1. Systems Design: Job-Order Costing

2. Objectives Uses of product costs for different organizations.
Types of product costing systems.
Distinguish between job order and process costing systems.
Understanding the cost accumulation procedures utilized in job order costing.

3. Product and Service Costing
A product costing system accumulates the costs incurred in a production process and assigns those costs to the organization’s final products.
Use in Financial accounting:
Value inventory on the balance sheet
Compute cost of goods sold expense on the income statement.

4. Product and Service Costing
Use in Managerial Accounting:
Help managers with planning and decision making.
Decisions about product prices, the mix of products to be produced and the quantity of the output to be manufactured involves the usage of product costs.
Use in Cost management:
For controlling or reducing production costs of a product.
Use in reporting to interested organizations

5. Product and Service Costing
Service firms and non profit organizations:
Service firms do not have inventories.
Their costs involve costs that are incurred in producing the services which are provided.
Costs are then used for planning, cost control and decision making purposes.

6. Introduction
An enterprise seeks to profit by providing customers with goods and services.
To realize this profit, it is necessary to make decisions based upon appropriate and timely information provided by the accounting reports.
So in order to fulfill the management needs, cost accounting consists of basic three phases,1)cost determination and measurement, 2)cost planning and control through budgets and standards 3)cost analysis for decision making purposes.

7. Cost systems: Actual or Standard.
Determination of a product’s cost is a basic objective of cost accounting and when the unit cost is identified, the obvious question arises," how are these costs accumulated?
In actual costs systems, costs are collected as they occur but they are determined at the end of the manufacturing procedures.

8. Cost systems: Actual or Standard.
In standard cost system, unit cost are predetermined in advance of production. Costing of the products, operations and processes are done by using standards for both quantity and dollar amount.
Difference between actual cost and standard cost gives the variance. And management’s role is to overcome the unfavorable conditions from predetermined standards.
Both actual cost system and standard cost system may be used in connection with either job order pr process costing.

9. 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 process costing system is best used by companies that produce many units of a single product and when one unit of output is indistinguishable from any other unit of output. Because the units of output are identical, the company will probably use an average cost system to determine product cost.

10. 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 and are unique in nature.

11. Comparing Process and Job-Order Costing
This table presents an overview of the differences between a job-order and process costing system. Notice that costs are accumulated by the job in a job-order system and by department in the process system. If you think of building a house, you can see how easy it is to accumulate costs for a particular house, even though you may be building more than one house at a time. If you think of mixing Coca-Cola, costs would naturally be accumulated by the department working on the current batch.
This table presents an overview of the differences between a job-order and process costing system. Notice that costs are accumulated by the job in a job-order system and by department in the process system. If you think of building a house, you can see how easy it is to accumulate costs for a particular house, even though you may be building more than one house at a time. If you think of mixing Coca-Cola, costs would naturally be accumulated by the department working on the current batch.

12. Example :
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.
See if you can identify those types of companies that would benefit from the use of a job-order costing system. There may be more than one company in the list.

13. Identify the documents used in a job-order costing system.
Learning objective number 2 is to identify the documents used in a job-order costing system.

14. Job-Order Costing – An Overview
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 traced directly to each job as the work is preformed.
Manufacturing Overhead
Job No. 3
In a job-order costing system, direct materials and direct labor are traced directly to each job as the work is preformed.

15. Direct Manufacturing Costs
Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.
Direct Materials
Job No. 1
Direct Labor
Job No. 2
Manufacturing Overhead
Manufacturing overhead (including indirect materials and indirect labor) represents 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.
Job No. 3
Manufacturing overhead (including indirect materials and indirect labor) represents 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.

16. Job Order Cost sheet
The job cost sheet is used by the accounting department to track the direct and indirect costs associated with a given job.
We will look at a job cost sheet used by a hypothetical company called PearCo. The company has a job that calls for the construction of wooden cargo crates.

