Module 1: Introduction To Cost System | PDF

Module 1 INTRODUCTION TO THE COST SYSTEM; JOB ORDER COSTING Introduction Management needs prompt cost information in the decision making process. In any type of organization, be it business, political, religious or civic, it is imperative for management to be aware not only of its tot...

Module 1 INTRODUCTION TO THE COST SYSTEM; JOB ORDER COSTING Introduction Management needs prompt cost information in the decision making process. In any type of organization, be it business, political, religious or civic, it is imperative for management to be aware not only of its total costs and expenses, but also of the specific product, department or activity for which they are incurred, costs per unit and per work unit of its products and services, respectively, and of whether the amounts incurred are in accordance with the financial plans and standards. Intended Learning Outcomes At the end of this module, students are expected to: 1. Define cost accounting 2. Explain the purpose of cost accounting 3. Compare Cost Accounting, Financial Accounting and Management Accounting 4. Describe the uses of cost data. 5. Examine the different classification of cost 6. Describe the cost system 7. Differentiate job order costing from process costing 8. Identify the major source documents for job order costing 9. Demonstrate the accounting procedures necessary in job order costing 10. Illustrate the journal entries under perpetual and periodic inventory methods COST DEFINED - The cash or cash equivalent value sacrificed for goods and services that are expected to bring a current or future benefit to the organization. - Expired costs are called expenses. In each period, expenses are deducted from revenues in the income statement to determine the period’’s profit. - Loss – a cost that expires without producing any revenue benefit. COST ACCOUNTING DEFINED - An area of accounting concerned with cost determination and cost control. - Following the flow of costs in a business entity, from purchase of materials to final conversion of finished goods into cash or to rendition of services, cost data are accumulated for the purpose of determining costs per unit and per work unit and estimating appropriate selling price. - Cost data are analyzed and reported to management to serve as a basis in the decision making process. PURPOSES OF COST ACCOUNTING Cost determination. This refers to accumulation of cost data by products, processes or services to be able to arrive at unit cost or cost per work unit. Cost control. Standards are set for costs per unit and per work unit and are subsequently compared with the figures per actual operations so that remedial measures may be adopted. Cost accounting facilitates the performance by management of its planning and control functions. Cost standards are established for materials, labor and factory overhead based on product design, time and motion studies, and analysis of factory overhead. These standards subsequently serve as bases in measuring performance and as deterrents to pilferages and unnecessary wastages of materials and inefficiency of manpower. Page | 1 Cost Accounting, Financial Accounting and Management Accounting Cost Accounting Financial Accounting Management Accounting Supplements financial accounting by Concerned with processing historical and providing breakdown or details for cost projected economic data of an entity to assist figures contained in all-purpose financial management in setting up reasonable economic statements objectives and in making rational decisions towards the attainment of these objectives Cost accounting reports are based on cost Financial accounting data as accumulated in subsidiary ledgers reports are derived for costs and expenses incurred from postings to the general ledger Information is usually for management Information is for both use internal and external users Facilitates management accounting Differences between Financial accounting and Managerial Accounting Financial Accounting Managerial Accounting External persons who make financial Users decisions Managers who plan for and control an organization Time Focus Historical perspective Future emphasis Verifiability Emphasis on verifiability Emphasis on relevance for planning and control Precision versus timeliness Emphasis on precision Emphasis on timeliness Subject Primary focus is on the whole organization Focuses on segments of an organization Requirements Must follow GAAP and prescribed formats Need not follow GAAP or any prescribed format PLANNING AND CONTROL One of the most important functions of cost accounting is the development of information which can be used by management in planning and controlling operations. - Planning o the