Managerial Accounting-Chapter 5: Systems Design

CHAPTER 5: Systems Design: Job- Order Costing Prepared by Shannon Butler, CPA, CA Carleton University  Learning Objectives Part 1 1 Distinguish between process costing and job-order costing, and identify the production or service processes that fi...

CHAPTER 5: Systems Design: Job- Order Costing Prepared by Shannon Butler, CPA, CA Carleton University  Learning Objectives Part 1 1 Distinguish between process costing and job-order costing, and identify the production or service processes that fit with each costing method. 2 Recognize the flow of costs through 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. © 2021 McGraw-Hill Limited 5-2  Learning Objectives Part 2 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 underapplied or overapplied overhead cost, and prepare the journal entry to close the balance in manufacturing overhead to the appropriate accounts. 8 (Appendix 5A) Explain the implications of basing the predetermined overhead rate on activity at full capacity rather than on estimated activity for the © 2021 McGraw-Hill Limitedperiod. 5-3 Types of Product Costing Systems 1 Process Job-Order Costing Costing (Chapter 6) (Chapter 5) © 2021 McGraw-Hill Limited 5-4  Types of Product Costing Systems 2 Process Job-Order Costing Costing (Chapter 6) (Chapter 5) Example companies: 1. St. Mary’s Cement (cement mixing) 2. Petro-Canada (refining oil) 3. Coca-Cola (mixing and bottling beverages) © 2021 McGraw-Hill Limited 5-5  Types of Product Costing Systems 3 Process Job-Order Costing Costing (Chapter 6) (Chapter 5) 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. © 2021 McGraw-Hill Limited 5-6  Types of Product Costing Systems 4 Process Job-Order Costing Costing (Chapter 6) (Chapter 5) Example companies: 1. Bombardier (aircraft manufacturing) 2. Bechtel International (large scale constructio 3. Hallmark (greeting card design and printing) © 2021 McGraw-Hill Limited 5-7  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. © 2021 McGraw-Hill Limited 5-8  Quick Check  Which of the following companies would be likely to use job-order costing rather than process costing? Answer: b. Architects. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels. © 2021 McGraw-Hill Limited 5-9  Job-Order Costing – An Overview 1 Direct Charge Materials Job No. 1 direct Direct Labour material and Job No. 2 direct labour costs to Job No. 3 each job as work is performed. © 2021 McGraw-Hill Limited 5-10  Job-Order Costing – An Overview 2 Manufacturin g Overhead, Direct including Materials Job No. 1 indirect materials and Direct Labour Job No. 2 indirect labour, are Manufacturing allocated to Job No. 3 Overhead all jobs rather than directly © 2021 McGraw-Hill Limited traced to 5-11 Measuring Direct Materials Cost 1 Materials Requisition form is a document that: 1.Specifies the type and quantity of materials to be drawn from the storeroom and 2.Identifies the job to which the costs of the materials are to be charged. The form controls the flow of materials into production and also makes entries in the accounting records. © 2021 McGraw-Hill Limited 5-12  Measuring Direct Materials Cost 2 Exhibit 5-1 Materials Requisition Form © 2021 McGraw-Hill Limited 5-13  The Job Cost Sheet A job cost sheet is a form prepared for each separate job that records the materials, labour, and overhead costs charged to the job. © 2021 McGraw-Hill Limited 5-14 Measuring Direct Labour Costs 1 Direct labour cost is handled in a similar way as direct materials cost. Direct labour consists of labour charges that are easily traced to a particular job. Many companies use a computerized systems to maintain employee time tickets. Only direct labour costs get posted to the job cost sheet, whereas indirect labour is part of manufacturing overhead and does not get posted on a job cost sheet. © 2021 McGraw-Hill Limited 5-15 Measuring Direct Labour Costs 2 Exhibit 5-3 Employee Time Ticket © 2021 McGraw-Hill Limited 5-16 Computing Predetermined Overhead Rates 1 An allocation base, such as direct labour hours, direct labour 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 the production manager’s salary. 3.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period. 