1. Chapter 5 Job Order Costing
COPYRIGHT © 2012 Nelson Education Ltd.

2. Learning Objectives
Describe the difference between job-order costing and process costing and identify the types of firms that would use each method
Compute the predetermined overhead rate and use the rate to assign overhead to units or services produced
Identify and set up the source documents used in job-order costing
Describe the cost flows associated with job-order costing
(Appendix 5A) Prepare the journal entries associated with job-order costing
(Appendix 5B) Allocate support department costs to producing departments

3. OBJECTIVE  1
Describe the differences between job-order costing and identify the types of firms that would use each method

4. Job-Order Production and Costing
Firms operating in job-order industries produce a wide-variety of services or products that are quite distinct from each other
Example industries:
Printing
Furniture making
Automobile repair
Medical and dental services
Beautician services
Construction
The key feature is that the cost of one job differs from that of another job and must be kept track of separately

5. Process Production and Costing
Firms in process industries mass-produce large quantities of similar or homogeneous products
Example industries:
Cement
Food
Petroleum
Chemicals
The key feature is that the cost of one unit of a product is identical to the cost of another

6. Production Costs in Job-Order Costing
Direct materials
Direct labour
Job #1
Job #2
Job #3
Direct materials and direct labour are fairly easy to trace to individual jobs

7. Production Costs in Job-Order Costing
Overhead
Overhead is not so easy to trace to individual jobs
Instead overhead is applied to production

8. OBJECTIVE  2
Compute the predetermined overhead rate and use the rate to assign overhead to units or services provided

9. Actual overhead can be hard to track
Actual Costing
Actual costs of direct materials, direct labour, and overhead are used to determine unit cost
Actual overhead can be hard to track
Problems with Actual Costing:
Many overhead costs are not incurred uniformly through the year
Uneven production levels
Give rise to fluctuating unit overhead costs

10. Virtually all firms use normal costing
Determine unit cost by adding actual direct materials, actual direct labour, and estimated overhead
Virtually all firms use normal costing

11. Importance of Unit Costs to Firms
For manufacturing firms, essential for:
valuing inventory
determining income
making important decisions
For service firms, used to determine:
profitability
feasibility of introducing new services

12. Normal Costing and Estimating Overhead
Three step process:
Calculate the predetermined overhead rate
Apply overhead to production
Reconcile applied overhead with actual overhead or allocate applied overhead to WIP and finished goods ending inventories

13. Example: Cornerstone 5-1
How to Calculate the Predetermined Overhead Rate and Apply Overhead to Production
Information:
At the beginning of the year, Argus Company estimated the following costs:
Overhead
$360,000
Direct labour cost
$720,000
Argus uses normal costing and applies overhead on the basis of direct labour cost. For the month of February, direct labour cost was $56,000

14. Example
Required:
Calculate the predetermined overhead rate for the year
Calculate the overhead applied to production in February

15. Calculate the Predetermined Overhead Rate
Formula:
Best estimate of manufacturing-related costs, such as factory-related costs, indirect materials, and indirect labour
Overhead Rate
Estimated Annual Overhead =
Estimated Annual Activity Level
Estimated Annual Activity Level: Also called the “Cost Driver”
Both overhead and activity level are estimated because overhead rate must be calculated at beginning of year

16. Example Overhead rate Overhead = Direct labour cost Overhead rate
$360,000 =
$720,000
Overhead rate
50% of direct labour cost =

17. Applying Overhead to Production
Applied overhead
Predetermined overhead rate
Actual activity level = ×
Let’s look at an example
Overhead applied to February production =
50% ×
$56,000
Direct labour Cost
Overhead
Overhead applied to February production =
$28,000

18. Reconciling Applied Overhead with Actual Overhead
Example:
Proto Company had actual overhead of $400,000 for the year but had applied $390,000 to production

19. Reconciling Applied Overhead with Actual Overhead
Example:
Actual Overhead
Applied Overhead
$400,000
$390,000
Actual ≠ Applied
This is called an overhead variance

