© 2015 Pearson Education, Limited.

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 © 2015 Pearson Education, Limited.

Distinguish between job order costing and process costing
Learning Objective 1 Distinguish between job order costing and process costing © 2015 Pearson Education, Limited.

Knowing the Cost of One Unit of Product Helps Managers to:
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 Managers use cost accounting systems to plan and control. If the manager can calculate the cost of one unit of product, then he or she can use that information to plan a selling price that will produce profits for the company. In addition, this enables the manager to compute both the cost of goods sold on the income statement and the value of the ending inventory on the balance sheet. Once the cost per unit of product is known, the manager can plan and control those costs. © 2015 Pearson Education, Limited.

Examples of Unit Costs Exhibit 19-1 Examples of Unit Costs Managers of a(n): Need to know the cost to: Fast food restaurant Make a cheeseburger Freight service Transport a pound of freight for a mile Automobile manufacturer Make a car Construction firm Build a house Accounting firm Prepare a tax return Exhibit 19-1 illustrates several examples of unit costs. Note that unit cost information is used by all types of businesses—not just by manufacturers. This data is useful for service businesses and merchandisers as well. © 2015 Pearson Education, Limited.

Costing Systems Job Order Costing Process Costing Unique product/ specialized service Identical units Accumulates costs by job Accumulates costs by process There are two types of 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 In contrast, process costing is used by businesses that manufacture large quantities of identical units. Production is carried out through a series of steps or processes and costs are accumulated for each process. Examples of the types of companies that use process costing are: soft drink manufacturers, whose processes may include mixing, bottling, and packaging; surfboard manufacturers, whose processes may include sanding, painting, waxing, and packaging; and medical equipment manufacturers of a blood glucose meter whose processes may include soldering, assembling, and testing. © 2015 Pearson Education, Limited.

Four-Step Method to Track Product Costs
Accumulate Assign Allocate Adjust There are four steps that are used to track product costs. These same four steps are followed whether we are using job order costing or process costing. The steps are: accumulate, assign, allocate, and adjust. These steps will be used as we follow how the product costs flow through the inventory accounts on the balance sheet to cost of goods sold on the income statement. © 2015 Pearson Education, Limited.

>TRY IT! Would the following companies most likely use job order costing or process costing? Paint manufacturer Process costing Print shop Caterer Soft drink bottler Yacht builder © 2015 Pearson Education, Limited.

>TRY IT! Would the following companies most likely use job order costing or process costing? Paint manufacturer Process costing Print shop Job order costing Caterer Soft drink bottler Yacht builder © 2015 Pearson Education, Limited.

Record materials and labor costs in a job order costing system
Learning Objective 2 Record materials and labor costs in a job order costing system © 2015 Pearson Education, Limited.

Flow of Product Costs in Job Order Costing
Exhibit 19-2 Flow of Product Costs in Job Order Costing Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead Exhibit 19-2 shows the flow of product costs through a job order costing system. It begins with the job cost record. As soon as a job is started, all of the direct materials, direct labor, and manufacturing overhead costs for the job are recorded on this job cost record. Here, Smart Touch Learning has started three jobs during the accounting period: Job 27, Job 28, and Job 29. Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records © 2015 Pearson Education, Limited.

Exhibit 19-2 Flow of Product Costs in Job Order Costing BALANCE SHEET Work-in-Process Inventory Costs Incurred Job 27 Job 28 Job 29 Finished Goods Inventory Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead Costs incurred for each job are added to WIP with debits Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead Work-in-process inventory and finished goods inventory are asset accounts on the balance sheet. The total costs of each job are added to work-in-process inventory by debiting the account. Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records © 2015 Pearson Education, Limited.

Exhibit 19-2 Flow of Product Costs in Job Order Costing BALANCE SHEET Work-in-Process Inventory Costs Incurred Job 27 Job 28 Job 29 COGM Finished Goods Inventory COGM Job 27 Job 28 Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead When the job is completed, the costs are transferred out of WIP with a credit and transferred into FG with a debit. This amount is called the job’s Cost of Goods Manufactured (COGM) Costs incurred for each job are added to WIP with debits Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead When a job is finished, the company totals the costs and transfers the costs from work-in-process inventory to finished goods inventory. The costs transferred to finished goods inventory are called cost of goods manufactured. In this example, Smart Touch finished Jobs 27 and 28. Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records © 2015 Pearson Education, Limited.

Exhibit 19-2 Flow of Product Costs in Job Order Costing BALANCE SHEET INCOME STATEMENT Work-in-Process Inventory Costs Incurred Job 27 Job 28 Job 29 COGM Finished Goods Inventory COGM Job 27 Job 28 COGS Cost of Goods Sold COGS Job 27 Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead When the job is sold, the costs are transferred out of FG with a credit and transferred into COGS with a debit. This amount is the job’s Cost of Goods Sold (COGS). When the job is completed, the costs are transferred out of WIP with a credit and transferred into FG with a debit. This amount is called the job’s Cost of Goods Manufactured (COGM) Costs incurred for each job are added to WIP with debits Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead When the job’s units are sold, the costing system moves the costs from finished goods inventory, which is an asset on the balance sheet, to cost of goods sold, which is an expense on the income statement. Here we see that Smart Touch sold all the units from Job 27. Taking a closer look, we see that the ending balance in work-in-process inventory is the cost of Job 29, which is the only job that is not complete and still in-process at the end of the period. The ending balance in finished goods inventory is the cost of Job 28, the only job that was completed but still not delivered to the customer. The ending balance in cost of goods sold is the cost of Job 27, the only job completed and sold during the period. Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records © 2015 Pearson Education, Limited.