process of establishing objectives or goals for the firm and determining the means by which the firm will attain them. o Cost accounting helps in the development of plans by providing historical costs that serve as basis for projecting data for planning. Management can analyze trends and relationship among such data as an aid in estimating future costs and operating results and in making decisions regarding the acquisition of additional facilities, changes in marketing strategies, and obtaining additional capital. - Control o The process of monitoring the company’s operations and determining whether the objectives identified in the planning process are being accomplished. COST ACCOUNTING AND OTHER FIELDS OF STUDY The recording of the costs of a product or a service is part of financial accounting. The use of cost for valuation of inventory and cost of goods sold for external reporting is also financial accounting. The use of cost data in choosing between two or more alternatives is part of managerial accounting. Differential cost analysis is considered by others as a form of applied microeconomics. Cost accounting provides data for use in decision models for finance, operations management, and marketing. Cost accounting is also related to motivation and behaviour because it is used in planning Page | 2 and performance evaluation. Finally, tools from statistics, mathematics, and computer sciences are used to perform cost analysis. USES OF COST DATA Cost data provides management with a basis in making decisions and these may involve the following: Price setting. Selling prices are set based on desired profit and incremental costs. Choice of product line. A product may be dropped or added based on estimated contribution to company’s income. Make or buy. The company may decide to buy its product instead of continuing to manufacture it depending on the relevant costs involved. Contraction or expansion. A department, agency, branch or an affiliate may be closed or added based on the estimated decrease or increase in revenue, costs and expenses. Temporary shutdown. Management may opt for temporary cessation of operations during slump seasons based on estimated decrease in both revenue and costs. CLASSIFICATION OF COSTS 1. Costs classified as to relation to a product a. Manufacturing costs/ product costs i. Direct materials - materials that become part of a finished product and can be conveniently and economically traced to specific product units. - Examples: Iron ore for steel Sheet steel for automobiles Flour for bread - The way a company buys, stores, and uses materials is important. Timely purchasing is important because if the company runs out of materials, the manufacturing process will be forced to shut down. Shutting down production results in no products, unhappy customers, and loss of sales and profits. - Buying too many direct materials, on the other hand, can lead to high storage costs. ii. Direct labor costs - Wages of machine operators and other workers involved in actually shaping the product. - Include all labor costs for specific work performed on products that can be conveniently and economically traced to end products. - Indirect labor costs - Labor costs for production related activities that cannot be conveniently and economically traced to end products - accounted for as part of factory overhead costs - include the wages and salaries of Machine helpers Supervisors Other support personnel iii. Factory overhead - A catchall for all the manufacturing costs that cannot be classified as direct materials or direct labor costs. - A varied collection of production – related costs that cannot be practically or conveniently traced directly to end products. - Also called Manufacturing overhead Factory burden Indirect manufacturing costs Prime costs = Direct materials + Direct labor Conversion costs = Direct labor + Factory overhead b. Non-manufacturing costs/ period costs Page | 3  i. Marketing or selling expense – - Include all costs necessary to secure customer orders and get the finished product or service into the hands of the customer - Often referred to as order-getting and order-filling costs. - Examples: a. Advertising d. Sales commissions b. Shipping e. Sales salaries c. Sales travel ii. General or administrative expense - Include all executive organizational and clerical expenses that cannot logically be included under either production or marketing. - Examples: a. Executive compensation c. Secretarial b. General accounting d. Public relations 2. Costs classified as to variability Activity refers to a measure of the organization’s output of products or services. In specifying cost behaviour, the managerial accountant often limits the description to a specific range