Job Order Cost Systems and Overhead Allocations

Chapter 17

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2012 The McGraw-Hill Companies, Inc.

Cost Accounting Systems

Determining unit manufacturing costs

Planning and control functions

Cost accounting systems provide information supporting decisions making the business successful Assessing the efficiency and effectiveness of operations Providing products or services to customers
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Cost Accounting Systems

Evaluate and reward employee performance

Disclose inventories and cost of goods sold

Cost accounting systems are the procedures and techniques used by management Track resources consumed by products and services
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Manage activities that consume resources

Job Order Costing

Used for production of large, unique, high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.

Typical job order cost applications: Special-order printing Building construction Also used in service industry Hospitals Law firms

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Job Order Cost Systems and the Creation of Goods and Services
Receive orders from customers Begin production

Schedule jobs

Order materials

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Job Order Cost Systems and the Creation of Goods and Services Manufacturing
overhead (OH) Direct materials

Applied to each job using a predetermined rate (POHR)

THE JOB
Direct labor
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Job Order Cost Systems and the Creation of Goods and Services Charge direct material and
Direct Materials direct labor costs to each job as work is performed. Job No. 1 Direct Labor Job No. 2 Job No. 3 Apply overhead to each job using a predetermined rate.
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Manufacturing Overhead

Overhead Application Rates

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 activity base for the coming period

POHR =

Ideally, the activity base is a cost driver that causes overhead.

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Overhead Application Rates

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.
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Overhead Application Rates

Based on estimates, and determined before the period begins.
Overhead applied = POHR Actual activity Actual amount of the cost driver such as units produced, direct labor hours, or machine hours incurred during the period.
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Overhead Application Rates

Compuline, Inc., applies overhead based on direct labor hours. Total estimated overhead for the year is $360,000. Total estimated labor hours are 30,000. What is Compulines predetermined overhead rate per hour?

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Overhead Application Rates

Estimated total manufacturing POHR = overhead cost for the coming period Estimated total units in the allocation base for the coming period

POHR =

$360,000

30,000 direct labor hours (DLH)

POHR = $12.00 per DLH

For each direct labor hour worked on a job, $12.00 of manufacturing overhead will be applied to the job.
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Job Order Costing

The primary document for tracking the costs associated with a given job is the job cost sheet.

Lets investigate

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The Job Cost Sheet

Oak and Glass Furniture Co. Job Cost Sheet Product: French Court Dining Tables Number of units: 100 Date started 831 1/03/11

Date Completed 1/21/11 Manufacturing Overhead Rate Cost Applied 150% $ 21,000 150% 9,000 Total Cost Unit Cost $ 25,000 $ 250 20,000 200 30,000 300 $ 75,000 $ 750
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Manufacturing Direct Direct Labor Department Materials Hours Cost Milling $ 10,000 70 $ 14,000 Finishing 15,000 300 6,000 Cost Summary Direct materials used Direct Labor Manufacturing overhead applied Cost of finished goods manufactured (100 tables)

The Job Cost Sheet

Oak and Glass Furniture Co. Job Cost Sheet Product: French Court Dining Tables Number of units: 100 Date started 831 1/03/11

Manufacturing Direct Department Materials Milling $ 10,000 Finishing 15,000

Date Completed 1/21/11 A materials requisition Direct Labor Manufacturing Overhead formRate used to is Hours Cost Cost Applied 70 authorize the use$of $ 14,000 150% 21,000 300 6,000 150% materials on a job. 9,000 Total Cost Unit Cost $ 25,000 $ 250 20,000 200 30,000 300 $ 75,000 $ 750
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Cost Summary Direct materials used Direct Labor Manufacturing overhead applied Cost of finished goods manufactured (100 tables)

The Job Cost Sheet

Oak and Glass Furniture Co. Job Cost Sheet Product: French Court Dining Tables Number of units: 100

Manufacturing Direct Direct Labor Department Materials Hours Cost Milling $ 10,000 70 $ 14,000 Finishing 15,000 300 6,000

Accumulate 831 direct1/03/11 labor Date started costs by Date Completed 1/21/11 means of a Manufacturing Overhead Rate work record, Cost Applied such as a time 150% $ 21,000 150% 9,000 ticket, for each employee.
Total Cost Unit Cost $ 25,000 $ 250 20,000 200 30,000 300 $ 75,000 $ 750
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Cost Summary Direct materials used Direct Labor Manufacturing overhead applied Cost of finished goods manufactured (100 tables)