Accounts and Explanations Raw Materials Inventory
Purchasing Materials Transaction 1—Materials Purchased: During 2016, Smart Touch purchased raw materials of $367,000 on account. Date Accounts and Explanations Debit Credit A = L + E We are now going to look at how specific transactions are journalized in a job order costing system. During 2016, Smart Touch purchased raw materials of $367,000 on account. Note: To simplify the recording process, we are recording the purchases as a summary journal entry for the year, rather than showing each individual purchase. The raw materials inventory account had a beginning balance of $70,000. Raw Materials Inventory Bal. 70,000 © 2015 Pearson Education, Limited.

Accounts and Explanations Raw Materials Inventory
Purchasing Materials Transaction 1—Materials Purchased: During 2016, Smart Touch purchased raw materials of $367,000 on account. Date Accounts and Explanations Debit Credit Trans. 1 Raw Materials Inventory 367,000 Accounts Payable A ↑ = L ↑ + E RM ↑ A/P ↑ This is a product cost that accumulates in the raw materials inventory account. Raw materials inventory is debited to increase the asset account. Accounts payable is credited to increase the liability account. It is important to note that Smart Touch’s raw materials inventory is a general ledger account. Smart Touch also has a subsidiary ledger for raw materials. The subsidiary ledger contains the details of a general ledger account, and the sum of the subsidiary ledger records equals the balance in the general ledger account. Raw Materials Inventory Bal. 70,000 Trans ,000 © 2015 Pearson Education, Limited.

Raw Materials Subsidiary Ledger
In this case, the raw materials subsidiary ledger would include a separate record for each type of material that Smart Touch Learning uses to produce its tablets. So, Smart Touch would have a separate page for the batteries, processors, cases, and other materials used. Exhibit 19-3 shows an example of Smart Touch’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. © 2015 Pearson Education, Limited.

Materials Requisition
When Smart Touch started Job 27 on January 14, the production team requested materials for the job by filling out a materials requisition, as shown in Exhibit 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 19-3 records the materials requisition number (342) along with the number of units requisitioned and their cost. © 2015 Pearson Education, Limited.

Job Cost Record—Direct Materials Recorded
When the raw materials are received on the production floor, they are recorded on the job cost record. Exhibit 19-5 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. © 2015 Pearson Education, Limited.

Using Materials Transaction 2—Materials Used: In 2016, Smart Touch used direct materials costing $355,000 and indirect materials of $17,000. Date Accounts and Explanations Debit Credit A = L + E Smart Touch 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 can be easily and cost-effectively traced directly to the finished product. In 2016, Smart Touch used direct materials costing $355,000 and indirect materials of $17,000. Work-in-process inventory had a beginning balance of $80,000. Raw Materials Inventory Bal. 70,000 Trans ,000 Work-in-Process Inventory Bal. 80,000 © 2015 Pearson Education, Limited.

Using Materials Transaction 2—Materials Used: In 2016, Smart Touch used direct materials costing $355,000 and indirect materials of $17,000. Date Accounts and Explanations Debit Credit Trans. 2 Work-in-Process Inventory (direct materials) 355,000 Manufacturing Overhead (indirect materials) 17,000 Raw Materials Inventory 372,000 A ↓ = L + E ↓ RM ↓ WIP ↑ MOH ↑ 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 to that account. 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. Raw Materials Inventory Bal. 70,000 Trans ,000 Trans ,000 Work-in-Process Inventory Bal. 80,000 Trans ,000 Direct materials $355,000 Manufacturing Overhead Trans. 2 17,000 Indirect materials $17,000 © 2015 Pearson Education, Limited.

Job Cost Record—Direct Labor Recorded
Now that we know how to record the purchase and use of materials, we will take a look at how labor is recorded in a job order costing system. Exhibit 19-6 shows the job cost record for Job 27. Direct materials have been recorded, as shown previously. Direct labor costs are assigned to the job based on labor time records. These labor time records may be obtained electronically when employees swipe their ID cards and enter job information, or they many be obtained from a manual system. In either case, the labor time record reports the number of hours worked on the job and the hourly wage rate, and then computes the total direct labor cost for the job. In this example, a Smart Touch employee worked 5 hours on Job 27. The employee’s hourly rate was $18 per hour. Therefore, the total direct labor cost is $90, which is calculated by multiplying the 5 hours worked by the $18 hourly rate. © 2015 Pearson Education, Limited.

Labor Costs Incurred Transaction 3—Labor Costs Incurred: During 2016, Smart Touch incurred total labor costs of $197,000, of which $169,000 was direct labor and $28,000 was indirect labor. Date Accounts and Explanations Debit Credit A = L + E Work-in-Process Inventory Bal. 80,000 Trans ,000 During 2016, Smart Touch 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. Manufacturing Overhead Trans. 2 17,000 © 2015 Pearson Education, Limited.

Labor Costs Incurred Transaction 3—Labor Costs Incurred: During 2016, Smart Touch incurred total labor costs of $197,000, of which $169,000 was direct labor and $28,000 was indirect labor. Date Accounts and Explanations Debit Credit Trans. 3 Work-in-Process Inventory (direct labor) 169,000 Manufacturing Overhead (indirect labor) 28,000 Wages Payable 197,000 A ↑ = L ↑ + E ↓ WIP ↑ Wages Pay ↑ MOH ↑ Wages Payable Trans ,000 Work-in-Process Inventory Bal. 80,000 Trans ,000 Trans ,000 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 the direct and indirect materials illustrated in Transaction 2. Direct labor $169,000 Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Indirect labor $28,000 © 2015 Pearson Education, Limited.