of activity. This is called the relevant range. a. Variable costs - Items of cost which vary directly, in total, in relation to volume of production. - Cost per unit remains constant as volume changes within a relevant range. - Examples: a. Direct materials b. Direct labor c. Royalties d. Commission of salesmen b. Fixed costs - Items of cost which remain constant in total, irrespective of the volume of production. - Cost per unit decreases as volume increases, and increases as volume decreases. - Examples: a. Salaries of production executives b. Depreciation of equipment computed on a straight-line basis c. Periodic rent payments, insurance c. Semi – variable costs - Items of cost with fixed and variable components. - Vary with the level of production, though not in direct relation to it, probably because part of the cost is fixed while the rest is variable. - Example: a. Cost of electricity where there is a basic minimum charge plus a specified cost per kilowatt hour above the minimum 3. Costs classified as to relation to manufacturing departments a. Direct departmental charges - Costs that are immediately charged to the particular manufacturing department(s) that incurred the costs since the costs can be conveniently identified or associated with the department(s) that benefited from said costs. b. Indirect departmental charges - Costs that are originally charged to some other manufacturing department(s) or account(s) but are later allocated or transferred to another department(s) that indirectly benefited from said costs. 4. Costs classified to their nature as common or joint a. Common costs Page | 4  - Costs of facilities or services employed in two or more accounting periods, operations, commodities or services. - Subject to allocation. b. Joint cost - Costs of materials, labor and overhead incurred in the manufacture of two or more products at the same time. - Major difficulty inherent to joint cost – they are invisible and they are not specifically identifiable with any of the products being simultaneously produced. - Subject to allocation. 5. Costs classified as to relation to an accounting period a. Capital expenditures - Expenditure intended to benefit more than one accounting period and is recorded as an asset. - The allocation of the cost to the different periods is a. Depreciation for fixed tangible assets b. Amortization for intangible assets c. Depletion for wasting assets b. Revenue expenditures - Expenditure that will benefit current period only and is recorded as expense 6. Costs for planning, control and analytical processes a. Standard costs - Predetermined costs for direct materials, direct labor, and factory overhead. - Established by using information accumulated from past experience and data secured from research studies. b. Opportunity costs - The benefit given up when one alternative is chosen over another. - Not usually recorded in the accounting system. - However, it is considered when evaluating alternatives for decision-making. - If an asset can be used to perform only one function and cannot be sold or used in other ways, the opportunity cost of that asset is zero. c. Differential costs - Cost that is present under one alternative but is absent in whole or in part under another alternative. - Encompasses both cost increases and cost decreases between alternatives. d. Relevant costs - A future cost that change across the alternatives. - Examples: a. Cost of goods sold c. Commissions b. Advertising d. Warehouse depreciation e. Out-of-pocket cost - Cost that requires the payment of money (or other assets) as a result of their incurrence. f. Sunk cost - A cost for which an outlay has already been made and it cannot be changed by present or future decision. g. Controllable cost - A cost is considered to be a controllable cost at a particular level of management if that level has power to authorize the cost. - Example: a. Entertainment expense would be controllable by a sales manager if he or she had power to authorize the amount and type of entertainment for customers. b. On the other hand, depreciation of warehouse facilities would not be controllable by the sales manager since he or she would have no power to authorize warehouse construction. Page | 5  THE COST SYSTEM - One wherein flow of costs is accounted for in detail so that unit costs and inventory costs can be promptly determined. - It is effective when it ensures that the company benefits from all its expenditures, that is, costs incurred contribute to the production of the desired quantity of goods and services. - May be designed to accumulate costs by products or by departments or processes. - Perpetual inventory method is used – involves the use of perpetual records showing the flow of costs