Systems Design:

Job-Order Costing

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 Types of Product Costing Systems

Process Job-order
Costing 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.

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 Types of Product Costing Systems

Process Job-order
Costing Costing

 A company produces many units of a single

product.companies:
Example
 1.One unit of product
Weyerhaeuser is indistinguishable
(paper manufacturing) from
2.other units Aluminum
Reynolds of product.(refining aluminum ingots)
 3.The
Coca-Cola
identical(mixing
nature and bottling
of each unit beverages)
of product enables
assigning the same average cost per unit.

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 Types of Product Costing Systems

Process Job-order
Costing 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.

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 Types of Product Costing Systems

Process Job-order
Costing Costing

 Many different products are produced each period.

Example companies:
 Products are manufactured to order.
1. Boeing (aircraft manufacturing)
 2.The unique
Bechtel nature of each
International order
(large requires
scale tracing or
construction)
allocating costs to each job, and maintaining cost
3.records
Walt Disney Studios
for each job. (movie production)

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 Comparing Process and Job-Order Costing

Job-Order Process
Number of jobs worked Many
Individual Single Product
Cost accumulated by Job Department
Average cost computed by Job Department

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 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.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 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.

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 Direct Manufacturing Costs

Charge
Direct Materials
Job No. 1 direct
material and
Direct Labor direct labor
Job No. 2
costs to
each job as
Manufacturing Job No. 3
Overhead work is
performed.

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 Direct Manufacturing Costs

Manufacturing
Overhead,
Direct Materials
including
Job No. 1
indirect
Direct Labor materials and
Job No. 2 indirect labor,
are allocated to
Manufacturing Job No. 3 jobs rather than
Overhead directly traced
to each job.

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 Job-Order Cost Accounting

PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-05
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost

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 Materials Requisition Form

Will E. Delite

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 Job-Order Cost Accounting

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 Employee Time Ticket

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 Job-Order Cost Accounting

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 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:
1. It is impossible or difficult to trace overhead costs to particular jobs.
2. Manufacturing overhead consists of many different items ranging
from the grease used in machines to production manager’s salary.
3. Many types of manufacturing overhead costs are fixed even though
output fluctuates during the period.

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

Ideally, the allocation base

is a cost driver that causes
overhead.

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 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.
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 Application of Manufacturing Overhead

Based on estimates, and

determined before the
period begins.

Overhead applied = POHR × Actual activity

Actual amount of the allocation

based upon the actual level of
activity.

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 Overhead Application Rate

Estimated total manufacturing

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

$640,000
POHR =
160,000 direct labor hours (DLH)

POHR = $4.00 per DLH

For each direct labor hour worked on a

particular job, $4.00 of factory overhead
will be applied to that job.
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 Job-Order Cost Accounting

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 Job-Order Cost Accounting

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 Interpreting the Average Unit Cost

The average unit cost should not be interpreted

as the costs that would actually be incurred if an
additional unit were produced.

Fixed overhead would not change if another unit

were produced, so the incremental cost of
another unit may be somewhat less than $118.

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 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.
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 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?
Pred. ovhd. rate $760,000/20,000hours $38
a. $200.
b. $350. Direct materials
Direct labor
$200
$15 x 10 hours $150
c. $380. Manufacturing overhead $38 x 10 hours $380
Total cost $730
d. $730.
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 Job-Order Costing
Document Flow Summary

Let’s summarize
the document flow
in a job-order
costing system.

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 Job-Order Costing
Document Flow Summary

A sales order is the A production

basis of issuing a order initiates
production order. work on a job.

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 Job-Order Costing
Document Flow Summary

Materials used
may be either Direct Job Cost
direct or materials Sheets
indirect.

Materials
Requisition

Manufacturing
Indirect
Overhead
materials
Account

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 Job-Order Costing
Document Flow Summary

An employee’s
time may be either Direct Job Cost
direct or indirect. Labor Sheets

Employee Time
Ticket

Manufacturing
Indirect
Overhead
Labor
Account

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 Job-Order Costing
Document Flow Summary

Employee Indirect
Time Ticket Labor

Other Manufacturing Applied

Job Cost
Actual OH Overhead
Overhead Sheets
Charges Account

Materials Indirect
Requisition Material

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 Job-Order System Cost Flows

Let’s examine the

cost flows in a
job-order costing
system.