>TRY IT! Record the following journal entries for Smith Company: Used $6,000 in direct materials and $500 in indirect materials in production. Work in Process Inventory 6,000 Manufacturing Overhead 500 Raw Materials Inventory 6,500 © 2015 Pearson Education, Limited.

>TRY IT! Record the following journal entries for Smith Company: Incurred $8,000 in labor costs, of which 80% was direct labor. Work in Process Inventory 6,400 Manufacturing Overhead 1,600 Wages Payable 8,000 © 2015 Pearson Education, Limited.

Actual Overhead Costs Incurred
Transaction 4—Actual Overhead Costs Incurred: Depreciation on manufacturing plant and equipment, $20,000. Date Accounts and Explanations Debit Credit A = L + E Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 We have already accumulated the costs of indirect materials (transaction 2) and indirect labor (transaction 3) to manufacturing overhead. In the next few transactions, we will see that all manufacturing overhead costs are accumulated as debits to the manufacturing overhead account. Let’s look at Transaction 4: Depreciation on manufacturing plant and equipment is $20,000. © 2015 Pearson Education, Limited.

Transaction 4—Actual Overhead Costs Incurred: Depreciation on manufacturing plant and equipment, $20,000. Date Accounts and Explanations Debit Credit Trans. 4 Manufacturing Overhead 20,000 Accumulated Depreciation A ↓ = L + E ↓ Accum Depr ↑ MOH ↑ Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Manufacturing overhead is debited for the actual overhead cost of $20,000, and accumulated depreciation is increased with a credit of $20,000. © 2015 Pearson Education, Limited.

Transaction 5—Actual Overhead Costs Incurred: Plant utilities, $7,000. Date Accounts and Explanations Debit Credit A = L + E Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 In Transaction 5, plant utilities of $7,000 are paid. © 2015 Pearson Education, Limited.

Transaction 5—Actual Overhead Costs Incurred: Paid $7,000 for plant utilities. Date Accounts and Explanations Debit Credit Trans. 5 Manufacturing Overhead 7,000 Cash A ↓ = L + E ↓ Cash ↓ MOH ↑ Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Manufacturing overhead is debited for the actual overhead cost of $7,000, and cash is decreased with a corresponding credit. © 2015 Pearson Education, Limited.

Transaction 6—Actual Overhead Costs Incurred: Plant insurance, $6,000 (previously paid). Date Accounts and Explanations Debit Credit A = L + E Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 In Transaction 6, plant insurance of $6,000 that was previously paid expires. © 2015 Pearson Education, Limited.

Transaction 6—Actual Overhead Costs Incurred: Plant insurance, $6,000 (previously paid). Date Accounts and Explanations Debit Credit Trans. 6 Manufacturing Overhead 6,000 Prepaid Insurance A ↓ = L + E ↓ Prepaid Ins ↓ MOH ↑ Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Manufacturing overhead is debited for the actual overhead cost of $6,000, and prepaid insurance is decreased with a credit. © 2015 Pearson Education, Limited.

Transaction 7—Actual Overhead Costs Incurred: Plant property taxes incurred but not yet paid, $5,000. Date Accounts and Explanations Debit Credit A = L + E Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 In Transaction 7, plant property taxes incurred but not yet paid are $5,000. © 2015 Pearson Education, Limited.

Transaction 7—Actual Overhead Costs Incurred: Plant property taxes incurred but not yet paid, $5,000. Date Accounts and Explanations Debit Credit Trans. 7 Manufacturing Overhead 5,000 Property Taxes Payable A = L ↑ + E ↓ Prop Tax Pay ↑ MOH ↑ Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Manufacturing overhead is debited for the actual overhead cost of $5,000, and property taxes payable is increased with a credit. Throughout the year, Smart Touch has debited manufacturing overhead for actual manufacturing overhead costs as they occur. By the end of the year, the manufacturing overhead account has accumulated all of the $83,000 of actual overhead costs as debits. As you can see, overhead includes a variety of costs that the company cannot trace to individual jobs. For example, it is impossible to say how much of the cost of plant utilities is related to Job 27. Yet manufacturing overhead costs are as essential as direct materials and direct labor, so Smart Touch must find some way to allocate overhead costs to specific jobs. Otherwise, each job would not bear its fair share of the total cost. Bal 83,000 © 2015 Pearson Education, Limited.

Steps for Allocating Overhead Costs
Calculating the predetermined overhead rate before the period Allocating overhead during the period Adjusting overhead at the end of the period To determine the amount of overhead to allocate to specific jobs, there is a three-step process that occurs at three different points in the accounting cycle: First, a predetermined overhead is calculated before the accounting period. Next, the overhead is allocated during the period. Finally, the overhead is adjusted at the end of the period. © 2015 Pearson Education, Limited.