4.The timing of payment of manufacturing overhead 5-17 costs often varies © 2021 McGraw-Hill Limited  Computing Predetermined Overhead Rates 2 The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Estimated total manufacturing overhead cost POHR Estimated total units in the = allocation base © 2021 McGraw-Hill Limited 5-18  Overhead Application Based on estimates, and determined before the period begins. Overhead applied = POHR × Actual activity Amount of the allocation base incurred by the job © 2021 McGraw-Hill Limited 5-19 Predetermined Overhead Rate Estimated total manufacturing overhead cost POHR Estimated total units in the = allocation base $320,000 POHR 40,000 direct labour hours (DLH) = POHR = $8.00 per DLH If there were 27 direct labour-hours charged to Job 2B47, then a total of $216 ($8/DLH x 27 DLHs) of overhead cost would be applied to the job. © 2021 McGraw-Hill Limited 5-20 A Completed Job Cost Sheet Exhibit 5-4 A Completed Job Cost Sheet © 2021 McGraw-Hill Limited 5-21  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. Predetermined rate is based on estimates rather than actual results Predetermined overhead rate is computed before the period begins and used to apply overhead cost to jobs throughout the period. © 2021 McGraw-Hill Limited 5-22  Choice of an Allocation Base for Overhead The allocation Cost base used in the POHR should drive the overhead cost. A cost driver is a factor that causes overhead costs. If the base used does not drive the costs then the results will be inaccurate overhead rates and distorted product costs. A common allocation base is direct labour. © 2021 McGraw-Hill Limited 5-23  Computation of the 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 the average unit cost. © 2021 McGraw-Hill Limited 5-24  Quick Check  Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labour hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labour hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730. 5-25 © 2021 McGraw-Hill Limited  Quick Check  Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labour hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labour hours were 20,000. What would be recorded as the cost of job WR53? Answer: d. $730. © 2021 McGraw-Hill Limited 5-26  Summary of Document Flows Exhibit 5-5 The Flow of Documents in a Job- Order Costing System © 2021 McGraw-Hill Limited 5-27  Job-Order Costing: The Flow of Costs We will now take a more detailed look at the flow of costs. We will look at both the T-account and journal entry form, that capture the flow of costs in a job- order costing system. © 2021 McGraw-Hill Limited 5-28 The Purchase and Issue of Raw Materials Raw Materials Work in Inventory  Material  Direct Process Purchase Inventory s Indirec  Materia (Job Cost  Direct t ls Sheet) Materia Materia Mfg.ls ls Overhead Actual Applied  Indirect Materia ls © 2021 McGraw-Hill Limited 5-29  Cost Flows – Material Purchases Raw material purchases are recorded in an inventory account. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Raw Materials Inventory XXX Accounts Payable XXX © 2021 McGraw-Hill Limited 5-30 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. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Work in Process Inventory XXX Manufacturing Overhead XXX Raw Materials Inventory XXX © 2021 McGraw-Hill Limited 5-31 The Recording of Labour Costs 1 Work in Salaries and Process Wages Inventory Payable  Direc  (Job Cost Direct t Sheet)  Indirec Material  Direct Labo t s ur Labour Labou Mfg. r Overhead Actual Applied  Indirect  Materia Indirec ls t 5-32 Labour © 2021 McGraw-Hill Limited The Recording of Labour Costs 2 The cost of direct labour incurred increases Work in Process and the cost of indirect labour increases Manufacturing Overhead. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Work in Process Inventory XXX Manufacturing Overhead XXX Salaries and Wages Payable XXX © 2021 McGraw-Hill Limited 5-33  Recording Actual Manufacturing Overhead 1 Salaries and Work in Wages Process Payable  Direc Inventory t  (Job Cost Direct  Indire Sheet) Labo ct Material  Direct ur Mfg.Labou s Actual r Applied Labou Overhead  Indirect r  Indirec Materia t ls  Other Labour Overhe © 2021 McGraw-Hill Limited 5-34  Recording Actual Manufacturing Overhead 2 In addition to indirect materials and indirect labour, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Manufacturing Overhead XXX Accounts Payable XXX Property Taxes Payable XXX Prepaid Insurance XXX Accumulated Depreciation XXX © 2021 McGraw-Hill Limited 5-35  Applying Manufacturing Overhead 1 Work in Salaries and Process Wages Inventory Payable  Direc  (Job Cost Direct t Sheet)  Indire Material  Direct Labo ct s ur Labou Mfg.  Overhe Labou r ad r Overhead Actual Applied  Indirect Applied If If actual actual and and applied applied  Overhe manufacturing Indirec manufacturing  Materia ad overhead overhead t ls Applied are Other are not not equal, equal, aa year- year-  Labour to Work end end adjustment adjustment is is Overhe in required. 5-36 © 2021 McGraw-Hill Limited required.  