5: Chapter JobOrder Costing
Cornerstones of Managerial Accounting, 4e
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Learning Objectives
1. Describe the differences between job-order costing and process costing, and identify the types of firms that would use each method. 2. Compute the predetermined overhead rate, and use the rate to assign overhead to units or services produced. 3. Identify and set up the source documents used in joborder costing. 4. Describe the cost flows associated with job-order costing. 5. (Appendix 5A) Prepare the journal entries associated with job-order costing. 6. (Appendix 5B) Allocate support department costs to 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a producingwith a certain product or service or otherwise on a password-protected website for classroom use. license distributed departments.
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The Differences Between JobOrder and Process Costing
Companies can be divided into two major types. 1. Those firms producing similar products or services can use a process-costing accounting system. 2. On the other hand, if a company's products/ services are unique, they require a job-order accounting system.
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Characteristics of the JobOrder Environment
Customized or built-to-order products fit into this category, as do services that vary from customer to customer.
A job is one distinct unit or set of units. Common job-order processes include: printing, construction, furniture making, medical and dental services, automobile repair, beautician services
For job-order production systems, costs are accumulated by job. This approach to assigning costs is called a joborder costing system.
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Process Production and Costing
Firms in process industries mass-produce large quantities of similar or homogeneous products. This approach to cost accumulation is known as a processcosting system. Examples of process manufacturers include:
Food canning and manufacturing Cement Petroleum Pharmaceutical and chemical manufacturing
Process firms accumulate production costs by process or by department for a given period of time. The output for the process for that period of time is measured. Unit costs are measured using the following equation:
Unit costs = Process Costs Output
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The Differences Between JobOrder and Process Costing
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Unit costs are very important because managers need accurate cost information on materials, labor, and overhead when making decisions. For example, when a construction company bills a client at set points throughout the construction, it is important that unit cost be generated in a timely manner. Job-order costing using a normal cost system will give the company the unit cost information it needs. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
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Normal Costing and Overhead Application
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Actual Costing
Two ways are commonly used to measure the costs associated with production: actual costing and normal costing. In an actual cost system, only actual costs of direct materials, direct labor, and overhead are used to determine unit cost. However, there are several issues involved in using actual costing.
Defining Overhead Costs: Overhead items do not have the direct relationship with units produced that direct materials and direct labor do. Uneven Overhead Costs: Many overhead costs are not incurred uniformly throughout the year. However, waiting until the end of the year to total the actual overhead costs is typically unrealistic. Uneven Production: Distortions can occur if when averages are used with uneven production. Strict actual cost systems are rarely used because accurate day-to-day unit cost information is needed on a timely basis.
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Normal Costing
Normal costing solves the problems associated with actual costing. A normal cost system determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead. Overhead can be estimated by approximating the year's actual overhead at the beginning of the year and then using a predetermined rate throughout the year to obtain the needed unit cost information. Virtually all firms use normal costing.
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Importance of Unit Costs to Manufacturing Firms
Unit cost is a critical piece of information for a manufacturer. Unit costs are essential for valuing inventory, determining income, and making numerous important decisions. Disclosing the cost of inventories and determining income are financial reporting requirements that a firm faces at the end of each period. In order to report the cost of its inventories, a firm must know the number of units on hand and the unit cost. The cost of goods sold (COGS), used to determine income, requires knowledge of the units sold and their unit cost. Full cost information is useful as an input for a number of important internal decisions as well as for financial reporting. In the long run, for any product to be viable, its price must cover its full cost. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
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Importance of Unit Costs to Service Firms
Service and nonprofit firms also require unit cost information. Conceptually, the way companies accumulate and assign costs is the same whether or not the firm is a manufacturer. The service firm must first identify the service ``unit'' being provided. For example, a hospital would accumulate costs by patient, patient day, and type of procedure. Because service firms do not produce physical products, they do not need to value work-in-process and finished goods inventories.
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Ethical Decisions
Nonprofit firms must track costs to be sure that they provide their services in a cost-efficient way. Governmental agencies must track costs to use the funds wisely because they have a fiduciary responsibility to taxpayers. A cost accounting system that measures and assigns costs so that the unit cost of a product or service can be determined which is a critical piece of information for both manufacturing and service firms. In addition, an important part of bidding and charging for services under Medicaid rules impacts government agencies and is commonly tied to the critical determination of unit cost.
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In normal costing, overhead is estimated and applied to production. The basics of overhead application can be described in three steps: Step 1: Calculate the predetermined overhead rate
Step 2: Apply overhead to production throughout the year Step 3: Reconcile the difference between the total actual overhead incurred during the year and the total overhead applied to production.
