Cost Allocation & Job-Order Costing

Learning Objective 1

Distinguish between process costing and joborder costing and identify companies that would use each costing method.

Types of Product Costing Systems

Process Costing Job-order 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.

Types of Product Costing Systems

Process Costing

Job-order Costing

A company produces many units of a single product. Example companies: One (paper manufacturing) 1.BILTunit of product is indistinguishable from 2.other units of(refining aluminum ingots) HINDALCO product. 3.The identical nature and bottling beverages)enables Coca-Cola (mixing of each unit of product assigning the same average cost per unit.

Types of Product Costing Systems

Process Costing

Job-order 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.

Types of Product Costing Systems

Process Costing

Job-order Costing

Example companies: Products are manufactured to order. 1. Boeing (aircraft manufacturing) 2.The unique nature construction) requires tracing or DLF (large scale of each order allocating costs to each job, and maintaining cost 3.records forFilms (movie production) Rajshree each job.

Many different products are produced each period.

Comparing Process and Job-Order Costing

Job-Order Number of jobs worked Cost accumulated by Average cost computed by Many Individual Job Job

Process Single Product Department Department

Quick Check
Which of the following companies would be likely to use job-order costing rather than process costing? a. ITC Paper Division. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

Quick Check
Which of the following companies would be likely to use job-order costing rather than process costing? a. ITC Paper Division. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.

Learning Objective 2

Identify the documents used in a job-order costing system.

Job-Order Costing An Overview

Direct Materials

Job No. 1
Direct Labor Job No. 2 Job No. 3

Manufacturing Overhead

Charge direct material and direct labor costs to each job as work is performed.

Direct Manufacturing Costs

Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.

Direct Materials

Job No. 1
Direct Labor Job No. 2 Job No. 3

Manufacturing Overhead

The Job Cost Sheet

PearCo Job Cost Sheet
Job Number A - 143 Department B3 Item Wooden cargo crate Direct Materials Req. No. Amount Date Initiated 3-4-11 Date Completed Units Completed

Direct Labor Manufacturing Overhead Ticket Hours Amount Hours Rate Amount

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Product Cost

Units Shipped Date Number Balance

Measuring Direct Materials Cost

Measuring Direct Materials Cost

Measuring Direct Labor Costs

Job-Order Cost Accounting

Learning Objective 3

Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

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 managers salary. 3. Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

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 Estimated total units in the allocation base for the coming period

POHR =

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

The Need for a POHR

Using a predetermined rate makes it possible to estimate total job costs sooner.

Rs.

Actual overhead for the period is not known until the end of the period.

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.

Overhead Application Rate

Estimated total manufacturing overhead cost for the coming period

POHR =

Estimated total units in the allocation base for the coming period
Rs.640,000 160,000 direct labor hours (DLH)

POHR =

POHR = Rs.4.00 per DLH For each direct labor hour worked on a particular job, Rs.4.00 of factory overhead will be applied to that job.

Job-Order Cost Accounting

Job-Order Cost Accounting

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 Rs.118.

Quick Check
Job WR53 at Custom Fabric required Rs. 200 of direct materials and 10 direct labor hours at Rs.15 per hour. Estimated total overhead for the year was Rs.760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. Rs.200. b. Rs.350. c. Rs.380. d. Rs.730.

Quick Check
Job WR53 at Custom Fabric required Rs.200 of direct materials and 10 direct labor hours at Rs.15 per hour. Estimated total overhead for the year was Rs.760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. Rs.200. b. Rs.350. c. Rs.380. d. Rs.730.

Learning Objective 4

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs.

Job-Order Costing Document Flow Summary

A sales order is the basis of issuing a production order.

A production order initiates work on a job.

Job-Order Costing Document Flow Summary

Materials used may be either direct or indirect.

Direct materials

Job Cost Sheets

Materials Requisition Indirect materials Manufacturing Overhead Account

Job-Order Costing Document Flow Summary

An employees time may be either direct or indirect.