17. The Job Cost Sheet PearCo Job Cost Sheet Job Number A - 143
Date Initiated
Date Completed
Department B3
Units Completed
Item Wooden cargo crate
Direct Materials
Direct Labor
Manufacturing Overhead
Req. No.
Amount
Ticket
Hours
Rate
Cost Summary
Units Shipped
Date
Number
Balance
Total Cost
Unit Product Cost
The job cost sheet is used by the accounting department to track the direct and indirect costs associated with a given job. We will look at a job cost sheet used by a hypothetical company called PearCo. The company has a job that calls for the construction of wooden cargo crates. You can see the separate sections for direct materials, direct labor, and manufacturing overhead. In addition, we have a section to summarize total costs of the job. A job number uniquely identifies each job. Direct material, direct labor and manufacturing overhead costs are accumulated for each job. The job cost sheet is a subsidiary ledger to the Work in Process account.

18. Measuring Direct Materials Cost
Will E. Delite
Once a sales order has been received and a production order issued, the Production Department prepares a materials requisition form to specify the type, quantity, and total cost of materials. Here is the materials requisition form completed for job A The requisition is number X The worker has requested twelve 2 x 4s, 12 feet long, and twenty 1 x 6s, 12 feet long. The unit cost of the lumber is shown in the unit cost column. The quantity requested is multiplied by the unit cost to arrive at the total cost for materials. The person in charge of the store room will issue the lumber once the materials requisition form has been properly authorized.

19. Description for Direct material Cost
Once a sales order has been received and a production order issued, the Production Department prepares a materials requisition form to specify the type, quantity, and total cost of materials. Here is the materials requisition form completed for job A The requisition is number X The worker has requested twelve 2 x 4s, 12 feet long, and twenty 1 x 6s, 12 feet long. The unit cost of the lumber is shown in the unit cost column. The quantity requested is multiplied by the unit cost to arrive at the total cost for materials. The person in charge of the store room will issue the number once the materials requisition form has been properly authorized.

20. Measuring Direct Materials Cost
Once the materials have been issued by the store room, they are charged to the job cost sheet for job number A – 143. We have a proper reference for the requisition number and the total amount. If we need to look at the details of the $116 cost, we can ask to see materials requisition form X
The direct materials were posted to the summary section of the job cost sheet.

21. Measuring Direct Labor Costs
Here is the time ticket for an employee who worked eight hours on job A – 143. The employee’s hourly pay rate is $11, so the total labor cost charged to the job will be $88. The time ticket, number 36, serves as the major source document for labor costs charged to this job. Let’s look at the labor posting to the job cost sheet.

22. Description For Direct Labor:
Here is the time ticket for an employee who worked eight hours on job A – 143. The employee’s hourly pay rate is $11, so the total labor cost charged to the job will be $88. The time ticket, number 36, serves as the major source document for labor costs charged to this job. Let’s look at the labor posting to the job cost sheet.

23. Job-Order Cost Accounting
The Accounting Department records the labor costs from each time ticket onto the job cost sheet. On the job cost sheet, we can see that time ticket number 36 posted 8 hours to job A – 143. The total amount of direct labor cost is $88. This amount is also posted to the summary section of the job cost sheet.

24. Compute predetermined overhead rates
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.

25. 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:
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 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 we believe causes overhead costs to be incurred. Some companies allocate manufacturing overhead using direct labor hours 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.

26. Manufacturing Overhead Application
The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.
Estimated total manufacturing overhead cost for the coming period
Estimated total units in the allocation base for the coming period
POHR =
To facilitate the allocation of manufacturing overhead to each job, we calculate a predetermined overhead rate before the period begins. The rate is calculated by dividing the total estimated manufacturing overhead for the coming period by the estimated total units of the allocation base. If our allocation base is machine hours, we would estimate the total number of machine hours used in production in the coming period.
Ideally, the allocation base should be a cost driver, that is, it causes overhead to be incurred.
Ideally, the allocation base is a cost driver that causes overhead.

27. The Need for a POHR
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, thus slowing down the ability to estimate job costs during the period;
Actual overhead costs can fluctuate seasonally, thus misleading decision makers;
It simplifies record keeping.
Predetermined overhead rates that rely upon estimated data are often used because (1) actual overhead costs for the period are not known until the end of the period, thus inhibiting the ability to estimate job costs during the period; (2) actual overhead costs can fluctuate seasonally, thus misleading decision makers; and (3) it simplifies record keeping.