20. Reconciling Applied Overhead with Actual Overhead
$400,000
$390,000
Underapplied – Overhead of $10,000
Actual Overhead
>
Applied Overhead =
Underapplied Overhead
Actual Overhead
<
Applied Overhead =
Overapplied Overhead

21. Disposition of Overhead Variance
At year end, costs reported on the financial statements must be actual, not estimated, amounts
Overhead Variance is assigned to Cost of Goods Sold

22. Disposition of Overapplied Overhead
Actual Overhead
Applied Overhead
Underapplied Overhead
> =
Underapplied overhead would be ADDED to Cost of Goods Sold
Actual Overhead
Applied Overhead
Overapplied Overhead
< =
Underapplied overhead would be SUBTRACTED from Cost of Goods Sold

23. Example: Cornerstone 5-2
How to Reconcile Actual Overhead with Applied Overhead
Information:
At the beginning of the year, Argus Company estimated the following:
Overhead $360,000
Direct labour Cost
$720,000
By the end of the year, actual data are:
Overhead $375,400
Direct labour Cost
$750,000

24. Example Information continued:
Argus uses normal costing and applies overhead on the basis of direct labour cost
At the end of the year, cost of goods sold (before adjusting for any overhead variance) is $632,000
Required:
Calculate the overhead variance for the year
Dispose of the overhead variance by adjusting cost of goods sold

25. Overhead Variance Calculation
Actual Overhead
Applied Overhead
$375,400
$375,000
Overhead Rate × Actual labour Cost 0.50 × $750,000
Overhead Variance – Underapplied
= $400

26. Disposition of Overhead Variance
Unadjusted COGS
$632,000
Add: Underapplied variance
400
Adjusted COGS
$632,400
Underapplied variances are added since not enough overhead was applied

27. Linear Cost and Revenue Functions: Cornerstone 5-3
How To Calculate Predetermined Departmental Overhead Rates and Apply Overhead to Production
Single overhead rate calculated using all estimated overhead for a factory and dividing by estimated activity for entire plant
Plantwide Overhead Rate
Estimated overhead for a department divided by estimated activity level for that same department
Departmental Overhead Rate

28. Example
Information:
At the beginning of the year, Sorrel Company estimated:
Machining Dept.
Assembly Dept.
Total
Overhead
$240,000
$360,000
$600,000
Direct labour hours
135,000
240,000
375,000
Machine hours
200,000
---
200,000
Sorrel uses departmental overhead rates:
Machining dept: overhead is applied on basis of machine hours
Assembly dept: overhead is applied on basis of direct labour hours

29. Example
Required:
Calculate the predetermined overhead rates for the machining and assembly departments
Calculate the overhead applied to production in each department for the month of June
By how much has each department’s overhead been overapplied? underapplied?

30. Overhead Rates Machining dept. Overhead rates Estimated overhead =
Estimated machine hours
Machining department’s overhead is applied on the basis of machine hours
Machining dept. Overhead rates
$240,000 =
200,000
Machining dept. Overhead rates
$1.20 per machine hour =

31. Overhead Rates Assembly dept. overhead rates Estimated overhead =
Estimated direct labour hours
Assembly dept. overhead rates
$360,000 =
240,000
Assembly dept. overhead rates =
$1.50 per direct labour hour

32. Example Information continued: Sorrel Company’s actual data for June:
Machining Dept.
Assembly Dept.
Total
Overhead
$22,500
$30,750
$53,250
Direct labour hours
11,000
20,000
31,000
Machine hours
17,000
---
17,000

33. Applying Overhead to Production
Machining Department
Overhead applied in June
Overhead Rate
Actual Machine Hours = ×
Overhead applied in June =
$1.20 ×
17,000
Machining Department applies $1.20 of overhead for every machine hour
Overhead applied in June =
$20,400

34. Applying Overhead to Production
Assembly Department
Overhead applied in June
Overhead Rate
Actual Direct labour Hours = ×
Overhead applied in June =
$1.50 ×
20,000
Assembly Department applies $1.50 of overhead for every direct labour hour.
Overhead applied in June =
$30,000