Direct Labor

Job Cost Sheets

Employee Time Ticket Indirect Labor Manufacturing Overhead Account

Job-Order Costing Document Flow Summary

Employee Time Ticket

Indirect Labor

Other Actual OH Charges

Manufacturing Applied Overhead Overhead Account

Job Cost Sheets

Materials Requisition

Indirect Material

Learning Objectives 4 & 7

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs. Use T-accounts to show the flow of costs in a job-order costing system.

Job-Order Costing: The Flow of Costs

The transactions (in Taccount and journal entry form) that capture the flow of costs in a joborder costing system are illustrated on the following slides.

The Purchase and Issue of Raw Materials

Raw Materials
Material Direct Purchases Materials Indirect Materials

Work in Process (Job Cost Sheet)

Direct Materials

Mfg. Overhead
Actual Applied Indirect Materials

Cost Flows Material Purchases

Raw material purchases are recorded in an inventory account.

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.

The Recording of Labor Costs

Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)

Direct Materials Direct Labor

Mfg. Overhead
Actual Indirect Materials Indirect Labor Applied

The Recording of Labor Costs

The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.

Recording Actual Manufacturing Overhead

Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)

Direct Materials Direct Labor

Mfg. Overhead
Actual Applied Indirect Materials Indirect Labor Other Overhead

Recording Actual Manufacturing Overhead

In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.

Learning Objective 5

Apply overhead cost to Work in Process using a predetermined overhead rate.

Applying Manufacturing Overhead

Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)

Direct Materials Direct Labor Overhead Applied

Mfg. Overhead
Actual Applied Indirect Materials Overhead Indirect Applied to Labor Work in Other Process Overhead

If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.

Applying Manufacturing Overhead

Work in Process is increased when Manufacturing Overhead is applied to jobs.

Accounting for Nonmanufacturing Cost

Nonmanufacturing costs are not assigned to individual jobs; rather they are expensed in the period incurred.

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

Accounting for Nonmanufacturing Cost

Nonmanufacturing costs (period expenses) are charged to expense as they are incurred.

Learning Objective 6

Prepare schedules of cost of goods manufactured and cost of goods sold.

Transferring Completed Units

Work in Process (Job Cost Sheet)
Direct Materials Direct Labor Overhead Applied

Finished Goods
Cost of Goods Mfd.

Cost of Goods Mfd.

Transferring Completed Units

As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.

Transferring Units Sold

Work in Process (Job Cost Sheet)
Direct Materials Direct Labor Overhead Applied

Finished Goods
Cost of Goods Mfd.

Cost of Goods Mfd.

Cost of Goods Sold

Cost of Goods Sold

Cost of Goods Sold

Transferring Units Sold

When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods.

Learning Objective 8

Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.

Problems of Overhead Application

The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is referred to as 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.

Overhead Application Example

PearCos actual overhead for the year was Rs.650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCos jobs during the year? Use PearCos predetermined overhead rate of Rs.4.00 per direct labor hour.

Overhead Applied During the Period

Applied Overhead = POHR Actual Direct Labor Hours Applied Overhead = Rs.4.00 per DLH 170,000 DLH = Rs.680,000

Overhead Application Example

PearCos actual overhead for the year was Rs.650,000 with a total of 170,000 direct labor hours worked on jobs. PearCo much total overhead was applied to has overapplied How overhead for the year PearCos jobs during the year? Use by Rs.30,000. What will PearCos predetermined overhead rate of PearCo do? Rs.4.00 per direct labor hour.

Overhead Applied During the Period

Applied Overhead = POHR Actual Direct Labor Hours Applied Overhead = Rs.4.00 per DLH 170,000 DLH = Rs.680,000

Quick Check
Tiger, Inc. had actual manufacturing overhead costs of Rs.1,210,000 and a predetermined overhead rate of Rs.4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tigers manufacturing overhead is a. Rs.50,000 overapplied. b. Rs.50,000 underapplied. c. Rs.60,000 overapplied. d. Rs.60,000 underapplied.

