Transcript
ACC 604 - Chapter 3 Notes
Job-order costing: an overview
Job-order costing systems are used when:
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.
B. Examples of companies that would use job-order costing include:
Boeing (aircraft manufacturing)
Bechtel International (large scale construction)
Walt Disney studios (movie production)
Job-order costingan example
Types of manufacturing costs (product costs) that are assigned to products using a job-order costing system:
Direct costs
Direct materials Traced directly to each job as the work is performed.
Direct labor Traced directly to each job as the work is performed.
Indirect costs
Manufacturing overhead (including indirect materials and indirect labor). These costs are allocated to jobs rather than directly traced to each job.
The job cost sheet The accounting department relies upon a job cost sheet for tracking the direct and indirect costs associated with a given job.
An overview of a job cost sheet:
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.
Measuring direct materials 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 to be drawn from the storeroom, and the job number to which the cost of the materials is to be charged.
For an existing product, the production department can refer to a bill of materials to determine the type and quantity of each item of materials needed to complete a unit of product.
The Accounting Department records the total direct material cost on the appropriate job cost sheet. The material requisition number is included on the job cost sheet to provide easy access to the source document.
Measuring direct labor costs
Workers use time tickets to record the amount of time that they spent on each job and the total cost assigned to each job.
The Accounting Department records the labor costs from the time tickets on to the job cost sheet.
Computing predetermined overhead rates
An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to products. Allocation bases are used because:
It is impossible or difficult to trace these costs to particular jobs (i.e., manufacturing overhead is an indirect cost).
Manufacturing overhead consists of many different items ranging from the grease used in machines to the production manager’s salary.
Many types of manufacturing overhead costs are fixed even though output may fluctuate during the year.
The predetermined overhead rate is calculated by dividing the estimated amount of manufacturing overhead for the coming period by the estimated quantity of the allocation base for the coming period. Ideally, the allocation base chosen should be the cost driver of overhead cost.
Predetermined overhead rates that rely upon estimated data are often used because:
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.
Actual overhead costs can fluctuate seasonally, thus misleading decision makers.
Predetermined overhead rates are calculated using a four-step process.
The first step is to estimate the total amount of the allocation base required for next period’s estimated level of production.
The second step is to estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base.
The third step is to use a cost formula to estimate the total manufacturing overhead cost for the coming period.
The fourth step is to compute the predetermined overhead rate.
v. Applying manufacturing overhead
Manufacturing overhead is applied to jobs using the predetermined overhead rate multiplied by the actual amount of the allocation base used completing the job (this is called a normal costing system). For example, assume PearCo:
Applies overhead to jobs based on direct labor hours.
Estimated that 160,000 direct labor hours would be required to support the planned production for the year.
Estimated $200,000 of total fixed overhead cost and $2.75 of variable overhead per direct labor-hour.
Used a cost formula to estimate its total manufacturing overhead cost of $640,000.
Calculated its predetermined overhead rate of $4 per direct labor hour.
The amount of overhead that would be applied to the job cost sheet that we have been working with related to Job A-143 is $32, calculated as follows:
Eight direct labor hours were worked on Job A-143.
The predetermined overhead rate is $4 per direct labor hour.
8 direct labor hours $4 per hour = $32.
Job-order costingthe flow of costs
Key definitions
Raw materials include any materials that go into the final product.
Work in process consists of units of production that are only partially complete and will require further work before they are ready for sale to customers.
Finished goods consist of completed units of product that have not yet been sold to customers.
Cost of goods manufactured includes the manufacturing costs associated with the goods that were finished during the period.
Flow of cost: a conceptual overview
Raw materials purchases are recorded in the Raw Materials inventory account.
When raw materials are used in production, their costs are transferred to the Work in Process inventory account as direct materials.
Direct labor costs are added directly to Work in Process—they do not flow through Raw Materials inventory.
Manufacturing overhead costs are applied to Work in Process by multiplying the predetermined overhead rate by the actual quantity of the allocation base consumed by each job.