The Job Cost Sheet

Apply jobs using 831 a predetermined overhead rate (POHR) based on Product: French Court Dining Tables Date started 1/03/11 direct labor cost.
Number of units: 100 Date Completed 1/21/11 Manufacturing Direct Direct Labor Department Materials Hours Cost Milling $ 10,000 70 $ 14,000 Finishing 15,000 300 6,000 Cost Summary Direct materials used Direct Labor Manufacturing overhead applied Cost of finished goods manufactured (100 tables) Manufacturing Overhead Rate Cost Applied 150% $ 21,000 150% 9,000 Total Cost Unit Cost $ 25,000 $ 250 20,000 200 30,000 300 $ 75,000 $ 750
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Oak and Glass Furniture Co. manufacturing overhead to Job Cost Sheet

Flow of Costs in Job Costing

A materials requisition indicates the cost of direct material to charge to jobs and the cost of indirect material to charge to overhead.
Direct Material Job Cost Job Cost Job Cost Sheets Job Cost Sheets Sheets Sheets

Materials Material Requisitioin Materials Requisitioin Materials Requisitioni Requisition Manufacturing Overhead Account

Indirect Material

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Flow of Costs in Job Costing

Employee time tickets indicate the cost of direct labor to charge to jobs and the cost of indirect labor to charge to overhead.
Direct Labor Job Cost Job Cost Job Cost Sheets Job Cost Sheets Sheets Sheets

Employee Time Employee Time Ticket Employee Time Ticket Employee Time Ticket Ticket
Manufacturing Overhead Account

Indirect Labor

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Flow of Costs in Job Costing

Employee Time Ticket Indirect Labor Overhead Applied with POHR

Other Actual OH Charges

Manufacturing Overhead Account

Job Cost Sheets

Materials Requisition

Indirect Material
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Flow of Costs in Job Costing

Materials Inventory
Material Direct Purchases Material Indirect Material

Work in Process (Job Cost Sheet)

Direct Material

Mfg. Overhead
Indirect Material

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Flow of Costs in Job Costing

Labor
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)

Direct Material Direct Labor Overhead Applied
When Actual Applied factory = factory overhead overhead the difference is closed to cost of goods sold.

Mfg. Overhead
Indirect Overhead Material Applied to Work in Indirect Process Labor

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Flow of Costs in Job Costing

Work in Process (Job Cost Sheet)
Direct Cost of Material Goods Direct Mfd. Labor Overhead Applied Cost of Goods Sold
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Finished Goods
Cost of Goods Mfd. Cost of Goods Sold

Cost of Goods Sold

Over- or Underapplied Overhead

If Manufacturing Overhead is . . . UNDERAPPLIED (Applied OH is less than actual OH) OVERAPPLIED (Applied OH is greater than actual OH) Effect of Closing to Cost of Goods Sold INCREASE Cost of Goods Sold DECREASE Cost of Goods Sold

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Activity-Based Costing (ABC)

One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost to assign to each job.
Assigning overhead is difficult.

I agree!

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Activity-Based Costing (ABC)

Activity-Based Costing

Departmental Overhead Rates

Plantwide Overhead Rate

A B C

Overhead Allocation

In the ABC method, we recognize that many activities within a department drive overhead costs.
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The Benefits of ABC

More detailed measures of costs. Better understanding of activities. More accurate product costs for . . . Pricing decisions. Product elimination decisions. Managing activities that cause costs. Benefits should always be compared to costs of implementation.

A B C
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Identifying Cost Drivers

Most cost drivers are related to either volume or complexity of production.
Examples:

machine time, machine setups, purchase orders, production orders.

Three factors are considered in choosing a cost driver:

Causal

relationship. received.

Benefits

Reasonableness.

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Activity-Based Costing Procedures

Identify activities that consume resources. Assign costs to a cost pool for each activity. Identify cost drivers associated with each activity. Compute overhead rate for each cost pool:

Estimated overhead costs in activity cost pool Rate = Assign

Estimated number costs to products:of activity units

Overhead Rate

Actual Activity
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ABC Versus a Single Application Rate: A Comparison

Pear Company manufactures a product in regular and deluxe models. Overhead is assigned on the basis of direct labor hours. Budgeted overhead for the current year is $2,000,000. Other information:
Deluxe Model $ 150 16 1.6 hours 5,000 Regular Model $ 112 8 0.8 hours 40,000

Direct Material Direct Labor Cost Direct Labor Time Expected Volume (units)

First, determine the unit cost of each model using a single application rate.
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Single Application Rate

Direct Labor Hours 8,000 32,000 40,000

Deluxe Model Regular Model

5,000 units @ 1.6 hours 40,000 units @ 0.8 hours

Total Direct Labor Hours (DLH)