Normal Costing and Estimating Overhead
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Step 1: Calculating the Predetermined Overhead Rate
The predetermined overhead rate is calculated at the beginning of the year by dividing the total estimated annual overhead by the total estimated level of associated activity or cost driver: Overhead Rate = Estimated Annual Overhead Estimated annual activity level Notice that the predetermined overhead rate includes estimated amounts in both the numerator and the denominator. This estimation is necessary because the predetermined overhead rate is calculated in advance, usually at the beginning of the year. Estimated overhead is the firm's best estimate of the amount of overhead (utilities, indirect labor, depreciation, etc.) to be incurred in the coming year. The number of machine hours could be a good choice of activity level for overhead of a company that has automated production. be copied, scanned, or in part, except for as 2012 Cengage Learning. All Rightsa Reserved. May noton last year's figuresorwebsite for classroomforpermitted in a Estimates may be based service or otherwise on aduplicated, in whole adjusteduseuse. license distributed with certain product or password-protected
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Step 2: Applying Overhead to Production Throughout the Year
Once the overhead rate has been computed, the company can begin to apply overhead to production. Applied overhead is found by multiplying the predetermined overhead rate by the actual use of the associated activity for the period:
Applied overhead = Predetermined overhead rate x Actual activity level
Once this is calculated, the total cost of product for the period is the actual direct materials and direct labor, plus the applied overhead:
Total costs = Actual direct materials + Actual direct labor + Applied overhead
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Calculating The Predetermined Overhead Rate and Applying Overhead to Production
Cornerstone 51
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Step 3: Reconciling Actual Overhead 2 with Applied Overhead
Remember that two types of overhead are recorded:
Actual overhead: Costs are tracked throughout the year in the overhead account. Applied overhead: Costs are computed throughout the year and added to actual direct materials and actual direct labor to get total product cost.
At the end of the year, however, it is time to reconcile any difference between actual and applied overhead and to correct the cost of goods sold account to reflect actual overhead spending. Applied overhead will rarely equal actual overhead.
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Step 3: Reconciling Actual Overhead with Applied Overhead
(continued)
The difference between actual overhead and applied overhead is called an overhead variance. If actual overhead is $400,000 for the year but $390,000 was applied to production, we would say that the variance is underapplied overhead. If actual overhead is $400,000 for the year but $410,000 was applied to production, we would say that the variance is overapplied overhead. If overhead has been underapplied, then product cost has been understated. If overhead has been overapplied, then product cost has been overstated.
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Step 3: Reconciling Actual Overhead with Applied Overhead
(continued)
Something must be done with the overhead variance at year-end to report costs at actual amounts on the financial statements. Generally, the entire overhead variance is assigned to Cost of Goods Sold, since the amount is usually small or immaterial.
Underapplied overhead is added to Cost of Goods Sold. Overapplied overhead is subtracted from Cost of Goods Sold.
If the overhead variance is material, or large, another approach would be taken. That approach is, to allocate the variance among the ending balances of Work in Process, Finished Goods, and Cost of Goods Sold.
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Actual Overhead and Applied Overhead
To help review these concepts, this exhibit illustrates the concepts of over- and underapplied overhead.
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Reconciling Actual Overhead with Applied Overhead
Cornerstone 52
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Departmental Overhead Rates
So far a plantwide overhead rate or single overhead rate has been explained by dividing all estimated overhead for a factory by the estimated activity level across the entire factory. However, some manufacturers and service firms believe that multiple overhead rates give more accurate costing information. Departmental overhead rates are a widely used type of multiple overhead rate. A departmental overhead rate is estimated overhead for a department divided by the estimated activity level for that same department. The steps involved in calculating and applying overhead are 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed those involved for on a password-protected website overhead the same as with a certain product or service or otherwise one plantwide for classroom use.
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Calculating Predetermined Departmental Overhead Rates and Applying Overhead to Production
Cornerstone 53
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Calculating Predetermined Departmental Overhead Rates and Applying Overhead to Production (continued)
Cornerstone 53
3.
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Converting Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production
Cornerstone 54
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Cornerstone 54 2 Converting Departmental Data to Plantwide Data to Calculate the Overhead Rate and Apply Overhead to Production (continued)
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Unit Costs in the JobOrder System
The unit cost of a job is the total cost of the job (materials used on the job, labor worked on the job, and applied overhead) divided by the number of units in the job: Unit cost = Total cost Number of units Although the concept is simple, the practical reality of the computation can be somewhat more complex because of the recordkeeping involved.
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JobOrder Cost Sheet
Accounting for job-order production begins by preparing the source documents that are used to keep track of the costs of jobs. The job-order cost sheet is prepared for every job.