When goods are completed, their costs are transferred from Work in Process to Finished Goods.
The amount transferred from Work in Process to Finished Goods is referred to as the cost of goods manufactured.
As goods are sold, their costs are transferred from Finished Goods to Cost of Goods Sold.
Period costs (or selling and administrative expenses) do not flow through inventories on the balance sheet. They are recorded as expenses on the income statement in the period incurred.
The transactions (in T-account and journal entry form) that capture the flow of costs in a job-order costing system are as follows:
The purchase and issue of raw materials
In T-account form:
The cost of raw material purchases is debited, and the credit side of the transaction would be to Accounts Payable.
The cost of direct material requisitions is debited to Work in Process and added to the job cost sheets which serve as a subsidiary ledger.
The cost of indirect material requisitions is debited to Manufacturing Overhead.
In journal entry form:
Debit Raw Materials and credit Accounts Payable.
Debit Work in Process and Manufacturing Overhead and credit Raw Materials.
The recording of labor costs
In T-account form:
Direct labor costs are debited to Work in Process and added to the job cost sheets which serve as a subsidiary ledger.
Indirect labor costs are debited to Manufacturing Overhead.
In journal entry form:
Debit Work in Process and Manufacturing Overhead and credit Salaries and Wages Payable.
Recording actual manufacturing overhead costs (other than indirect materials and indirect labor)
In T-account form:
The manufacturing overhead costs are debited to Manufacturing Overhead.
The credit side of the entry is the various liability accounts (e.g., Accounts Payable and Property Taxes Payable), prepaid asset accounts (e.g., Prepaid Insurance), and contra-asset accounts (e.g., Accumulated Depreciation).
In journal entry form:
Debit Manufacturing Overhead and credit various accounts as shown.
Applying manufacturing overhead costs to work in process
In T-account form:
Work in process is debited and Manufacturing Overhead is credited by the amount of the actual quantity of the allocation base multiplied by the predetermined rate.
Actual manufacturing overhead costs are not debited to Work in Process, nor are they charged to jobs via the job cost sheets.
The Manufacturing Overhead account is a clearing account. The actual amount of overhead incurred during the period on the debit side of the account will almost certainly not equal the amount applied to Work in Process as shown on the credit side of the account. This requires a year-end adjusting entry that will be discussed shortly.
In journal entry form:
Debit Work in Process and credit Manufacturing Overhead.
Accounting for nonmanufacturing costs
Companies that use job-order cost systems to assign manufacturing costs to products also incur nonmanufacturing costs.
Nonmanufacturing costs should not go into the Manufacturing Overhead account.
Nonmanufacturing costs are not assigned to individual jobs, rather they are expensed in the period incurred. For example:
The salary expenses of employees that work in a marketing, selling, or administrative capacity are expensed in the period incurred.
Advertising expenses are expensed in the period incurred.
Transferring completed units from work in process to finished goods
In T-account form:
The sum of all amounts transferred from work in process to finished goods represents the cost of goods manufactured for the period.
The Finished Goods Inventory is debited and the Work in Process account is credited.
In journal entry form:
Debit Finished Goods and credit Work in Process.
Transferring finished goods to cost of goods sold
In T-account form:
Debit Cost of Goods Sold and credit Finished Goods.
If only a portion of the units associated with a particular job are shipped, then the unit cost figure from the job cost sheet is used to determine the amount of the journal entry.
This journal entry is also accompanied by a journal entry that recognizes the sales revenue.
In journal entry form:
Debit Accounts Receivable and credit Sales.
Debit Cost of Goods Sold and credit Finished Goods.
Schedules of cost of goods manufactured and cost of goods sold
Key concepts
This schedule contains three types of costs, namely direct materials, direct labor, and manufacturing overhead.
It calculates the cost of raw material and direct labor used in production and the amount of manufacturing overhead applied to production.
It calculates the manufacturing costs associated with goods that were finished during the period.