Applying Manufacturing Overhead 2 Work in Process is increased when Manufacturing Overhead is applied to jobs. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Work in Process Inventory XXX Manufacturing Overhead XXX © 2021 McGraw-Hill Limited 5-37 The Concept of a Clearing Account © 2021 McGraw-Hill Limited 5-38 Non-Manufacturing Cost 1 Non-manufacturing 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. © 2021 McGraw-Hill Limited 5-39 Non-Manufacturing Cost 2 Non-manufacturing costs (period expenses) are charged to expense as they are incurred. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Salaries Expense XXX Salaries Payable XXX Advertising Expense XXX Accounts Payable XXX © 2021 McGraw-Hill Limited 5-40  Cost of Goods Manufactured 1 Work in Process Finished Inventory Goods (Job Cost  Direct Inventory  Cost  Cost Sheet) of Material  Direct of Good Good s s  Overhe s Labou Mfd. ad Mfd. r Applied © 2021 McGraw-Hill Limited 5-41  Cost of Goods As jobsManufactured 2 Goods are completed, the Cost of Manufactured is transferred to Finished Goods from Work in Process. The sum of all amounts transferred between WIP and Finished Goods represents the cost of goods manufactured for the period. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Finished Goods Inventory XXX Work in Process Inventory XXX © 2021 McGraw-Hill Limited 5-42  Cost of Goods Sold 1 Finished Work in Process Goods Inventory Inventory Cost  Cost  (Job Cost  Direct of of  Cost Sheet) Good Good Material  Direct of s s s Good Mfd. Sold  Overhe s Labou Cost of Goods Mfd. ad r Applied Sold  Cost of Good s Sold © 2021 McGraw-Hill Limited 5-43  Cost of Goods Sold 2 When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods Inventory. GENERAL JOURNAL Post. Date Description Ref. Debit Credit Accounts Receivable XXX Sales XXX Cost of Goods Sold XXX Finished Goods Inventory XXX © 2021 McGraw-Hill Limited 5-44 Complications 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© 2021 overhead actually incurred McGraw-Hill Limited 5-45 Overhead Application Example 1 the year was Actual overhead for $650,000 with a total of 170,000 direct labour hours worked on jobs. How much total overhead was applied to jobs during the year? Use a predetermined overhead rate of $4.00 per direct labour hour. Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labour Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 © 2021 McGraw-Hill Limited 5-46 Overhead Application Example 2 Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labour Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000 Actual Overhead = $650,000 Applied Overhead = $680,000 Therefore, overhead has been  Overapplied by $30,000. © 2021 McGraw-Hill Limited 5-47 Disposition of Underapplied or Overapplied Overhead 1 Current accounting standards applicable in Canada (IAS 2) state that: Unallocated overheads are recognized as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. 5-48 © 2021 McGraw-Hill Limited Disposition of Underapplied or Overapplied Overhead 2 The balance in the manufacturing overhead account must be treated in one of two ways depending on whether it was under- or overapplied during the year: 1. If overhead was underapplied, the remaining balance is closed out to COGS. 2. If overhead was overapplied, the remaining balance is allocated among WIP, FG, and COGS in proportion to the overhead applied during the current period in the ending balances of these accounts. © 2021 McGraw-Hill Limited 5-49  Close Out Underapplied Overhead to COGS Cost of Goods Mfg. Sold Overhead Actual Overhea Unadjuste d Balance overhea d d costs applied to jobs $30,0 $650,00 00 0 $680,00 Adjusted $30,000 0 overapplied Balance $30,0 00 $0 © 2021 McGraw-Hill Limited 5-50  Allocate Overapplied Overhead among Accounts 1 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 Inventory $ 68,000 10% $ 3,000 Finished Goods Inventory 204,000 30% 9,000 Cost of Goods Sold 408,000 60% 18,000 Total $ 680,000 100% $ 30,000 © 2021 McGraw-Hill Limited 5-51  Allocate Overapplied Overhead among Accounts 2 the following We would complete 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 © 2021 McGraw-Hill Limited 5-52  Allocate Overapplied Overhead among Accounts 3 Amount Percent of Total Allocation 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 GENERAL JOURNAL Post. Date Description Ref. Debit Credit Manufacturing Overhead 30,000 Work in Process Inventory 3,000 Finished Goods Inventory 9,000 Cost of Goods Sold 18,000 © 2021 McGraw-Hill Limited 5-53  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. © 2021 McGraw-Hill Limited 5-54  Quick Check  Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 