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JobOrder Cost Sheet
(continued)
The job-order cost sheet is subsidiary to the work-inprocess account and is the primary document for accumulating all costs related to a particular job. As more and more jobs are produced, a company will usually find it convenient to number them. Work in process consists of all incomplete work. In a job-order system, this will be all of the unfinished jobs. The balance in Work in Process at the end of the month will be the total of all the job-order cost sheets for the incomplete jobs.
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Materials Requisition Form
The cost of direct materials is assigned to a job by the use of a source document known as a materials requisition form.
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Materials Requisition Form
(continued)
Notice that the form asks for the type, quantity, and unit price of the direct materials issued and, most importantly, the number of the job. Using this form, the cost accounting department can enter the cost of direct materials onto the correct job-order cost sheet. If the accounting system is automated, this posting may entail directly entering the data into a computer, using the materials requisition forms as source documents. No attempt is made to trace the cost of other materials, such as supplies, lubricants, and the like, to a job. particular These indirect materials are assigned to jobs through the predetermined overhead rate.
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Time Ticket
The means by which direct labor costs are assigned to individual jobs is the source document known as a time ticket.
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Time Ticket
(continued)
Each day, the employee fills out a time ticket that identifies his or her name, wage rate, and the hours worked on each job. These time tickets are collected and transferred to the cost accounting department where the information is used to post the cost of direct labor to individual jobs. Again, in an automated system, posting involves entering the data into the computer. Time tickets are used only for direct laborers. All completed job-order cost sheets of a firm can serve as a subsidiary ledger for the finished goods inventory. Then, the work-in-process account consists of all of the job order cost sheets for be copied, scanned, or duplicated, in whole or 2012 Cengage Learning. All Rights Reserved. May not the unfinished jobs. in part, except for use as permitted in a
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Creating Source Documents for Other Activities
You Decide
You are the cost accounting manager for a company that provides photography services for special events, such as weddings, bar mitzvahs, anniversary parties, and corporate functions. The cost of the services vary from job to job. The time of the photographers assigned to the job is already kept track of using labor time tickets. However, your company now wants to reimburse the photographers for mileage, and may want to include an additional charge to clients for mileage. What type of source document could serve to accumulate miles driven?
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Creating Source Documents For Other Activities (continued)
You Decide
In this case, your company needs to know not only the number of miles each photographer drives, but also which job the mileage pertains to. A relatively simple mileage log, listing the date, starting mileage, ending mileage, and purpose of the trip should suffice. This will allow you to compute the miles driven (ending mileage minus beginning mileage) and assign it to the specific photographic job. In addition, total miles for each photographer can be computed on a monthly basis and multiplied by your company's mileage reimbursement rate for purposes of reimbursing each photographer for automotive operating costs. Some companies might have other specific needs. For example, perhaps the company has a fleet of different vehicles and wants to compute different rates depending on the vehicle. Using a van might require a higher rate than using a small automobile. In this case, an additional column to record the type of vehicle, or vehicle's license plate would be necessary. Still other companies may use an overhead application base other than direct labor hours. Perhaps machine hours may be used to apply overhead. Then, a new document must be developed. A source document that will track the machine hours used by each job can be modeled on job time tickets.
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Flow of Costs 4 Through a JobOrder Costing Firm
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Accounting for Materials
Here is a summary of raw materials cost flow for Johnson Leathergoods and its two jobs.
Raw material beginning balance + Purchases - Materials used = Raw materials ending balance
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Accounting for Direct Labor Cost
Notice that the direct labor costs assigned to the two jobs exactly equal the total labor costs assigned to Work in Process.
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Accounting for Overhead
Overhead costs can be assigned using a single plantwide overhead rate or departmental rates. Typically, direct labor hours is the measure used to calculate a plantwide overhead rate, and departmental rates are based on drivers such as direct labor hours, machine hours, or direct materials dollars. In the example of Johnson Leathergoods, plantwide overhead rate is calculated based on direct labor hours as shown here. Overhead rate = $9,600 2,400 = $4 per direct labor hour
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Accounting for Overhead
Take a minute to review the summary of overhead cost flows. Notice that the total overhead applied from all jobs is entered in the work-in-process account.
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Accounting for Finished Goods
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Schedule of Cost of Goods Manufactured
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Statement of Cost of Goods Sold
A schedule of cost of goods sold usually is prepared at the end of each reporting period, as shown here for Johnson Leathergoods for January.
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Cornerstone 55 Preparing Brief JobOrder Cost Sheets
Required: 1.Calculate the overhead rate based on direct labor cost. 2.Prepare a brief job-order cost sheet for the four jobs. Show the balance as of June 1 as well as direct materials and direct labor added in June. Apply overhead to the four jobs for the month of June, and show the ending balances. 3.Calculate the ending balances of Work in Process and Finished Goods as of June 30. 4.Calculate Cost of Goods Sold for June.