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 Job-Order System Cost Flows

Raw Materials Work in Process

Material Direct
 (Job Cost Sheet)
Purchases Materials Direct
Indirect Materials
Materials

Mfg. Overhead
Actual Applied
Indirect

Materials

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 Cost Flows – Material Purchases

Raw material purchases are recorded in an

inventory account.

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 Cost Flows – Material Usage

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.

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 Job-Order System Cost Flows

Salaries and Work in Process

Wages Payable (Job Cost Sheet)
Direct Direct
Labor Materials
Indirect Direct

Labor Labor

Mfg. Overhead
Actual Applied
Indirect

Materials
Indirect

Labor
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 Cost Flows – Labor

The cost of direct labor incurred increases Work in

Process and the cost of indirect labor increases
Manufacturing Overhead.

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 Job-Order System Cost Flows

Salaries and Work in Process

Wages Payable (Job Cost Sheet)
Direct Direct
Labor Materials
Indirect Direct

Labor Labor
Mfg. Overhead
Actual Applied
Indirect

Materials
Indirect

Labor
Other

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Overhead Copyright © 2006, The McGraw-Hill Companies, Inc.
 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.

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 Job-Order System Cost Flows

Salaries and Work in Process

Wages Payable (Job Cost Sheet)
Direct Direct
Labor Materials
Indirect Direct

Labor Labor
Overhead
Mfg. Overhead
Actual Applied Applied
Indirect
If actual and applied
Materials Overhead
manufacturing overhead
Indirect Applied to are not equal, a year-end
Labor Work in adjustment is required.
Other
Process
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Overhead Copyright © 2006, The McGraw-Hill Companies, Inc.
 Cost Flows – Overhead Applied

Work in Process is increased when

Manufacturing Overhead is applied to jobs.

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 Nonmanufacturing Cost Flows

Nonmanufacturing costs are not assigned to

individual jobs, rather they are expensed in the
period incurred.

Examples:
1. Salary expense of employees
that work in a marketing, selling,
or administrative capacity.
2. Advertising expenses are expensed
in the period incurred.

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 Nonmanufacturing Cost Flows

Nonmanufacturing costs (period expenses) are

charged to expense as they are incurred.

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 Job-Order System Cost Flows

Work in Process Finished Goods

(Job Cost Sheet)
Direct
 Cost of


Materials Cost of Goods

Goods Mfd.
Direct
Mfd.
Labor
Overhead
Applied

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 Cost Flows – Cost of Goods Manufactured

As jobs are completed, the Cost of Goods

Manufactured is transferred to Finished Goods
from Work in Process.

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 Job-Order System Cost Flows

Work in Process Finished Goods

(Job Cost Sheet)
Direct
 Cost of
  Cost of
Materials Cost of Goods Goods
Goods Mfd. Sold
Direct
Mfd.
Labor
Overhead
Applied Cost of Goods Sold
Cost of
Goods
Sold

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 Cost Flows – Sales

When finished goods are sold, two entries are

required: (1) to record the sale, and (2) to
record COGS and reduce Finished Goods.

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 Defining Under- 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 Overapplied 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.
McGraw-Hill/Irwin
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.
Copyright © 2006, The McGraw-Hill Companies, Inc.
 Overhead Application Example

PearCo’s actual overhead for the year was

$650,000 with a total of 170,000 direct labor
hours worked on jobs.
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 Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Overhead Application Example

PearCo’s actual overhead for the year was

$650,000 with a total of 170,000 direct labor
hours worked on jobs.
PearCo has overapplied
How much total overhead was applied to
overhead for the year
PearCo’s jobs during the year? Use
by $30,000. What will
PearCo’s predetermined overhead rate of
PearCo do?
$4.00 per direct labor hour.
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check 

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.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

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
Overhead Applied
period. Tiger’s manufacturing
$4.00 per overhead is hours
hour × 290,000
= $1,160,000
a. $50,000 overapplied.
Underapplied Overhead
b. $50,000 underapplied.
$1,210,000 - $1,160,000
= $50,000
c. $60,000 overapplied.
d. $60,000 underapplied.