Predetermined Overhead Allocation Rate
Total estimated overhead costs Total estimated quantity of the overhead allocation base If we wanted to make the most accurate allocation of overhead, we could only do this when the total overhead cost was known—and that is not until the end of the period. However, managers cannot wait that long for product cost information. Therefore, a predetermined overhead rate is used to allocate estimated overhead costs to individual jobs. This predetermined overhead allocation rate is calculated before the period begins. The formula to calculate the rate is: total estimated overhead costs for the period divided by total estimated quantity of the overhead allocation base. What do we mean by “overhead allocation base”? The allocation base is a denominator that links overhead costs to the products. It is the primary cost driver of manufacturing overhead. In other words, a cost driver is the primary factor that causes, or drives, a cost. For example, the cost of electricity to operate machinery increases with increased machine use. Therefore, the cost driver for electricity is machine usage. So, the allocation base would be the number of hours the machine runs. There is a relationship between the overhead cost and the allocation base; that is, the higher the quantity of the allocation base, the higher the overhead costs, and vice versa. © 2015 Pearson Education, Limited.

Traditional Cost Drivers
Direct labor hours (for labor-intensive production environments) Direct labor cost (for labor-intensive production environments) Machine hours (for machine-intensive production environments) There are three cost drivers that 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. © 2015 Pearson Education, Limited.

At the end of 2015, Smart Touch estimated that total overhead costs for 2016 would be $68,000 and direct labor cost would total $170,000. Let’s take a look at an example of how this predetermined overhead allocation rate is computed. At the end of 2015, Smart Touch estimated that total overhead costs for 2016 would be $68,000 and direct labor cost would total $170,000. © 2015 Pearson Education, Limited.

At the end of 2015, Smart Touch estimated that total overhead costs for 2016 would be $68,000 and direct labor cost would total $170,000. Total estimated overhead costs Total estimated quantity of the overhead allocation base $ 68,000 $170,000 = 0.40 = 40% We take Smart Touch’s estimated overhead costs of $68,000 for the year and divide by their estimated direct labor cost of $170,000 for the year. The result is a rate of 40%. © 2015 Pearson Education, Limited.

Allocating Overhead Allocated Manufacturing Overhead Cost =
Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job So, how does a company allocate overhead costs to jobs? As jobs are completed, the company will use the predetermined overhead allocation rate to allocate overhead costs to the particular job as follows: the predetermined overhead rate will be multiplied by the actual quantity of the allocation base used by each job. © 2015 Pearson Education, Limited.

Allocating Overhead Smart Touch Learning’s total direct labor cost for Job 27 was $1,250. How much overhead should be allocated to Job 27? Let’s look at an example using Smart Touch Learning. The total direct labor cost for Job 27 was $1,250. © 2015 Pearson Education, Limited.

Allocating Overhead Smart Touch Learning’s total direct labor cost for Job 27 was $1,250. How much overhead should be allocated to Job 27? Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job 40% $1,250 $500 To allocate overhead to Job 27, Smart Touch will multiply the predetermined overhead allocation rate of 40% by the actual direct labor cost for the job. The result is that $500 of overhead is allocated to Job 27. Smart Touch uses the same predetermined overhead rate to allocate manufacturing overhead to all jobs worked on throughout the year, including jobs still in process at the end of the accounting period. © 2015 Pearson Education, Limited.

Job Cost Record—Completed
Exhibit 19-7 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. Cost of goods manufactured Total units produced $4,500 15 tablets = $300 per tablet © 2015 Pearson Education, Limited.

Accounts and Explanations
Overhead Allocation Transaction 8—Overhead Allocation: Smart Touch’s total direct labor cost for 2016 was $169,000. Overhead was allocated based on direct labor cost. Date Accounts and Explanations Debit Credit A = L + E Smart Touch’s total direct labor cost for 2016 was $169,000, as seen previously in Transaction 3. This information is used to calculate the amount of manufacturing overhead to be allocated. © 2015 Pearson Education, Limited.

Overhead Allocation Transaction 8—Overhead Allocation: Smart Touch’s total direct labor cost for 2016 was $169,000. Overhead was allocated based on direct labor cost. Date Accounts and Explanations Debit Credit Trans. 8 Work-in-Process Inventory 67,600 Manufacturing Overhead A ↑ = L + E ↑ WIP ↑ MOH ↓ Manufacturing Overhead Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Work-in-Process Inventory Bal. 80,000 Trans ,000 Trans ,000 Trans. 8 67,600 Smart Touch allocated manufacturing overhead to each of the jobs worked on in 2016, including jobs still in process at the end of the year. We calculate the total overhead allocated to all jobs by multiplying the predetermined overhead allocation rate of 40% by the $169,000 direct labor cost. The result is $67,600 of overhead being allocated to the work-in-process inventory. Work-in-Process is increased with a debit for the allocated overhead cost of $67,600, and manufacturing overhead is decreased with a credit. After Transaction 8, the manufacturing overhead account has a debit balance of $15,400. This means that Smart Touch’s actual overhead costs of $83,000 were greater than the allocated overhead of $67,600. We say that Smart Touch’s manufacturing overhead is underallocated because the company allocated less costs to jobs than actual costs incurred. Recall that manufacturing overhead is a temporary account used to accumulate indirect production costs during the accounting period. At the end of the accounting period, the manufacturing overhead account must have a zero balance. Therefore, an adjustment is required if overhead is underallocated or overallocated at the end of the period. We will show how to prepare this adjustment after we account for the completion and sale of the goods. Overhead Allocated 40% × $169,000 Bal 15,400 © 2015 Pearson Education, Limited.

>TRY IT! Smith Company expected to incur $10,000 in manufacturing overhead costs and use 4,000 machine hours for the year. Actual manu-facturing overhead was $9,700 and the company used 4,250 machine hours. © 2015 Pearson Education, Limited.