Quick Check
Tiger, Inc. had actual manufacturing overhead costs of Rs.1,210,000 and a predetermined Overhead Applied overhead rate of Rs.4.00 Rs.4.00 per hour 290,000 per machine hour. hours Tiger, Inc. worked 290,000 machine hours during = Rs.1,160,000 the period. Tigers manufacturing overhead is a. Rs.50,000 b. Rs.50,000 underapplied. c. Rs.60,000 overapplied. d. Rs.60,000 underapplied.
Underapplied Overhead overapplied. Rs.1,210,000 - Rs.1,160,000 = Rs.50,000

Disposition of Under- or Overapplied Overhead

PearCos Method

Rs.30,000 may be allocated to these accounts.

Rs.30,000 may be closed directly to cost of goods sold.

OR
Work in Process Finished Goods Cost of Goods Sold

Cost of Goods Sold

Disposition of Under- or Overapplied Overhead

PearCos Cost of Goods Sold

Unadjusted Balance Rs.30,00 0 Adjusted Balance

PearCos Mfg. Overhead

Actual Overhead overhead applied costs to jobs Rs.650,00 Rs.680,00 0 0 Rs.30,000 Rs.30,000 overapplied

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:

Allocating Under- or Overapplied Overhead Between Accounts

We would complete the following allocation of Rs.30,000 overapplied overhead:

Allocating Under- or Overapplied Overhead Between Accounts

Overapplied and Underapplied Manufacturing Overhead - Summary

PearCos Method
If Manufacturing Overhead is . . . UNDERAPPLIED (Applied OH is less than actual OH) OVERAPPLIED (Applied OH is greater than actual OH) DECREASE Cost of Goods Sold Alternative 1 Close to Cost of Goods Sold INCREASE Cost of Goods Sold Alternative 2 Allocation INCREASE Work in Process Finished Goods Cost of Goods Sold DECREASE Work in Process Finished Goods Cost of Goods Sold

Quick Check
What effect will the overapplied overhead have on PearCos net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease.

Quick Check
What effect will the overapplied overhead have on PearCos net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease.

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 often use multiple predetermined overhead rates.

May be more complex but . . .

May be more accurate because it reflects differences across departments.

Job-Order Costing in Service Companies

Job-order costing is used in many different types of service companies.

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 webbased programming language called Extensible Markup Language (XML), bar coding eliminates the inefficiencies and inaccuracies associated with manual clerical processes.

The Predetermined Overhead Rate & Capacity

Appendix 3A

Learning Objective 9

(Appendix 3A)
Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

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.

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.

Lets look at the difference!

An Example
Equipment is leased for Rs.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?

An Example
Equipment is leased for Rs.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 = Method Rs.100,000 = Rs.2.50 per unit 40,000

Capacity Method

Rs.100,000 = Rs.2.00 per unit 50,000

Quick Check
Crest Winery in Woodinville leases an automatic corking machine for Rs.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. Rs.2.00 per case. b. Rs.2.50 per case. c. Rs.4.00 per case.

Quick Check
Crest Winery in Woodinville leases an automatic corking machine for Rs.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. Rs.2.00 per case. b. Rs.2.50 per case. c. Rs.4.00 per case.

Quick Check
Crest Winery in Woodinville leases an automatic corking machine for Rs.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. Rs.2.00 per case. b. Rs.2.50 per case. c. Rs.4.00 per case.

Quick Check
Crest Winery in Woodinville leases an automatic corking machine for Rs.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. Rs.2.00 per case. b. Rs.2.50 per case. c. Rs.4.00 per case.

Quick Check
When capacity is used in the denominator of 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.

Quick Check
When capacity is used in the denominator of 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.

Quick Check
When estimated activity is used in the denominator of 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.

Quick Check
When estimated activity is used in the denominator of 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.

Income Statement Preparation

Income Statement Preparation

End of Topic