units). The overhead for April was underapplied by $5,000.

The Direct Method of Determining Cost of Goods Sold 750 of the 1,000 gold medallions included in Job A were shipped to customers by the end of April. Cost of the medallions sold to customers 750 $158 per unit = $118,500 Cost of the medallions sold to customers 750 $158 per unit = $118,500

The Direct Method of Determining Cost of Goods Sold

Learning Objective 7 Use the indirect method to determine cost of goods sold.

The Indirect Method of Determining Cost of Goods Sold Let’s recall some key facts from the Rand Company example: The beginning work in process inventory was $30,000—the beginning balance on Job A’s cost sheet. There was no beginning finished goods inventory on April 1. The total manufacturing costs charged to jobs in April was $200,000 (direct materials of $50,000, direct labor of $60,000, and manufacturing overhead applied of $90,000). The ending work in process inventory is $72,000—the accumulated cost of Job B. Manufacturing overhead was underapplied by $5,000.

Computing Ending Finished Goods Inventory 250 of the 1,000 gold medallions included in Job A were unsold and in ending finished goods inventory. Cost of the medallions in ending finished goods inventory 250 $158 per unit = $39,500 Cost of the medallions in ending finished goods inventory 250 $158 per unit = $39,500

Computing Cost of Goods Manufactured

Computing Cost of Goods Manufactured

Computing Cost of Goods Sold

Computing Cost of Goods Sold Add $5,000 underapplied overhead to obtain $123,500 cost of goods sold.

Prepare an Income Statement To complete the income statement, let’s assume that Rand Company’s total sales revenue and selling and administrative expenses for April were $225,000 and $87,000, respectively.

Prepare an Income Statement

Multiple Predetermined Overhead Rates To this point, we have assumed that there is a single predetermined overhead rate called a plantwide overhead rate. Large companies often use multiple predetermined overhead rates, Which is more complex but... it is more accurate because it reflects differences across departments.

Job-Order Costing in Service Companies Job-order costing is used in many different types of service companies.

5-66 Appendix 5A The Predetermined Overhead Rate and Capacity

Learning Objective 8 Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

Predetermined Overhead Rate and Capacity Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because: 1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level. 2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use. Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because: 1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level. 2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use.

Capacity-Based Overhead Rates These criticisms can be overcome by using estimated total units in the allocation base at capacity in the denominator of the predetermined overhead rate calculation. Let’s look at the difference!

An Example Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate?

An Example Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate? Estimated Method = $2.50 per unit $100,000 40,000 = Capacity Method = $2.00 per unit $100,000 50,000 =

5-72 Quick Check Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

5-73 Quick Check Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

5-74 Quick Check Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

5-75 Quick Check Quick Check Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

5-76 Quick Check Quick Check When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

5-77 Quick Check Quick Check When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

5-78 Quick Check Quick Check When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

5-79 Quick Check Quick Check When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

5-80 Income Statement Preparation (Capacity Method)

5-81 Income Statement Preparation (Estimated Method)

5-82 End of Chapter 5