$2.50 per machine hour × 4,250 machine hours
>TRY IT! How much manufacturing overhead was allocated during the year? $2.50 per machine hour × 4,250 machine hours = $10,625 © 2015 Pearson Education, Limited.

Record the completion and sales of finished goods
Learning Objective 4 Record the completion and sales of finished goods © 2015 Pearson Education, Limited.

Exhibit 19-8 Flow of Product Costs for Jobs 27, 28, and 29 BALANCE SHEET INCOME STATEMENT Work-in-Process Inventory Costs Incurred Job 27 4,500 Job 28 6,000 Job 29 3,300 Bal 3,300 COGM Finished Goods Inventory COGM Job 27 4,500 Job 28 6,000 Bal 6,000 COGS Cost of Goods Sold COGS Job 27 4,500 Bal 4,500 Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead When the job is sold, the costs are transferred out of FG with a credit and transferred into COGS with a debit. This amount is the job’s Cost of Goods Sold (COGS). When the job is completed, the costs are transferred out of WIP with a credit and transferred into FG with a debit. This amount is called the job’s Cost of Goods Manufactured (COGM) Costs incurred for each job are added to WIP with debits Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead Let’s review the flow of costs through the accounts. Exhibit 19-8 shows the flow of costs of three jobs at Smart Touch—Job 27, Job 28, and Job 29. When Job 27 and Job 28 were completed, their costs were transferred from work-in-process inventory to finished goods inventory. The amount transferred is the cost of goods manufactured. The ending balance in work-in-process inventory is equal to the cost of partially completed Job 29. Looking next at the finished goods inventory account, we see that Job 27 was sold and its costs were transferred to cost of goods sold. Therefore, the ending balance in finished goods inventory is equal to Job 28, which is the only job completed but not sold. The balance in cost of goods sold is equal to the cost of Job 27, which was the only job sold. Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records © 2015 Pearson Education, Limited.

Jobs Completed Transaction 9—Jobs Completed: The $644,600 Cost of Goods Manufactured is the cost of all jobs Smart Touch completed during 2016. Date Accounts and Explanations Debit Credit A = L + E Following this flow of costs through the accounts, we next look at how to account for the completion of jobs. Normally, this entry 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 completed during 2016 is $644,600. This is the cost of goods manufactured. This amount must be transferred from work-in-process inventory to finished goods inventory as jobs are completed and moved into the finished goods storage area. © 2015 Pearson Education, Limited.

Jobs Completed Transaction 9—Jobs Completed: The $644,600 Cost of Goods Manufactured is the cost of all jobs Smart Touch completed during 2016. Date Accounts and Explanations Debit Credit Trans. 9 Finished Goods Inventory 644,600 Work-in-Process Inventory A ↑ ↓ = L + E FG ↑ WIP ↓ Work-in-Process Inventory Bal. 80,000 Trans ,000 Trans ,600 Trans ,000 Trans. 8 67,600 Finished Goods Inventory Bal. 0 Trans ,600 To accomplish this, finished goods inventory is increased with a debit of $644,600, and work-in-process inventory is decreased with a credit. Cost of Goods Manufactured © 2015 Pearson Education, Limited.

Jobs Sold Transaction 10—Jobs Sold: During 2016, sales on account were $1,200,000. Date Accounts and Explanations Debit Credit A = L + E Transaction 10 records $1,200,000 of sales on account. © 2015 Pearson Education, Limited.

Jobs Sold Transaction 10—Jobs Sold: During 2016, sales on account were $1,200,000 Date Accounts and Explanations Debit Credit Trans. 10 Accounts Receivable 1,200,000 Sales Revenue A ↑ = L + E ↑ A/R ↑ Sales ↑ The asset accounts receivable is increased with a debit, and sales revenue is increased with a credit. © 2015 Pearson Education, Limited.

Cost of Jobs Sold Transaction 11—Cost of Jobs Sold: The cost of all jobs that Smart Touch sold during 2016 was $584,600. Date Accounts and Explanations Debit Credit A = L + E Transaction 11 records the $584,000 cost of all jobs that were sold in 2016. © 2015 Pearson Education, Limited.

Accounts and Explanations Finished Goods Inventory
Cost of Jobs Sold Transaction 11—Cost of Jobs Sold: The cost of all jobs that Smart Touch sold during 2016 was $584,600. Date Accounts and Explanations Debit Credit Trans. 11 Cost of Goods Sold 584,600 Finished Goods Inventory A ↓ = L + E ↓ FG ↓ COGS ↑ Finished Goods Inventory Bal. 0 Trans ,600 Trans ,600 Cost of Goods Sold Trans ,600 Cost of goods sold is increased with a debit, and the asset finished goods inventory is decreased with a credit. Cost of Goods Sold © 2015 Pearson Education, Limited.

Summary of the Completion and Sale of Jobs
BALANCE SHEET INCOME STATEMENT Work-in-Process Inventory Costs Incurred COGM Bal. 80,000 Trans ,000 Trans ,600 Trans ,000 Trans. 8 67,600 Bal. 27,000 Finished Goods Inventory COGM COGS Bal. 0 Trans ,600 Trans ,600 Bal. 60,000 Cost of Goods Sold COGS Trans ,600 To summarize the flow of costs through the accounts when jobs are completed and sold, we look at the work-in-process accounts, which are assets on the balance sheet; and cost of goods sold, which is an expense on the income statement. As jobs are completed, their costs are transferred from work-in-process inventory to finished goods inventory. The $27,000 ending balance in the work-in-process inventory account represents the cost of jobs started but not finished at the end of the period. The cost of all jobs sold is transferred from finished goods inventory to cost of goods sold. The $60,000 ending balance in finished goods inventory represents the cost of all jobs that are completed but not sold. © 2015 Pearson Education, Limited.