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Preparing Brief JobOrder Cost Sheets (continued)
Cornerstone 55
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Preparing Brief JobOrder Cost Sheets (continued)
Cornerstone 55
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Accounting for Nonmanufacturing Costs
Manufacturing costs are not the only costs experienced by a firm. Nonmanufacturing, or period, costs are also incurred. These include selling and general administrative costs, which are never assigned to the product; they are not part of the manufacturing cost flows. Controlling accounts accumulate all of the selling and administrative expenses for a period. At the end of the period, all of these costs flow to the period's income statement.
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Income Statement
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Journal Entries For JobOrder Costing
Purchased raw materials costing $2,500 on account.
Description
Debit
Credit
1. Raw Materials
Accounts Payable
2,500 2,500
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Journal Entries For JobOrder Costing (continued)
Requisitioned materials costing $1,500 for use in production.
Description
Debit
Credit
2. Work in Process
Raw Materials
1,500 1,500
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Journal Entries For JobOrder Costing (continued)
Recognized direct labor costing $1,530.
Description
Debit
Credit
3. Work in Process
Wages Payable
1,530 1,530
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Applied overhead to production at the rate of $4 per direct labor hour. A total of 85 direct labor hours were worked.
Description Debit Credit
Journal Entries For JobOrder Costing (continued)
4. Work in Process
Overhead Control
340 340
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Journal Entries For JobOrder Costing (continued)
Incurred actual overhead costs of $415.
Description
Debit
Credit
5. Overhead Control
Lease Payable Utilities Payable Accumulated Depreciation Wages Payable
415 200 50 100 65
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Journal Entries For JobOrder Costing (continued)
Completed the backpack job and transferred it to Finished Goods.
Description
Debit
Credit
6. Finished Goods
Work in Process
2,320 2,320
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Journal Entries For JobOrder Costing (continued)
Sold the backpack job at cost plus 50 percent.
Description
Debit
Credit
7. Cost of Goods Sold
Finished Goods Accounts Receivable Sales Revenue
2,320 2,320 3,480 3,480
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Journal Entries For JobOrder Costing (continued)
Closed underapplied overhead to Cost of Goods Sold.
Description
Debit
Credit
8. Cost of Goods Sold
Overhead Control
75 75
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Posting of Journal Entries to the Accounts
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Producing and Supporting Departments
Nearly every company or factory has producing departments and support departments.
Producing departments are directly responsible for creating the products or services sold to customers.
For example, a public accounting firm might have producing departments devoted to auditing, tax, and management advisory services. In a factory, producing departments are those that work directly on the products being manufactured, such as the grinding and assembly departments.
Support departments provide essential services for producing departments, but they do not actually make the product or service being sold.
Examples include the maintenance, grounds, engineering, housekeeping, personnel, and photocopying departments.
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Steps for Determining Product Costs by Using 6 Predetermined Departmental Overhead Rates
Once the direct overhead costs of each department are determined, the next step is to assign the support department costs to producing departments using causal factors (drivers).
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Assigning Costs of Multiple Support Departments
The three methods of assigning costs of multiple support departments to producing departments are:
the direct method, the sequential method, and the reciprocal method.
In determining which support department cost allocation method to use, companies must determine the extent of support department interaction and weigh the individual costs and benefits of each method.
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Assigning Costs of Multiple Support 6 Departments Using the Direct Method
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Assigning Support Department Costs by Using the Direct Method
Cornerstone 56
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Assigning Support Department Costs by Using the Direct Method (continued)
Cornerstone 56
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Assigning Costs of Multiple Support Departments Using the Sequential Method
The sequential (or step) method of allocation recognizes that interactions among support departments occur. However, the sequential method does not fully account for support department interaction. Cost allocations are performed in a step-down fashion, following a predetermined ranking procedure. Usually, the sequence is defined by ranking the support departments in order of the amount of service rendered, from the greatest to the least, where degree of service is measured by the direct costs of each support department.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Assigning Costs of Multiple Support Departments Using the Sequential Method
(continued)
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Assigning Support Department Costs by Using the Sequential Method
Cornerstone 57
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Assigning Support Department Costs by Using the Sequential Method (continued)
Cornerstone 57
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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The Reciprocal Method
The reciprocal method of allocation recognizes all interactions among support departments. Under the reciprocal method, one support department's use by another figures in determining the total cost of each support department, where the total cost reflects interactions among the support departments. Then, the new total of support department costs is allocated to the producing departments. This method fully accounts for support department interaction by using a system of simultaneous linear equations. The reciprocal method is not widely used due to its complexity. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Technology and Support Department Cost Allocation
Another factor in allocating support department cost is the rapid change in technology. Many firms currently find that support department cost allocation is useful for them. However, the move toward activitybased costing and just-in-time manufacturing can virtually eliminate the need for support department cost allocation.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.