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 Disposition of Under- or Overapplied Overhead

PearCo’s Method

$30,000 $30,000 may be

may be allocated closed directly to
to these accounts. cost of goods sold.
OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold

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 Disposition of Under- or Overapplied Overhead

PearCo’s Cost PearCo’s

of Goods Sold Mfg. Overhead
Unadjusted Actual Overhead
Balance overhead applied
costs to jobs
$30,000
$650,000 $680,000
Adjusted $30,000 $30,000
Balance overapplied

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 Allocating Under- or Overapplied
Overhead Between Accounts

Assume the overhead applied in ending Work in

Process Inventory, ending Finished Goods
Inventory, and Cost of Goods Sold is shown below:
Percent of Allocation of
Amount Total $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

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 Allocating Under- or Overapplied
Overhead Between Accounts

We would complete the following allocation of

$30,000 overapplied overhead:

Percent of Allocation of
Amount Total $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

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 Allocating Under- or Overapplied
Overhead Between Accounts
Percent of Allocation of
Amount Total $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

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 Overapplied and Underapplied Manufacturing
Overhead - Summary

PearCo’s
Method
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASE

Cost of Goods Sold Work in Process
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASE

Cost of Goods Sold Work in Process
(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold

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 Quick Check 

What effect will the overapplied overhead

have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

What effect will the overapplied overhead

have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.

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Multiple Predetermined Overhead Rates

To this point we have assumed that there is a

single predetermined overhead rate called a
plantwide overhead rate.

Large companies May be more

often use multiple complex but . . .
predetermined
overhead rates. May be more
accurate because it
reflects differences
across departments.
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 Job-Order Costing in Service Companies

Job-order costing is used in many

difference types of service companies.

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 The Use of Information Technology

Technology plays an important part in many

job-order cost systems. When combined with
Electronic Data Interchange (EDI) or a web-
based programming language called
Extensible Markup Language (XML), bar
coding eliminates the inefficiencies and
inaccuracies associated with manual clerical
processes.

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 Appendix 3a

The Predetermined Overhead

Rate & Capacity

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 Predetermined Overhead Rate and Capacity

Calculating predetermined overhead rates using

an estimated, or budgeted amount of the
allocation base has been criticized because:
1. Basing the predetermined overhead rate upon
budgeted activity results in product costs that
fluctuate depending upon the activity level.
2. Calculating predetermined rates based upon
budgeted activity charges products for costs that
they do not use.

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 Capacity-Based Overhead Rates

Criticisms can be overcome by using

estimated total units in the allocation base at
capacity in the denominator of the
predetermined overhead rate calculation.

Let’s look at the difference!

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 An Example

Equipment is leased for $100,000 per year.

Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 units
will be produced and sold next year. What is the
predetermined overhead rate?

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 An Example

Equipment is leased for $100,000 per year.

Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 units
will be produced and sold next year. What is the
predetermined overhead rate?
Traditional $100,000
= = $2.50 per unit
Method 40,000

Capacity $100,000
= = $2.00 per unit
Method 50,000

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

Crest Winery in Woodinville leases an automatic

corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

Crest Winery in Woodinville leases an automatic

corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

Crest Winery in Woodinville leases an automatic

corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

Crest Winery in Woodinville leases an automatic

corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

When capacity is used in the denominator in the

predetermined rate, what happens to the
predetermined overhead rate as estimated
activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down
when activity goes down.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

When capacity is used in the denominator in the

predetermined rate, what happens to the
predetermined overhead rate as estimated
activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down
when activity goes down.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

When estimated activity is used in the

denominator in the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a.The predetermined overhead rate goes up when
activity goes down.
b.The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down
when activity goes down.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check 

When estimated activity is used in the

denominator in the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a.The predetermined overhead rate goes up when
activity goes down.
b.The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down
when activity goes down.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Basing the rate on capacity

Actual volume 40,000 cases

Selling price $40.00 per case
Variable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Capacity 50,000 cases
Predetermined overhead rate $2.00 per case
Fixed selling and admin. expense $500,000 per year

Revenue $ 1,600,000
Cost of goods sold 1,040,000
Gross margin 560,000
Cost of idle capacity 20,000
Selling and admin. expense 500,000
Net operating income $ 40,000

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Basing the rate on expected volume

Actual volume 40,000 cases

Selling price $40.00 per case
Variable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Expected volume 40,000 cases
Predetermined overhead rate $2.50 per case
Fixed selling and admin. expense $500,000 per year

Revenue $ 1,600,000
Cost of goods sold 1,060,000
Gross margin 540,000
Cost of idle capacity -
Selling and admin. expense 500,000
Net operating income $ 40,000

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 End of Chapter 3

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