CHAPTER 3

SYSTEMS DESIGN:
JOB-ORDER COSTING
 CHAPTER LEARNING OBJECTIES
 After studying Chapter 3, you should be able to:
1. Distinguish between process costing and job-order costing and
identify companies that would use each costing method.
2. Identify the documents used in a job-order costing system.
3. Compute predetermined overhead rates and explain why estimated
overhead costs (rather than actual overhead costs) are used in the
costing process.
4. Record the journal entries that reflect the flow of costs in a job-order
costing system.
5. Apply overhead cost to Work in Process using a predetermined
overhead rate.
6. Prepare schedules of cost of goods manufactured and cost of goods
sold.
7. Compute under- or overapplied overhead cost and prepare the
journal entry to close the balance in Manufacturing Overhead to the
appropriate accounts.
 Learning Objective 1

Distinguish between process costing and job-order

costing and identify companies that would use
each costing method.
 Introduction
 Product costing is the process of assigning costs to the products and
services provided by a company.
 The essential purpose of any managerial costing system should be to
provide cost data to help managers plan, control, direct and make
decisions.
 Chapter 2 uses an absorption costing approach to determine
product costs.
 In absorption (or full) costing, all manufacturing costs, fixed and
variable, are assigned to units of product.
 Most countries require absorption costing for both external financial
reporting and tax reporting.
 Two costing systems are commonly used in manufacturing and in
many service companies; these two systems are known as process
costing and job-order costing.
4
Types of Product Costing Systems
Process Job-order
Costing Costing

 A company produces many units of a single product for long periods.

 One unit of product is indistinguishable from other units of product.
 Costs are accumulated by each department or operation in the
process.
 Total costs are divided by the number of units produced to get unit
product cost.
 The identical nature of each unit of product enables assigning the
same average cost per unit.
Types of Product Costing Systems
Process Job-order
Costing Costing

Example companies:
1. Paper manufacturing
2. Refining aluminum ingots
3. Mixing and bottling beverages
4. Gasoline/Petroleum
Types of Product Costing Systems
Process Job-order
Costing Costing

Chapter 4
 Many different products are produced each period.
 Products are manufactured to order.
 Cost records must be maintained for each distinct product or job.
Costs are traced and allocated to jobs and then the costs of the
job are divided by the number of units in the job to arrive at an
average cost per unit.
The record keeping and cost assignment problems are more
complex when a company sells many different products and
services than when it has only a single product.
Types of Product Costing Systems
Process Job-order
Costing Costing

Typical job order cost applications:

 Aircraft manufacturing
 Ship building
 Large scale construction
 Movie production
 Special-order printing
 Building construction
Also used in the service industry
 Hospitals
 Law firms
 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
 Learning Objective 2

Identify the documents used in a job-order costing

system.
 Job-Order Costing – An Overview

Manufacturing
overhead (OH)
Applied to each
Direct job using a
material predetermined
rate

The Job

Direct
labor
 Job-Order Costing – An Overview

Direct Materials Charge direct

Job No. 1 material and
direct labor
Direct Labor costs to each
Job No. 2
job as work is
performed.
Manufacturing Job No. 3
Overhead
 Job-Order Costing – An Overview
Manufacturing
Overhead, including
indirect materials,
indirect labor, and
Direct other indirect
Materials Job No. 1 manufacturing costs
are allocated to all jobs
rather than directly
Direct Labor traced to each job.
Job No. 2
Apply overhead
to each job
Manufacturing Job No. 3 using a
Overhead predetermined
overhead rate.
Job-Order Cost Accounting

The primary document for

tracking the costs associated
with a given job is the job
cost sheet.

Let’s investigate
 The Job Cost Sheet
PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 03-04-09

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
Job-Order Cost Accounting
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 03 – 04 – 13
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

Materials requisition form A detailed source

Cost Summary document that
Units Shipped
specifies the type and quantity of materials
Direct Materials thatNumber
Date are to Balance
be drawn
from the storeroom and identifies the job to which the costs of
Direct Labor
Manufacturing Overhead
materials
Total Costare to be charged.
Unit Product Cost
Measuring Direct Materials Cost

Cost of material is charged to job

A-143.

Type, quantity, and total cost of

material charged to job A-143.

Will E. Delite
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.
 Allocation Base
 A cost driver is a factor that directly causes overhead costs
to be incurred.
 The cost driver must be common to all company products
and services.
 Cost drivers include machine-hours, direct labor,
computer time, direct material cost, etc.
 Selection of an appropriate cost driver is essential to proper
overhead allocation.
 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.
 Application
of Manufacturing Overhead
The predetermined overhead rate (POHR) used to
apply overhead to jobs is determined before the
period begins.
Estimated total manufacturing
POHR =
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period

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.

Actual overhead for the period is not

known until the end of the period.
 Determining Predetermined
Overhead Rates
Predetermined overhead rates are calculated using a three-step process.

