1. Systems Design: Job-Order Costing
Chapter 2: Systems Design: Job-Order Costing
Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach (also called a full cost approach) to calculating product costs known as job-order costing.

2. 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.
A company would use a job-order costing system when many different products are produced each period. The products are usually manufactured to customers’ specifications. The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

3. Types of Product Costing Systems
Process Costing
Job-order Costing
Example companies: 1. Boeing (aircraft manufacturing) 2. Bechtel International (large scale construction)
3. Walt Disney Studios (movie production)
Companies that may benefit from using job-order cost systems include Boeing, Bechtel International, and Walt Disney Studios. Bechtel is perhaps the largest international construction company. The company works on huge projects that are unique to customer needs.

4. Manufacturing Overhead
Job-Order Costing
Charge direct material and direct labor costs to each job as work is performed.
Direct Materials
Job No. 1
Direct Labor
Job No. 2
In a job-order costing system, direct materials and direct labor are both assigned to individual jobs on which the materials were used and the labor incurred.
Manufacturing Overhead
Job No. 3

5. Manufacturing Overhead
Job-Order Costing
Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job.
Direct Materials
Job No. 1
Direct Labor
Job No. 2
Manufacturing overhead includes indirect materials and indirect labor as well as other manufacturing costs, like the power used to run the machinery in the factory. Manufacturing overhead cannot be traced directly to specific jobs; rather, it is allocated to jobs on the basis of a predetermined rate. Overhead is applied to each job that’s in process using the predetermined rate. We’ll see how to calculate the rate in a few minutes.
Manufacturing Overhead
Job No. 3

6. Manufacturing Overhead Application
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:
It is impossible or difficult to trace overhead costs to particular jobs.
Manufacturing overhead consists of many different items ranging from the grease used in machines to a production manager’s salary.
Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.
Part I Manufacturing overhead is applied to all jobs that are in process. We apply overhead using a base which we believe causes overhead costs to be incurred. Some companies allocate manufacturing overhead using direct labor hours, direct labor dollars, or machine hours.
Part II We must allocate overhead costs to jobs for a variety of reasons. First, it is difficult, if not impossible, to actually trace overhead costs to a particular job. The cost of grease for machinery to manufacture our product is part of our manufacturing costs. It would be impossible to accurately trace the amount of grease consumed to manufacture one unit of output.
Manufacturing overhead also includes a number of different costs and it would be very difficult to gather all of them together in time to charge them to a particular job. A job may be complete and sold before we can determine the actual overhead costs incurred. Finally, many types of overhead are fixed in nature even though output fluctuates during the period.

7. Learning Objective
LO3
To compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process
Learning objective number 3 is to compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

8. Manufacturing Overhead Application
Using a predetermined overhead rate (POHR) makes it possible to estimate total job costs sooner.
Actual overhead for the period is not known until sometime after the period has ended. $
Predetermined overhead rates that rely upon estimated data are often used because actual overhead costs for the period are not known until sometime after the end of the period; thereby inhibiting the ability to estimate job costs during the period. Actual overhead costs can fluctuate seasonally, thus misleading decision makers. Therefore, using a predetermined overhead rate simplifies record keeping.

9. Manufacturing Overhead Application
Based on estimates, and determined before the period begins.
Overhead applied = POHR × Actual activity
Manufacturing overhead is applied to jobs using the predetermined overhead rate multiplied by the actual amount of the allocation base used completing the job (this is called a normal costing system).
Actual amount of the allocation based upon the actual level of activity.

10. Manufacturing Overhead Application
Estimated total manufacturing overhead cost for the coming period
Estimated total units in the allocation base for the coming period
POHR =
$640,000
160,000 direct labor hours (DLH)
POHR =
For example, assume PearCo applies overhead to jobs based on direct labor hours and the estimated total overhead for the year is $640,000.
If estimated total direct labor hours for the year is 160,000 hours, then PearCo’s predetermined overhead rate is $4 per direct labor hour.
POHR = $4.00 per DLH
For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

11. Summary of Cost Flows Raw Materials Work in Process (Job Cost Sheet)
Direct Materials
Material
Purchases
Indirect Materials
Mfg. Overhead
Part I
Here is a T account approach to looking at the cost flows in a job-order cost system. When raw materials are purchased, they are debited to the raw materials inventory account and credited to accounts payable.
Part II
The cost of direct material requisitions is debited to Work in Process and added to the job cost sheet, which serves as a subsidiary ledger.
Part III
The manufacturing overhead account is debited and the raw materials inventory is credited for the indirect materials used.
Actual
Applied

12. Cost Flows – Material Purchases
Raw material purchases are recorded in an inventory account.
Here is an example of the general journal entry to record the purchase of raw materials on account. We debit raw materials and credit accounts payable.