>TRY IT! The following information pertains to Smith Company, which you worked with previously in this chapter: Smith Company completed jobs that cost $25,000 to manufacture. Record the journal entry. © 2015 Pearson Education, Limited.

>TRY IT! The following information pertains to Smith Company, which you worked with previously in this chapter: Smith Company completed jobs that cost $25,000 to manufacture. Record the journal entry. Finished Goods Inventory 25,000 Work-in-Process Inventory 25,000 © 2015 Pearson Education, Limited.

>TRY IT! Smith Company sold jobs to customers on account for $52,000 that cost $22,000 to manufacture. Record the journal entries. Accounts Receivable 52,000 Sales Revenues 52,000 Cost of Goods Sold 22,000 Finished Goods Inventory 22,000 © 2015 Pearson Education, Limited.

Adjust for overallocated and underallocated overhead
Learning Objective 5 Adjust for overallocated and underallocated overhead © 2015 Pearson Education, Limited.

Manufacturing Overhead Balance
Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal. 15,400 Allocated costs Actual costs $83,000 The last step of recording costs in a job order costing system is to adjust the manufacturing overhead account for the amount of overallocated or underallocated overhead. The total debits to the Manufacturing Overhead account rarely equal the total credits because overhead is allocated using a predetermined overhead allocate rate based on estimates. At the end of the accounting period, Smart Touch has a $15,400 debit balance in the manufacturing overhead account. When there is a debit balance in the manufacturing overhead account, we say that overhead is underallocated because the manufacturing overhead allocated to work-in-process inventory was less than the actual overhead cost. If there is a credit balance in the manufacturing overhead account, we say that overhead is overallocated. This occurs when the actual manufacturing overhead costs are less than allocated manufacturing costs. © 2015 Pearson Education, Limited.

Adjusting Manufacturing Overhead
Transaction 12—Adjusting Manufacturing Overhead: At the end of 2016, the Manufacturing Overhead account is closed. Date Accounts and Explanations Debit Credit A = L + E At the end of the accounting period, the underallocated and overallocated overhead is adjusted by closing the manufacturing overhead account. Closing the account means zeroing it out. © 2015 Pearson Education, Limited.

Adjusting Manufacturing Overhead
Transaction 12—Adjusting Manufacturing Overhead: At the end of 2016, the Manufacturing Overhead account is closed. Date Accounts and Explanations Debit Credit Trans. 12 Cost of Goods Sold 15,400 Manufacturing Overhead A = L + E ↑ ↓ COGS ↑ MOH ↓ Manufacturing Overhead Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal. 15,400 Trans ,400 Bal. 0 Cost of Goods Sold Trans ,600 Trans ,400 Bal. 600,000 In order to bring the balance of Smart Touch’s manufacturing overhead account to zero, we need to credit the account. The debit portion of the entry increases the cost of goods sold account. The underallocated overhead indicates that Smart Touch undercosted jobs by $15,400 during the year. The costs flowed through work-in-process inventory, finished goods inventory, and ultimately were transferred to cost of goods sold. Therefore, the adjustment is made to cost of goods sold. After transaction 12, the manufacturing overhead balance is zero, and the cost of goods sold is up to date. Underallocated Manufacturing Overhead © 2015 Pearson Education, Limited.

Accounting for Manufacturing Overhead
Exhibit 19-9 Accounting for Manufacturing Overhead Before the Period Calculating the Predetermined Overhead Allocation Rate Predetermined Overhead Allocation Rate = Total estimated manufacturing costs Total estimated quantity of the overhead allocation base Exhibit 19-9 summarizes the accounting for manufacturing overhead. Before the period, the predetermined overhead allocation rate is calculated by dividing total estimated manufacturing costs by total estimated quantity of the overhead allocation base. © 2015 Pearson Education, Limited.

Exhibit 19-9 Accounting for Manufacturing Overhead Before the Period Calculating the Predetermined Overhead Allocation Rate Predetermined Overhead Allocation Rate = Total estimated manufacturing costs Total estimated quantity of the overhead allocation base During the Period Allocating Overhead Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job During the period, manufacturing overhead is allocated by multiplying the predetermined overhead allocation rate by actual quantity of the allocation base used by each job. © 2015 Pearson Education, Limited.

Exhibit 19-9 Accounting for Manufacturing Overhead Before the Period Calculating the Predetermined Overhead Allocation Rate Predetermined Overhead Allocation Rate = Total estimated manufacturing costs Total estimated quantity of the overhead allocation base During the Period Allocating Overhead Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job At the end of the period, an adjustment is made for any overallocated or underallocated overhead. If actual manufacturing overhead costs were greater than allocated manufacturing overhead costs, manufacturing overhead is underallocated and cost of goods sold is undercosted. To close manufacturing overhead, cost of goods sold is increased with a debit, and manufacturing overhead is decreased with a credit. At the End of the Period Adjusting for Overallocated and Underallocated Overhead Manufacturing Overhead Cost of Goods Sold Journal Entry Actual costs > allocated costs Underallocated Undercosted DR – COGS ↑ CR – MOH ↓ © 2015 Pearson Education, Limited.