28. Application of Manufacturing Overhead
Based on estimates, and determined before the period begins.
Overhead applied = POHR × Actual activity
We calculate the predetermined overhead rate before the period begins. As we work on a particular job, we apply overhead by multiplying the predetermined rate times the actual level of activity. If overhead is applied on the basis of machine hours, we would apply overhead by multiplying the predetermined rate times the actual number of machine hours used on a particular job.
Actual amount of the allocation based upon the actual level of activity.

29. Overhead Application Rate
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 =
POHR = $4.00 per DLH
Part I
Here is our equation for calculating the predetermined manufacturing overhead rate.
Part II
PearCo’s predetermined overhead rate is $4 per direct labor hour. Part III
So, at PearCo, each job will be charged $4 of overhead for each hour of direct labor worked.
Let’s see how this works.
For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

30. Job-Order Cost Accounting
Our predetermined overhead rate is $4 per direct labor hour, so we will apply $32 of overhead to job number A – 143. The computation is shown in the manufacturing overhead section of the job cost sheet and in the summary section.

31. Job-Order Cost Accounting
The total direct material, direct labor, and manufacturing overhead costs assigned to Job A-143 is $236. Since this particular job included 2 units of production, the average cost per unit is $118. We calculated the average by dividing the total cost of $236 by the 2 crates produced.

32. Example:
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.
This problem may take a while to solve, but it will be well worth your time to work it carefully.

33. Example:
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.
The correct answer is $730. You can see the costs incurred for direct materials, direct labor and manufacturing overhead applied to job WR53 in the blue box.

34. 3-34
Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs.
Learning objective number 4 is to understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs.

35. Cost Flows – Material Purchases
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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.

36. Cost Flows – Material Usage
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Cost Flows – Material Usage
Direct materials issued to a job increase Work in Process and decrease Raw Materials.
When materials are requisitioned from raw materials inventory, we debit work in process (job cost sheet) for direct materials, and debit manufacturing overhead for indirect materials.

37. Indirect materials used are charged to Manufacturing Overhead and also decrease Raw Materials.

38. The Recording of Labor Costs
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The Recording of Labor Costs
The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.
The cost of direct labor is debited to Work in Process account, while the indirect labor is debited to the Manufacturing Overhead account. The cost of labor (direct and indirect) is credited to the Salaries and Wages Payable account.

39. Recording Actual Manufacturing Overhead
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Recording Actual Manufacturing Overhead
In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.
This journal entry represents the accumulation of other actual overhead amounts like property taxes on the manufacturing plant, insurance on the plant structure and depreciation of manufacturing assets.

40. Applying Manufacturing Overhead
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Applying Manufacturing Overhead
Work in Process is increased when Manufacturing Overhead is applied to jobs.
This journal entry shows the application of overhead to work in process inventory.

41. Accounting for Nonmanufacturing Cost
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Accounting for Nonmanufacturing Cost
Nonmanufacturing costs (period expenses) are charged to expense as they are incurred.
This journal entry illustrates the expensing of nonmanufacturing costs in the current period.

42. Transferring Completed Units
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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.

43. Transferring Units Sold
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Transferring Units Sold
When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods.
Assuming the company uses a perpetual inventory system, two journal entries are required to record the sale.
The first entry is to debit either accounts receivable or cash and credit sales for the selling price of the job completed.
The second entry is to debit cost of goods sold and credit finished goods inventory for the cost incurred to complete the job.
The difference between the selling price and cost is the company’s gross margin on the job.

44. 3-44
Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.
Learning objective number 8 is to compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.

45. Problems of Overhead Application
3-45
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.
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.

46. Allocating Under- or Overapplied Overhead Between Accounts
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Allocating Under- or Overapplied Overhead Between Accounts
The journal entry to record the allocation is to debit Manufacturing Overhead for $30,000, credit Work in Process Inventory for $3,000, credit Finished Goods Inventory for $9,000, and credit Cost of Goods Sold for $18,000.