13. Cost Flows – Material Usage
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.
When materials are requisitioned from raw materials inventory, we debit work in process (job cost sheet) for direct materials, and we debit manufacturing overhead for indirect materials.

14. Salaries and Wages Payable
Summary of Cost Flows
Salaries and Wages Payable
Work in Process (Job Cost Sheet)
Direct Labor
Direct Materials
Direct Labor
Indirect Labor
Indirect Labor
Mfg. Overhead
Part I
Wages and salaries are initially recorded in a payable account.
Part II
Direct labor is charged to work in process inventory through the Job-Cost Sheet. Indirect labor is charged to manufacturing overhead.
Actual
Applied
Indirect Materials

15. Cost Flows – Labor
The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.
Here is an example of the entry to charge direct and indirect labor to the work in process inventory account and the manufacturing overhead account.

16. Summary of Cost Flows
Mfg. Overhead
In addition to indirect materials and indirect labor, other actual manufacturing overhead costs are debited to the Manufacturing Overhead account.
Actual
Applied
Indirect Materials
Indirect Labor
Other Overhead
Other actual manufacturing overhead costs are debited to Manufacturing Overhead. The credit side of the entry is the various liability accounts (e.g., Accounts Payable and Property Taxes Payable), prepaid asset accounts (e.g., Prepaid Insurance) and contra-asset accounts (e.g., Accumulated Depreciation).

17. Summary of Manufacturing Overhead Cost Flows
Work in Process (Job Cost Sheet)
Mfg. Overhead
Actual
Applied
Direct Materials
Indirect Materials
Overhead Applied to Work in Process
Direct Labor
Indirect Labor
Overhead Applied
Other Overhead
Manufacturing overhead is applied to each job in work in process inventory by debiting Work in Process and crediting Manufacturing Overhead for the amount of applied overhead based on the predetermined overhead rate. Actual manufacturing overhead costs are not debited to Work in Process, nor are they charged to jobs via the job cost sheets.
The Manufacturing Overhead account is a clearing account. The actual amount of overhead incurred during the period (debit side of the account) will not be equal to the amount applied to the Work in Process account (credit side of the account). Any variance between actual and applied will be accounted for as a year-end adjusting entry. This requires a year-end adjusting entry that will be discussed shortly.
If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.

18. Cost Flows – Overhead Applied
Work in Process is increased when Manufacturing Overhead is applied to jobs.
Recording applied overhead requires a debit to Work in Process and a credit to Manufacturing Overhead.

19. Summary of Goods Manufactured Cost Flows
Work in Process (Job Cost Sheet)
Finished Goods
Cost of Goods Mfd.
Direct Materials
Cost of Goods Mfd.
Direct Labor
Overhead Applied
The sum of all amounts transferred from work in process to finished goods represents the cost of goods manufactured for the period. The Finished Goods account is debited and the Work in Process account is credited.

20. Cost Flows – Cost of Goods Manufactured
As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.
The transfer is accomplished with a debit to finished goods inventory and a credit to work in process inventory.

21. Learning Objective
LO6
To prepare schedules of cost of goods manufactured and cost of goods sold
Learning objective number 6 is to prepare schedules of cost of goods manufactured and cost of goods sold.

22. Job-Order System Cost Flows
Work in Process (Job Cost Sheet)
Finished Goods
Cost of Goods Sold
Cost of Goods Mfd.
Direct Materials
Cost of Goods Mfd.
Direct Labor
Overhead Applied
Cost of Goods Sold
When a finished job is sold to the customer, the cost of that job is transferred from finished goods inventory to cost of good sold. Recall that cost of goods sold is an income statement account. If only a portion of the units associated with a particular job are shipped, then the unit cost figure from the job cost sheet is used to determine the amount of the journal entry.

23. Defining Under- and Overapplied Overhead
The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is termed 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.
When we apply overhead on the basis of a predetermined overhead rate, there is always the chance that the amount of overhead applied will be different from the amount of overhead actually incurred during the period. When there is a difference, we refer to the amount as either underapplied overhead 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.

24. Disposition of Under- or Overapplied Overhead
PearCo’s Mfg. Overhead
PearCo’s Cost of Goods Sold
Actual overhead costs
$650,000
Overhead applied to jobs
$680,000
Unadjusted Balance
$30,000
Part I
The simplest way to close out any remaining balance in the Manufacturing Overhead account is to close it out to Cost of Goods Sold.
Part II
The journal entry, in T-account form, to close out PearCo.’s $30,000 of overapplied overhead into Cost of Goods Sold would be to debit Manufacturing Overhead and credit Cost of Goods Sold.
$30,000 overapplied
Adjusted Balance