35. Under of Overapplied Overhead?
Machining Dept.
Assembly Dept.
Actual overhead
$22,500
$30,750
Applied overhead
20,400
30,000
Underapplied overhead
$2,100
$ 750
Actual overhead exceeded applied overhead in both departments

36. Example: Cornerstone 5-4
How to Convert Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production
Information:
At the beginning of the year, Sorrel Company estimated:
Machining Dept.
Assembly Dept.
Total
Overhead
$240,000
$360,000
$600,000
Direct labour hours
135,000
240,000
375,000
Machine hours
200,000
---
200,000
Sorrel has decided to use a plant-wide overhead rate based on direct labour hours

37. Example Required: Calculate the predetermined plant-wide overhead rate
Calculate the overhead applied to production for the month of June
Calculate the overhead variance for the month of June

38. Plantwide Overhead Rate
Total overhead =
Direct labour Hours
Total Estimated Overhead
Plantwide overhead rate
$600,000 =
375,000
Plantwide overhead rate
$1.60 per direct labour hour =

39. Example Information continued: Sorrel Company’s actual data June:
Machining Dept.
Assembly Dept.
Total
Overhead
$22,500
$30,750
$53,250
Direct labour hours
11,000
20,000
31,000
Machine hours
17,000
---
17,000

40. Applying Overhead to Production
Formula:
Applied Overhead
Plantwide overhead rate
Actual activity level × =
Actual direct labour hours for June:
Machining 11,000 + Assembly 20,000 hours
Applied Overhead =
$1.60 ×
31,000 direct labour hours
Applied Overhead =
$49,600

41. Over or Underapplied Overhead?
Actual Overhead -
Applied Overhead
$53,250 -
$49,600
$3,650
Underapplied
Not enough overhead was applied to production

42. Unit Costs in the Job-Order System
Unit cost of a job is the total cost of:
materials used on the job (direct materials)
labour worked on the job (direct labour)
applied overhead

43. Identify and set up the source documents used in job-order costing
OBJECTIVE  3
Identify and set up the source documents used in job-order costing

44. Job-Order Cost Sheet Contains: Jobs are named or numbered
Job description
Cost of materials, labour, and overhead
Jobs are named or numbered
Total of all unfinished job-order cost sheets should equal the ending balance of the Work In Process account

45. Materials Requisition Form
Provides information for assigning direct materials costs to jobs
Useful for maintaining proper control over a firm’s inventory of direct materials

46. Job Time Tickets Employees fill out a time ticket that identifies:
His or her name
Wage rate
Hours worked on each job
Cost accounting department posts cost of direct labour to individual jobs

47. Source Documents as Sources for Account Balances
Work in Process
Total of all job-order cost sheets for unfinished jobs
Finished Goods
Total of all job-order cost sheets for finished but unsold jobs
Cost of Goods Sold
Total of all job-order cost sheets for sold jobs

48. Describe the cost flows associated with job-order costing
OBJECTIVE  4
Describe the cost flows associated with job-order costing

49. Accounting for Materials
Purchases are added to Raw Materials Inventory account
As they are used in production, direct materials are moved from Raw Materials to Work in Process
Materials used in production are classified by job and recorded in job-order cost sheets
Raw Materials
Purchases
Direct Materials used in production

50. Accounting for Direct Labour Cost
Time tickets indicate the amount of labour spent on each job
Labour costs are added to job-order costs sheets
Total of all direct labour from all jobs is recorded as a debit in the Work In Process account
Work In Process
Direct materials
Direct labour

51. Accounting for Overhead
Normal costing is used
Actual overhead is not assigned directly to jobs
Overhead is applied to each job using a predetermined rate
Work In Process
Direct Materials
Direct labour
Applied Overhead

52. Accounting for Actual Overhead Costs
Never enters Work in Process account
Costs are recorded as debits in Manufacturing Overhead control account
At end of period, actual overhead is reconciled with applied overhead

53. Accounting for Finished Goods
Costs of completed jobs are transferred from Work in Process to Finished Goods
Work in Process
Finished Goods
Direct Materials
Completed jobs
Completed jobs
Direct labour
Applied Overhead