Exhibit 19-9 Accounting for Manufacturing Overhead Before the Period Calculating the Predetermined Overhead Allocation Rate Predetermined Overhead Allocation Rate = Total estimated manufacturing costs Total estimated quantity of the overhead allocation base During the Period Allocating Overhead Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job If actual manufacturing overhead costs were less than allocated manufacturing overhead costs, manufacturing overhead is overallocated and cost of goods sold is overcosted. To close manufacturing overhead, manufacturing overhead is increased with a debit, and cost of goods sold is decreased with a credit. At the End of the Period Adjusting for Overallocated and Underallocated Overhead Manufacturing Overhead Cost of Goods Sold Journal Entry Actual costs > allocated costs Underallocated Undercosted DR – COGS ↑ CR – MOH ↓ Actual costs < allocated costs Overallocated Overcosted DR – MOH ↑ CR – COGS ↓ © 2015 Pearson Education, Limited.

Summary of Journal Entries
Exhibit 19-10 Date Accounts and Explanations Debit Credit Trans. 1 Raw Materials Inventory 367,000 Accounts Payable Materials purchased, accumulated in RM Trans. 2 Work-in-Process Inventory (direct materials) 355,000 Manufacturing Overhead (indirect materials) 17,000 372,000 Materials used, direct materials assigned to WIP, indirect materials accumulated in MOH Trans. 3 Work-in-Process Inventory 169,000 Manufacturing Overhead 28,000 Wages Payable 197,000 Labor incurred, direct labor assigned to WIP, indirect labor accumulated in MOH A ↑ = L ↑ + E RM ↑ A/P ↑ A ↓ = L + E ↓ RM ↓ WIP ↑ MOH ↑ As costs flow through the job order costing system, we go through a four-step process to accumulate, assign, allocate and adjust. Exhibit is a list of all journal entries illustrated in the chapter with notations on the four steps. A ↑ = L ↑ + E ↓ WIP ↑ Wages Pay ↑ MOH ↑ © 2015 Pearson Education, Limited.

Summary of Journal Entries (continued)
Exhibit Continued Date Accounts and Explanations Debit Credit Trans. 4 Manufacturing Overhead 20,000 Accumulated Depreciation Overhead incurred, costs accumulated in MOH Trans. 5 7,000 Cash Trans. 6 6,000 Prepaid Insurance A ↓ = L + E ↓ Accum Depr ↑ MOH ↑ A ↓ = L + E ↓ Cash ↓ MOH ↑ A ↓ = L + E ↓ Prepaid Insurance ↓ MOH ↑ © 2015 Pearson Education, Limited.

Exhibit Continued Date Accounts and Explanations Debit Credit Trans. 7 Manufacturing Overhead 5,000 Property Taxes Payable Overhead incurred, costs accumulated in MOH Trans. 8 Work-in-Process Inventory 67,600 Overhead allocated to WIP Trans. 9 Finished Goods Inventory 644,600 Jobs completed, costs assigned to FG A = L ↑ + E ↓ Prop Tax Pay ↑ MOH ↑ A ↑ = L + E ↑ WIP ↑ MOH ↓ A ↑↓ = L + E FG ↑ WIP ↓ © 2015 Pearson Education, Limited.

Exhibit Continued Date Accounts and Explanations Debit Credit Trans. 10 Accounts Receivable 1,200,000 Sales Revenue Jobs sold; entry reflects sales price, not costs Trans. 11 Cost of Goods Sold 584,600 Finished Goods Inventory Jobs sold, costs assigned to COGS Trans. 12 15,400 Manufacturing Overhead MOH adjusted for underallocated overhead A ↑ = L + E ↑ A/R ↑ Sales Revenue ↑ A ↓ = L + E ↓ FG ↓ COGS ↑ A = L + E ↑↓ COGS ↑ MOH ↓ © 2015 Pearson Education, Limited.

Schedule of Cost of Goods Manufactured
Exhibit shows the schedule of cost of goods manufactured for Smart Touch for 2016, as shown previously in chapter 18. © 2015 Pearson Education, Limited.

>TRY IT! The following information pertains to Smith Company for the year: Estimated manufacturing overhead $500,000 Estimated direct labor hours 10,000 hours Actual manufacturing overhead $550,000 Actual direct labor hours 10,500 hours © 2015 Pearson Education, Limited.

>TRY IT! Calculate the predetermined overhead allocation rate using direct labor hours as the allocation base. $500,000 10,000 direct labor hours $50 per direct labor hour © 2015 Pearson Education, Limited.

$50 per direct labor hour × 10,500 hours
>TRY IT! Determine the amount of overhead allocated during the year. Record the journal entry. $50 per direct labor hour × 10,500 hours = $525,000 Work-in-Process Inventory 525,000 Manufacturing Overhead 525,000 © 2015 Pearson Education, Limited.

>TRY IT! 15. Determine the amount of underallocated or overallocated overhead. Record the journal entry to adjust Manufacturing Overhead. Actual overhead $ 550,000 – Allocated overhead 525,000 Underallocated $ 25,000 Cost of Goods Sold 25,000 Manufacturing Overhead 25,000 © 2015 Pearson Education, Limited.

Calculate job costs for a service company
Learning Objective 6 Calculate job costs for a service company © 2015 Pearson Education, Limited.

