1. Systems Design: Job-Order costing Chapter 2

2. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 2 Types of Costing Systems Used to Determine Product Costs Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  Cost are traced or allocated to jobs.  Cost records must be maintained for each distinct product or job. Chapter 3

3. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 3 Types of Costing Systems Used to Determine Product Costs Process Costing Job-order Costing Typical job order cost applications:  Special-order printing  Building construction Also used in the service industry  Hospitals  Law firms

4. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 4 Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

5. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 5 Quick Check Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

6. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 6 Job-Order Costing THE JOB Direct material Traced directly to each job Direct labor Traced directly to each job Manufacturing overhead (OH) Applied to each job using a predetermined rate

7. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 7 Sequence of Events in a Job-Order Costing System Receive orders from customers Schedule jobs Begin production Order materials

8. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 8 Manufacturing Overhead Job No. 1 Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed. Sequence of Events in a Job-Order Costing System Direct Materials Direct Labor

9. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 9 Apply overhead to each job using a predeter- mined rate. Sequence of Events in a Job-Order Costing System Direct Materials Direct Labor Job No. 1 Job No. 2 Job No. 3 Manufacturing Overhead

10. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 10 Job-Order Cost Accounting The primary document for tracking the costs associated with a given job is the job cost sheet. Let’s investigate

11. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 11 PearCo Job Cost Sheet Job Number A - 143Date Initiated 3-4-01 Date Completed Department B3Units Completed Item Wooden cargo crate Direct MaterialsDirect LaborManufacturing Overhead Req. No.AmountTicketHoursAmountHoursRateAmount Cost SummaryUnits Shipped Direct MaterialsDateNumberBalance Direct Labor Manufacturing Overhead Total Cost Unit Cost Job-Order Cost Accounting

12. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 12 Job-Order Cost Accounting

13. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 13 Materials Requisition Form Will E. Delite

14. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 14 Materials Requisition Form Will E. Delite Type, quantity, and total cost of material charged to job A-143. Cost of material is charged to job A-143.

15. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 15 Note Why go to all the trouble to fill out a materials requisition form every time someone needs materials for a job?  Maintain control of assets. Prevent pilferage, loss, and waste. Prevent supervisors from stockpiling materials “just in case the stockroom runs out.”  Trace costs of materials to particular jobs.  The materials requisition form, like all the others illustrated today, can be electronic rather than hardcopy.

16. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 16 Job-Order Cost Accounting

17. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 17 Job-Order Cost Accounting Workers use time tickets to record the time spent on each job. Let’s see one

18. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 18 Employee Time Ticket

19. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 19 Job-Order Cost Accounting

20. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 20 Job-Order Cost Accounting Apply manufacturing overhead to jobs using a predetermined overhead rate of $4 per direct labor hour (DLH). Let’s do it

21. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 21 Job-Order Cost Accounting

22. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 22 Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Application of Manufacturing Overhead Ideally, the allocation base is a cost driver that causes overhead.

23. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 23 Application of Manufacturing Overhead Overhead applied = POHR × Actual activity Actual amount of the allocation base such as units produced, direct labor hours, or machine hours incurred during the period. Based on estimates, and determined before the period begins.

24. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 24 Application of Manufacturing Overhead Recall the wooden crate example where: Overhead applied = $4 per DLH × 8 DLH = $32 Overhead applied = POHR × Actual activity

25. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 25 The Need for a Predetermined Manufacturing Overhead Rate 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. $

26. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 26 Note If we wait until the end of the period, we will know the actual TOTAL overhead cost. However, still we won’t know the actual overhead cost of a particular job. Why?  Overhead consists of costs that are either difficult or impossible to trace to particular jobs. Difficult-to-trace costs include the cost of indirect materials like glue in a furniture factory. Impossible-to-trace costs include fixed common costs like the property taxes on the factory building and land.

27. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 27 PearCo applies overhead based on direct labor hours. Total estimated overhead for the year is $640,000. Total estimated labor cost is $1,400,000 and total estimated labor hours are 160,000. What is PearCo’s predetermined overhead rate per hour? Overhead Application Example

28. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 28 For each direct labor hour worked on a job, $4.00 of factory overhead will be applied to the job. Overhead Application Example POHR = $4.00 per DLH $640,000 160,000 direct labor hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR =

29. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 29 Overhead Application Example What amount of overhead will PearCo apply to Job X-32?

30. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 30 Overhead Application Example

31. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 31 Overhead Application Example

32. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 32 Quick Check If the number of wooden crates in the order on the previous page is increased or decreased by one unit, what would you expect to happen to the total spending of PearCo? a. Total spending would probably change by less than $105. b. Total spending would probably change by about $105. c. Total spending would probably change by more than $105.

33. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 33 Quick Check If the number of wooden crates in the order on the previous page is increased or decreased by one unit, what would you expect to happen to the total spending of PearCo? a. Total spending would probably change by less than $105. b. Total spending would probably change by about $105. c. Total spending would probably change by more than $105. Total spending would change by $105 only if all of the costs were variable with respect to the number of units produced. Direct materials is variable, but much of the overhead and perhaps even direct labor may be fixed.

34. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 34 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.

35. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 35 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.

36. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 36 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 19,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $750. d. $730.

37. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 37 Quick Check Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 19,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $750. d. $730.

38. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 38 Quick Check If overhead contains fixed costs, what will happen to the predetermined overhead rate if lower unit sales volume is expected? a. The predetermined overhead rate will likely increase. b. The predetermined overhead rate would be unaffected. c. The predetermined overhead rate will likely decrease.

39. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 39 Quick Check If overhead contains fixed costs, what will happen to the predetermined overhead rate if lower unit sales volume is expected? a. The predetermined overhead rate will likely increase. b. The predetermined overhead rate would be unaffected. c. The predetermined overhead rate will likely decrease.

40. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 40 Quick Check If overhead contains fixed costs, what will happen to product costs computed by the accounting system if lower unit sales volume is expected? a. Product costs will likely increase. b. Product costs would be unaffected. c. Product costs will likely decrease.

41. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 41 Quick Check If overhead contains fixed costs, what will happen to product costs computed by the accounting system if lower unit sales volume is expected? a. Product costs will likely increase. b. Product costs would be unaffected. c. Product costs will likely decrease.

42. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 42 Quick Check If overhead contains fixed costs and management set prices by marking up product costs by a preset percentage, what will happen to selling prices if lower unit sales volume is expected? a. Selling prices will likely increase. b. Selling prices would be unaffected. c. Selling prices will likely decrease.

43. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 43 Quick Check If overhead contains fixed costs and management set prices by marking up product costs by a preset percentage, what will happen to selling prices if lower unit sales volume is expected? a. Selling prices will likely increase. b. Selling prices would be unaffected. c. Selling prices will likely decrease.

44. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 44 Quick Check If selling prices increase, what will happen to unit sales volume? a. Unit sales volume will likely increase. b. Unit sales volume would be unaffected. c. Unit sales volume will likely decrease.

45. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 45 Quick Check If selling prices increase, what will happen to unit sales volume? a. Unit sales volume will likely increase. b. Unit sales volume would be unaffected. c. Unit sales volume will likely decrease.

46. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 46 Let’s summarize the document flow we have been discussing in a job-order costing system. Job-Order Costing Document Flow Summary

47. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 47 Job-Order Costing Document Flow Summary Job Cost Sheets Materials Requisition Manufacturing Overhead Account Direct material s Indirect materials Materials used may be either direct or indirect.

48. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 48 Job-Order Costing Document Flow Summary Job Cost Sheets Employee Time Ticket Manufacturing Overhead Account Direct Labor Indirect Labor An employee’s time may be either direct or indirect.

49. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 49 Job-Order Costing Document Flow Summary Manufacturing Overhead Account Other Actual OH Charges Job Cost Sheets Applied Overhead Materials Requisition Indirect Material Employee Time Ticket Indirect Labor

50. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 50 Let’s examine the cost flows in a job-order costing system. We will use T-accounts and start with materials. Job-Order System Cost Flows

51. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 51 Raw Materials Material Purchases Mfg. Overhead Job-Order System Cost Flows Work in Process (Job Cost Sheet) Direct Materials Indirect Materials ActualApplied

52. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 52 Next let’s add labor costs and applied manufacturing overhead to the job-order cost flows. Are you with me? Job-Order System Cost Flows

53. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 53 Job-Order System Cost Flows Mfg. Overhead Salaries and Wages Payable Work in Process (Job Cost Sheet) Direct Materials Overhead Applied Overhead Applied to Work in Process Direct Labor Indirect Labor Indirect Materials ActualApplied If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.

54. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 54 Now let’s complete the goods and sell them. Still with me? Job-Order System Cost Flows

55. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 55 Finished Goods Cost of Goods Mfd. Cost of Goods Sold Job-Order System Cost Flows Work in Process (Job Cost Sheet) Direct Materials Direct Labor Overhead Applied

56. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 56 Let’s return to PearCo and see what we will do if actual and applied overhead are not equal. Job-Order System Cost Flows

57. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 57 Overhead Application Example PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour.

58. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 58 Overhead Application Example SOLUTION Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour.

59. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 59 SOLUTION Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 PearCo’s actual overhead for the year was $650,000 for a total of 170,000 direct labor hours. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour, Overhead Application Example PearCo has overapplied overhead for the year by $30,000. What will PearCo do?

60. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 60 Work in Process Finished Goods Cost of Goods Sold $30,000 may be allocated to these accounts. Overapplied and Underapplied Manufacturing Overhead $30,000 may be closed directly to cost of goods sold. Cost of Goods Sold PearCo’s Method OR

61. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 61 Overapplied and Underapplied Manufacturing Overhead PearCo’s Mfg. Overhead Actual overhead costs $650,000 $30,000 overapplied PearCo’s Cost of Goods Sold Unadjusted Balance $30,000 Adjusted Balance Overhead Applied to jobs $680,000

62. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 62 Quick Check What effect will the overapplied overhead have on PearCo’s cost of goods sold? a. Cost of goods sold will increase. b. Cost of goods sold will be unaffected. c. Cost of goods sold will decrease.

63. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 63 Quick Check What effect will the overapplied overhead have on PearCo’s cost of goods sold? a. Cost of goods sold will increase. b. Cost of goods sold will be unaffected. c. Cost of goods sold will decrease.

64. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 64 Quick Check What effect will the overapplied overhead have on PearCo’s net income? a. Net income will increase. b. Net income will be unaffected. c. Net income will decrease.

65. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 65 Quick Check What effect will the overapplied overhead have on PearCo’s net income? a. Net income will increase. b. Net income will be unaffected. c. Net income will decrease.

66. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 66 Overapplied and Underapplied Manufacturing Overhead - Summary

67. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 67 Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Quick Check

68. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 68 Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Quick Check Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000 Underapplied Overhead $1,210,000 - $1,160,000 = $50,000

69. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 69 Let’s look at summary journal entries for a job- order costing system. We’ll omit the numbers so that we can focus on accounts. Job-Order Costing – Typical Accounting Entries

70. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 70 Cost Flows – Material Purchases Raw material purchases are recorded in an inventory account.

71. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 71 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. Cost Flows – Material Usage

72. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 72 Cost Flows – Labor The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.

73. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 73 Cost Flows – Actual Overhead In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.

74. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 74 Cost Flows – Overhead Applied Work in Process is increased when Manufacturing Overhead is applied to jobs.

75. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 75 Cost Flows – Period Expenses Nonmanufacturing costs (period expenses) are charged to expense as they are incurred.

76. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 76 Cost Flows – Cost of Goods Manufactured As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.

77. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 77 Cost Flows – Sales When finished goods are sold, two entries are required: (1) to record the sale; and (2) to record Cost of Goods Sold and reduce Finished Goods.

78. © The McGraw-Hill Companies, Inc., 2002 Irwin/McGraw-Hill 78 End of Chapter 2