54. Accounting for Actual Overhead Costs
Once job is sold, it is added to cost of goods sold which is reported on income statement
Finished Goods
Cost of Goods Sold
Completed jobs
Sold jobs
Sold jobs

55. Cost of Goods Manufactured Statement
To ensure the accuracy in computing these costs, a cost of goods manufactured statement is prepared

56. Accounting for Cost of Goods Sold
When jobs are sold:
finished goods inventory is decreased
costs of goods sold is increased
The selling price is recognized by:
increasing (crediting) sales revenue
increasing (debiting) accounts receivable (or cash)

57. Normal and Adjusted Cost of Goods Sold
Normal Cost of Goods Sold
Cost of Goods Sold before an adjustment for an overhead variance
Adjusted Cost of Goods Sold
Cost of Goods Sold after adjusting for an overhead variance

58. Example: Cornerstone 5-5
How to Prepare Brief Job-Order Cost Sheets
Information:
At the beginning of June, Galway Company had two jobs in process:
Job 78
Job 79
Direct materials
$1,000
$ 800
Direct labour
600
1,000
Applied overhead
750
1,250
Balance, June 1
$2,350
$3,050

59. Example
Required:
Calculate the overhead rate based on direct labour cost
Prepare a job-order cost sheet for the four jobs
Show the balance as of June 1 as well as direct materials and direct labour added in June
Apply overhead to the four jobs for the month of June, and show the ending balances
Calculate the ending balances of Work in Process and Finished Goods and of June 30
Calculate the Cost of Goods Sold for June

60. Calculating Overhead Rate
We were not given estimated overhead or estimated direct labour cost. So we will have to work backwards to find the rate
Applied Overhead
Predetermined overhead rate
Actual activity level = ×
We can compute the rate using the information from Job 78

61. Calculating Overhead Rate
Applied Overhead
Predetermined overhead rate
Actual activity level = ×
Predetermined overhead rate
$750 = ×
$600
Predetermined overhead rate
$750/$600 =
1.25 or 125% of direct labour cost

62. Example Job 78 Job 79 Job 80 Job 81 Direct materials $500 $1,110 $900
Information:
During June, two more jobs were started
The following direct materials and direct labour costs were added to the four jobs during the month of June:
Job 78
Job 79
Job 80
Job 81
Direct materials
$500
$1,110
$900
$100
Direct labour
400
1,400
2,000
320

63. Job-Order Cost Sheets Job 78 Job 79 Job 80 Job 81 $2,350 $3,050 $ 0
Beg. Bal. June 1
$2,350
$3,050
$ 0
$ 0
500
1,110
900
100
Direct materials
400
1,400
2,000
320
Direct labour
Applied overhead
500
1,750
2,500
400
Direct labour x Overhead Rate $400 x $1.25
Direct labour x Overhead Rate $1,400 x $1.25
Direct labour x Overhead Rate $2,000 x $1.25
Direct labour x Overhead Rate $320 x $1.25

64. Job-Order Cost Sheets Job 78 Job 79 Job 80 Job 81 $2,350 $3,050 $ 0
Beg. Bal. June 1
$2,350
$3,050
$ 0
$ 0
500
1,110
900
100
Direct Materials
400
1,400
2,000
320
Direct labour
Applied Overhead
500
1,750
2,500
400
$3,750
$7,310
$5,400
Total, June 30
$820

65. Computing Ending Balances
At the end of June,
Jobs 78, 79 and 80 were completed
Work in Process
Only Job 81 was still in process at June 30
Work in Process = $820

66. Computing Ending Balances
On June 1, the balance in Finished Goods was zero. Three jobs were finished during June (Jobs 78, 79 & 80)
Job 79 was sold and transferred out of Finished Goods
Finished Goods
Finished goods, June 1 $
Job 78
3,750
Job 80
5,400
Finished goods, June 30
$9,150

67. Computing Ending Balances
One job, Job 79, was sold during June
Cost of Goods Sold
June 30 Balance = $7,310

68. Accounting for Nonmanufacturing Costs
Manufacturing costs are not the only costs incurred by a firm
Selling and general administrative are period costs
Period costs are shown on the Income Statement