Overhead = Estimated overhead costs Rate Estimated activity

Overhead = $2,000,000 = $50 per DLH Rate 40,000 DLH

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Single Application Rate

ABC will have different overhead cost per unit.
Direct Material Direct Labor Manufacturing Overhead $50 per hour 1.6 hours $50 per hour 0.8 hours Total Unit Cost

Deluxe Model $ 150 16 80 $ 246

Regular Model $ 112 8

40 160

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Activity-Based Costing
Pear Company plans to adopt activitybased costing. Using the following activity center data, determine the unit cost of the two products using activity-based costing.
Activity Cost Pool Purchasing Scrap Rework Testing Machine Related Total Overhead Cost Driver Orders Orders Tests Hours Overhead Cost for Activity $ 84,000 216,000 450,000 1,250,000 $ 2,000,000 Units of Activity Deluxe Regular 400 800 300 600 4,000 11,000 20,000 30,000

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Activity-Based Costing

Activity Cost Pool Purchasing Scrap Rework Testing Machine Related Total Overhead

Cost Driver Orders Orders Tests Hours

Overhead Cost for Activity $ 84,000 216,000 450,000 1,250,000 $ 2,000,000

Units of Activity 1,200 900 15,000 50,000

Rate

400 deluxe + 800 regular = 1,200 total

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Activity-Based Costing

Activity Cost Pool Purchasing Scrap Rework Testing Machine Related Total Overhead

Cost Driver Orders Orders Tests Hours

Overhead Cost for Activity $ 84,000 216,000 450,000 1,250,000 $ 2,000,000

Units of Activity 1,200 900 15,000 50,000

Rate $ 70 per order $240 per order $ 30 per test $ 25 per hour

Rate = Overhead Cost for Activity Units of Activity

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Activity-Based Costing
Activity Cost Pool Purchasing Scrap Rework Testing Machine Related Total Overhead Deluxe Actual Units of Activity 400 300 4,000 20,000 Model Cost Allocated to Product $ 28,000 ? ? ? ? Regular Model Actual Cost Units of Allocated Activity to Product 800 $ 56,000 600 ? 11,000 ? 30,000 ? ?

Rate $ 70/order $240/order $ 30/test $ 25/hour

Cost Allocated to Product = Actual Units of Activity Rate

$70 400 = $28,000 Lets complete the table.

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Activity-Based Costing
Activity Cost Pool Purchasing Scrap Rework Testing Machine Related Total Overhead Deluxe Actual Units of Activity 400 300 4,000 20,000 Model Cost Allocated to Product $ 28,000 72,000 120,000 500,000 $ 720,000 Regular Model Actual Cost Units of Allocated Activity to Product 800 $ 56,000 600 144,000 11,000 330,000 30,000 750,000 $ 1,280,000

Rate $ 70/order $240/order $ 30/test $ 25/hour

Cost Allocated to Product = Actual Units of Activity Rate

Total overhead = $720,000 + $1,280,000 = $2,000,000 Recall that $2,000,000 was the original amount of overhead assigned to the products using traditional overhead costing.
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Activity-Based Costing
Overhead Costs Assigned to Products: Deluxe Model $720,000 5,000 units = $144 per unit Regular Model $1,280,000 40,000 units = $32 per unit Deluxe Model $ 150 16 144 $ 310 Regular Model $ 112 8 32 $ 152

Direct Materials Direct Labor Manufacturing Overhead Total Unit Cost

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ABC Versus a Single Application Rate: A Comparison

Single Deluxe Model Direct materials $ 150 Direct labor 16 Overhead 80 Total cost $ 246 Rate Regular Model $ 112 8 40 $ 160 ABC Deluxe Regular Model Model $ 150 $ 112 16 8 144 32 $ 310 $ 152

This result is not uncommon when activity-based costing is used. Many companies have found that low-volume, specialized products have greater overhead costs than previously realized.
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Costs and Cost Drivers in Activity-Based Costing

Cost
Materials purchasing Materials handling Personnel processing Equipment depreciation Quality inspection Indirect labor for equipment setups Engineering costs for product modifications

Cost Driver
Number of purchase orders Number of materials requisitions Number of employees hired or laid off Number of products produced or hours of use Number of units inspected Number of setups required Number of modifications

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Ethics, Fraud, and Corporate Governance

In addition to allocating manufacturing overhead costs to products, many companies allocate corporate overhead charges to their segments or divisions. Failure to allocate corporate overhead properly can result in misleading financial statement information.
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End of Chapter 17

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