Overhead Applied and a predetermined overhead $4.00 per hour rate of hours × 290,000 $4.00 per machine hour. =Tiger, $1,160,000 Inc. worked 290,000 Underapplied Overhead machine hours during the period. Tiger’s $1,210,000 – $1,160,000 manufacturing overhead = $50,000 is Answer: b. $50,000 underapplied. © 2021 McGraw-Hill Limited 5-55 Summary of Overhead Costs © 2021 McGraw-Hill Limited 5-56 A General Model of Cost Flow Exhibit 5- 12 © 2021 McGraw-Hill Limited 5-57  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. © 2021 McGraw-Hill Limited 5-58  Job-Order Costing in Service Companies Part 1 Job-order costing is used in service and non-profit organizations, such as accounting firms, hospitals, airlines, and repair shops, as well as in manufacturing companies. In an accounting firm, for example, different services provided to each client are classified as a “job” in our manufacturing example. Costs of providing that service are accumulated day by day on a job cost sheet as the service is being© 2021 provided. McGraw-Hill Limited 5-59  Job-Order Costing in Service Companies Part 2 The most significant cost categories in a service firm are direct labour and overhead, for example the cost of rent, depreciation of office equipment, salaries of secretarial staff, and so forth. These two cost categories are often blended into a “charge-out rate” for the staff providing service. The charge-out rate represents the total cost, including salaries and estimated overhead, of one hour of that staff person’s time. © 2021 McGraw-Hill Limited 5-60  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. © 2021 McGraw-Hill Limited 5-61  End of Chapter Summary Job-order costingPart 1 is used in situations where the organization offers many different products or services, such as in furniture manufacturers, hospitals, and legal firms. Process costing is used where units of product are homogeneous, such as in flour milling or cement production. Manufacturing overhead costs are assigned to jobs through use of a predetermined overhead rate. © 2021 McGraw-Hill Limited 5-62 End of Chapter Summary Part The predetermined 2 overhead rate is established before the period begins by dividing the estimated total manufacturing overhead cost for the period by the estimated total allocation base for the period. Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base used by the job. © 2021 McGraw-Hill Limited 5-63 End of Chapter Summary Part overhead Since the predetermined 3 rate is based on estimates, the actual overhead cost incurred during a period may be more or less than the amount of overhead cost applied to production. Such a difference is referred to as underapplied or overapplied overhead. The schedules of Cost of Goods Manufactured and Cost of Goods Sold summarize the flow of costs through the job- order costing system. © 2021 McGraw-Hill Limited 5-64 End of Chapter Summary Part 4 Any under- or overapplied overhead for a period can be (1) closed out to Cost of Goods Sold; (2) allocated among Work in Process, Finished Goods, and Cost of Goods Sold; or (3) carried forward to the end of the year. © 2021 McGraw-Hill Limited 5-65 The Predetermined Overhead Rate & Capacity Appendix 5A © 2021 McGraw-Hill Limited 5-66  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. © 2021 McGraw-Hill Limited 5-67 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! © 2021 McGraw-Hill Limited 5-68  An Example 1 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? © 2021 McGraw-Hill Limited 5-69  An Example 2 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? Capacity $100,000 = = $2.00 per unit Method 50,000 © 2021 McGraw-Hill Limited 5-70  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. © 2021 McGraw-Hill Limited 5-71  Quick Check  When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? Answer b. The predetermined overhead rate stays the same; it is not affected by changes in activity. © 2021 McGraw-Hill Limited 5-72  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. © 2021 McGraw-Hill Limited 5-73  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? Answer: a. The predetermined overhead rate goes up when activity goes down. © 2021 McGraw-Hill Limited 5-74  Predetermined Overhead Rate and Capacity IAS 2 now prohibits basing predetermined overhead rates on capacity for external reports. Predetermined overhead rates based on capacity could still be used for internal reporting. Managers would need to examine the benefits of improved decision making against the costs of having to calculate inventory values and COGS using two different methods. © 2021 McGraw-Hill Limited 5-75