Product cost flows
To create a schedule of cost of goods manufactured, as well as a balance sheet and income statement, it is important to understand the flow of product costs:
Raw material purchases made during the period are added to beginning raw materials inventory. The ending raw materials inventory is deducted to arrive at the raw materials used in production.
As items are removed from raw materials inventory and placed into the production process, they are called direct materials.
Direct labor used in production and manufacturing overhead applied to production are added to direct materials to arrive at total manufacturing costs.
Total manufacturing costs are added to the beginning work in process to arrive at total work in process.
The ending work in process inventory is deducted from the total work in process for the period to arrive at the cost of goods manufactured.
The cost of goods manufactured is added to the beginning finished goods inventory to arrive at cost of goods available for sale. The ending finished goods inventory is deducted from this figure to arrive at cost of goods sold.
Underapplied and overapplied overhead—a closer look
There are two key concepts related to this topic, the first of which is:
Defining and computing underapplied and overapplied overhead
The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is termed 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.
Disposition of underapplied or overapplied overhead balances
Any remaining balance in the Manufacturing Overhead account is disposed of in one of two ways:
It can be closed out to Cost of Goods Sold.
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It can be allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the current period in the ending balances of these accounts.
The journal entry, in T-account form, to close out overapplied overhead into Cost of Goods Sold would be as follows:
Debit Manufacturing Overhead and credit Cost of Goods Sold.
Calculating the allocation of underapplied or overapplied overhead between Work in Process, Finished Goods, and Cost of Goods Sold.
Assume the overhead applied in Ending Work in Process Inventory, Ending Finished Goods Inventory, and Cost of Goods Sold is $68,000, $204,000, and $408,000, respectively (total value of accounts $680,000).
In this case, the allocation percentages for Work in Process, Finished Goods, and Cost of Goods
Sold would be 10%, 30%, and 60%, respectively.
The journal entry to close out overapplied overhead to each of the three accounts would be:
Debit Manufacturing Overhead and credit Work in Process, Finished Goods, and Cost of Goods Sold.
In summary, there are two methods for disposing of underapplied and overapplied overhead.
Close out to Cost of Goods Sold.
Allocate between Work in Process, Finished Goods, and Cost of Goods Sold.
The latter method is considered more accurate, but it is more complex to compute.
Multiple predetermined overhead rates
The chapter discussion assumes that there is a single predetermined overhead rate for an entire factory called a plantwide overhead rate.
In larger companies, multiple predetermined overhead rates are often used. For example, each production department may have its own predetermined overhead rate.
While using multiple predetermined overhead rates is more complex, it is also more accurate because it reflects differences across departments in how overhead costs are incurred.
Job-order costing in services companies
Although our attention has focused upon manufacturing applications, it bears re-emphasizing that job-order costing is also used in services industries.
For example, in a law firm, each client represents a “job.” Legal forms and similar inputs represent direct materials. The time expended by attorneys represents direct labor. The costs of secretaries, clerks, rent, depreciation, and so forth, represent the overhead.
DM USED
Beginning Materials inventory
Add: Materials purchased
Cost of materials available for use
Less: Ending Materials inventory
Less: Indirect Materials (if any)
= Cost of direct materials used
Total Product Costs Incurred this Period
Cost of direct materials used
Add: Direct Labor
Add: Factory Overhead
= Total manufacturing (product) costs incurred
Cost of Goods Manufactured (COGM)
Beginning Work in Process inventory
Add: Total manufacturing costs incurred
Total Work in Process
Less: Ending Work in Process inventory
= Cost of Goods Manufactured
Cost of Goods Sold (COGS)
Beginning Finished Goods inventory
Add: Cost of Goods Manufactured
Goods available for sale
Less: Ending Finished Goods inventory
= Cost of Goods Sold
Gross Profit
Sales
Less: COGS
= Gross Profit
Operating Income
Gross Profit
Less: Selling and Administrative Expenses
= Operating Income