  
Estimate the level of Estimate total amount Estimate total
production for the of the allocation base manufacturing
period. for the period. overhead costs.

POHR =  ÷ 
 Application of Manufacturing
Overhead

Based on estimates, and determined

before the period begins.

Overhead applied = POHR × Actual activity

Actual amount of the allocation base

such as units produced, direct labor
hours, or machine hours incurred during
the period.
 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.
Job-Order Cost Accounting
Job-Order Cost Accounting
 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? POHR = $760,000/20,000 hours $38
a. $200.
Direct materials $200
b. $350. Direct labor $15 x 10 hours $150
c. $380. Manufacturing overhead $38 x 10 hours $380
Total cost $730
d. $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 A production

basis of issuing a order initiates
production order. work on a job.
 Job-Order Costing
Document Flow Summary
Materials
used may be Direct Job Cost
either direct or materials Sheets
indirect.
Materials
Requisition

Manufacturing
Indirect
Overhead
materials
Account
 Job-Order Costing
Document Flow Summary
An
employee’s
time may be either Direct Job Cost
Labor Sheets
direct or
indirect.
Employee Time
Ticket

Manufacturing
Indirect
Overhead
Labor
Account
 Job-Order Costing
Document Flow Summary

Materials Indirect
Requisition Material POHR rate
used to
apply
Other Manufacturing overhead Job Cost
Actual OH Overhead
Sheets
Charges Account

Employee Indirect
Time Ticket Labor
 Summary of the Flow of
Documents in a
Job-Order Costing System
 Learning Objectives 4 and 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 T-account
and journal entry form) that
capture the flow of costs in a
job-order costing system are
illustrated on the following
slides.
 The Purchase and Issue of
Raw Materials
Raw Materials Work in Process
Material (Job Cost Sheet)
 Direct
Purchases Materials Direct

Indirect Materials
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 Work in Process
Wages Payable (Job Cost Sheet)
Direct
 Direct
Labor Materials
Indirect Direct
Labor Labor

Mfg. Overhead
Actual Applied
Indirect

Materials
Indirect

Labor
 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 Work in Process
Payable (Job Cost Sheet)
Direct
 Direct
Labor Materials
Indirect Direct

Labor 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 Work in Process
Payable (Job Cost Sheet)
 Direct  Direct
Labor Materials
Indirect Direct

Labor Labor
Mfg. Overhead 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
Overhead
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.
Transferring Completed Units
Work in Process Finished Goods
(Job Cost Sheet)
Direct Cost of


Materials Cost of
 Goods
Goods Mfd.
Direct
Mfd.
Labor
Overhead
Applied
 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 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
 Transferring Units Sold
 When finished goods are sold, two entries are required: (1) to
record the sale, and (2) to record the Cost of Goods Sold.
A General Model of Cost Flows
 PROBLEMS

CHAPTER 3 REVIEW PROBLEM.pptx

CHAPTER 3 DEMONSTRATIVE PROBLEM.pptx
 Learning Objective 6

 Prepare schedules of cost of goods manufactured and cost

of goods sold.
Schedules of
CGM and CGS
Income Statement
 Learning Objective 7

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 Overapplied overhead

exists when the amount of exists when the amount of
overhead applied to jobs overhead applied to jobs
during the period using the during the period using the
predetermined overhead rate predetermined overhead
is less than the total amount rate is greater than the total
of overhead actually incurred amount of overhead actually
during the period. incurred during the period.
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
 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?
PearCo Use has
PearCo’s predetermined overhead rate of $4.00 per
overapplied
direct labor hour.
overhead for the year
by $30,000. What will
PearCo do? Applied During the Period
Overhead
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
 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.Overhead Applied
$4.00 per hour × 290,000 hours
b. $50,000 underapplied. = $1,160,000
c. $60,000 overapplied.Underapplied Overhead
$1,210,000 - $1,160,000
d. $60,000 underapplied. = $50,000
 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
 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
 If Over/Under significant,
Allocate Between Accounts
 Determine the amount of overhead applied to WIP,
Finished Goods and COGS
 Calculate the % of total Overhead applied to each
account
 Multiply the Over/Under amount times the %’s and
allocate to each account
 See example on the following slides.
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
Amount Total of $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
Allocating Under- or Overapplied
Overhead Between Accounts
We would complete the following allocation of $30,000
overapplied overhead:

Percent of Allocation
Amount Total of $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

10% × $30,000
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
 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

More accurate but more complex to compute.

Summary of Overhead Concepts
 Quick Check 

 What effect will the adjustment of over-applied

overhead have on Pear Co’s cost of goods sold?
a. Cost of goods sold will increase.
b. Cost of goods sold will be unaffected.
c. Cost of goods sold will decrease.
 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.
End of Chapter 3!!