Predetermined Overhead Allocation Rate in a Service Company
Walsh Associates, a law firm, estimates the following indirect costs for 2016: Office rent $ 200,000 Office support staff 70,000 Maintaining and updating law library for case research 25,000 Advertisements 3,000 Sponsorship of the symphony 2,000 Total indirect costs $ 300,000 Because service firms have no inventory, these firms incur only noninventoriable costs. But their managers still need to know the costs of different jobs in order to set prices for their services. Using a law firm as an example, direct labor costs would be traced to a specific job (in this case, a client) through a labor time record, just as was done in a manufacturing company. A predetermined overhead allocation rate is calculated the same way that we did for the manufacturer Smart Touch Learning. First, total indirect costs are estimated. © 2015 Pearson Education, Limited.

Walsh uses direct labor hours as the allocation base because direct labor hours are the main driver of indirect costs. It is estimated that Walsh attorneys will work 10,000 direct labor hours in The predetermined overhead allocation rate is: Walsh uses direct labor hours as the allocation base because direct labor hours drive overhead costs. © 2015 Pearson Education, Limited.

Walsh uses direct labor hours as the allocation base because direct labor hours are the main driver of indirect costs. It is estimated that Walsh attorneys will work 10,000 direct labor hours in The predetermined overhead allocation rate is: $300,000 expected indirect costs 10,000 expected direct labor hours = $30 per direct labor hour The estimated overhead of $300,000 is divided by the 10,000 direct labor hours that are estimated to be worked in The resulting predetermined overhead allocation rate is $30 per direct labor hour. © 2015 Pearson Education, Limited.

Allocating indirect costs to jobs
Direct labor costs are $50 per hour. Client 367 required 14 direct labor hours. The total costs assigned to Client 367 are: Next, we determine the total costs assigned to Client 367. Fourteen direct labor hours are worked on Client 367’s case, and the hourly rate for direct labor is $50 per hour. © 2015 Pearson Education, Limited.

Allocating indirect costs to jobs
Direct labor costs are $50 per hour. Client 367 required 14 direct labor hours. The total costs assigned to Client 367 are: Direct labor: 14 hours × $50 per hour $ 700 Indirect costs: 14 hours × $30 per hour 420 Total costs $ 1,120 To determine the total cost of working on Client 367’s case, we add the direct labor costs and the allocated indirect costs. Multiplying the 14 direct labor hours by the $50 hourly rate, we see that the cost of direct labor was $700. To calculate the allocated indirect costs, we multiply the 14 hours by the $30 predetermined overhead allocation rate, for a cost of $420. Therefore, the total cost of this job was $1,120. © 2015 Pearson Education, Limited.

Pricing Decisions The total hourly rate for the company is $80 ($50 per hour for direct labor plus $30 per hour for indirect costs). If the firm desires a profit equal to 75% of the firm’s cost, then the price would be: Markup = Total Cost × Markup Percentage Once a service company has a good estimate for total job costs, it is better prepared to make pricing decisions. If Walsh Associates desires a profit equal to 75% of the firm’s costs, it would use the following formula to determine the amount of the markup: total cost of the job multiplied by the markup percentage. © 2015 Pearson Education, Limited.

Pricing Decisions The total hourly rate for the company is $80 ($50 per hour for direct labor plus $30 per hour for indirect costs). If the firm desires a profit equal to 75% of the firm’s cost, then the price would be: Markup = Total Cost × Markup Percentage = $80 per hour × 75% = $60 per hour For Walsh, the markup would be $60 per hour. © 2015 Pearson Education, Limited.

Pricing Decisions The total hourly rate for the company is $80 ($50 per hour for direct labor plus $30 per hour for indirect costs). If the firm desires a profit equal to 75% of the firm’s cost, then the price would be: Markup = Total Cost × Markup Percentage = $80 per hour × 75% = $60 per hour Price = Total Cost + Markup To determine the price charged, the markup would be added to the total cost of the job. © 2015 Pearson Education, Limited.

Pricing Decisions The total hourly rate for the company is $80 ($50 per hour for direct labor plus $30 per hour for indirect costs). If the firm desires a profit equal to 75% of the firm’s cost, then the price would be: Markup = Total Cost × Markup Percentage = $80 per hour × 75% = $60 per hour Price = Total Cost + Markup = $80 per hour + $60 per hour = $140 per hour In this example, Walsh would need to bill its clients $140 per hour to earn the desired markup. © 2015 Pearson Education, Limited.

>TRY IT! Wesson Company is a consulting firm. The firm expects to have $45,000 in indirect costs during the year and bill customers for 6,000 hours. The cost of direct labor is $75 per hour. Calculate the predetermined overhead allocation rate for Wesson. © 2015 Pearson Education, Limited.

>TRY IT! Wesson Company is a consulting firm. The firm expects to have $45,000 in indirect costs during the year and bill customers for 6,000 hours. The cost of direct labor is $75 per hour. Calculate the predetermined overhead allocation rate for Wesson. $45,000 6,000 billable hours $7.50 per billable hour © 2015 Pearson Education, Limited.

>TRY IT! 17. Wesson completed a consulting job for George Peterson and billed the customer for 15 hours. What was the total cost of the consulting job? Direct labor 15 billable hours × $75.00 per billable hour = $1,125.00 Indirect costs 15 billable hours × $7.50 per billable hour = Total cost $1,237.50 © 2015 Pearson Education, Limited.

>TRY IT! 18. If Wesson wants to earn a profit equal to 60% of the cost of a job, how much should the company charge Mr. Peterson? Profit = 60% of cost = 60% × $1, = $ Price = Cost + Profit = $1, $ = $1,980.00 © 2015 Pearson Education, Limited.

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