or resources. o For a manufacturing firm, cost of raw materials used, cost of completed units and cost of goods sold can be readily determined and responsibility for inventories can be pinpointed based on records kept. o The controlling accounts and the corresponding subsidiary records are as follows: Controlling Accounts Subsidiary Records Materials (Materials Control) – Materials ledger cards Used for all items of materials, whether direct or indirect. Stores Used for all items in the storeroom, whether raw materials, Stores ledger cards factory supplies, store supplies, or office supplies. Work in process Job order cost sheet – under job order costing Used for costs charged to production Cost of production reports ( or departmental cost sheets) – under process costing Finished goods Finished goods ledger cards Used for all goods completed and ready for sale The postings to the controlling accounts are as shown below: Materials Materials purchases Purchase returns Freight in Purchase discounts Returns of materials previously issued Materials issued Work in Process Materials, labor and factory overhead Cost of goods manufactured charged to production Finished Goods Cost of goods manufactured Cost of goods sold Cost of returned goods which were Goods returned to factory previously sold for reprocessing Flow of cost as reflected by postings to both controlling accounts and subsidiary records – Next page Page | 6 USE OF CONTROLLING AND SUBSIDIARY ACCOUNTS (JOB ORDER) COST SYSTEM Materials Work in Process Finished Goods Purchase Balances, beg xx returns xx Balance, beg. xx Cost of goods Balance, beg. xx Cost of goods sold xx Purchases Cost of goods xx Issuance: Direct materials xx manufactured xx manufactured xx Cost of goods Returns of excess mat. xx Direct mat. xx Direct labor xx Cost of goods returned xx returned to factory xx Applied factory Indirect mat. xx overhead xx Per materials ledger cards: Per job order cost sheets Per finished goods ledger cards Direct Labor Received Issued Balance Direct Mat. Cost Cost FOH Applied Received Issued Balance xx xx xx xx xx xx xx xx xx xx xx xx (xx) xx xx xx xx xx (xx) xx xx (xx) xx (xx) xx Summary Direct mat. Cost P xx Payroll Direct labor cost xx Gross earnings xx Direct labor xx FOH applied xx Indirect labor xx P xx Factory overhead Indirect materials xx Charged to Indirect labor xx production xx Others xx Page | 7 Other controlling accounts - They may be used under both periodic and perpetual inventory methods because they do not affect the inventories. They are: o Factory overhead control o Selling expenses control o General and Administrative Expenses Control o These are supported by subsidiary records or analysis sheets. Example: The company pays for the following: Factory supplies – P 600; factory repairs – P 500; store supplies – P 300; and office supplies – P 200. The journal entry and the corresponding postings to be made on subsidiary records would be as follows: Subsidiary records Dr. Cr. Factory Overhead Control 1,100.00 Factory supplies P600.00 Factory repairs 500.00 Selling Expenses Control 300.00 Store supplies 300.00 General and Adm. Exp. Control 200.00 Office supplies 200.00 Cash P 1,600.00 The footings per subsidiary records must tally with the balances per controlling accounts in the general ledger. Chart of Accounts, Cost System - Similar to that under the non-cost system with the exception of the account titles affecting cost of goods manufactured and cost of goods sold. - The chart of accounts as given under the non-cost system is revised and is shown below. CHART OF ACCOUNTS FOR A MANUFACTURING FIRM Balance Sheet Accounts (10-99) Assets ( 10-99 ) Current Assets (10-99) 11 Cash in Bank 44.1 Accumulated Depreciation – Machinery and Equipment – Factory 12 Cash on Hand 46 Delivery Equipment 13 Petty Cash Fund 46.1 Accumulated Depreciation – Delivery Equipment 14 Marketable Securities 51 Automobiles 15 Notes Receivable 52 Accumulated Depreciation – Automobiles 15-1 Notes Receivable – Discounted 56 Office furniture and fixtures 16 Accounts Receivable 56.1 Accumulated Depreciation – Office Furniture and Fixtures 16-1 Accounts Receivable – Discounted 20 Finished Goods inventory Intangible Assests (70-79) 21 Work in Process Inventory 71 Goodwill 22 Materials inventory 72 Patents 26 Prepaid Insurance 79 Other Intangible Assets 39 Miscellaneous Prepaid Items Plant, Property and Equipment (40-69) Other Assets (80-89) 41 Land 42 Buildings Other Assets (90-99) 42.1 Accumulated Depreciation – Buildings 44 Machinery and Equipment – Factory Page | 8  Liabilities and Capital (100-199) Current Liabilities (100-149) Long-Term Liabilities (150-169) 101 Noted Payable 151 Loans Payable 102 Accounts Payable 156 Other Long-Term Debt 103 Vouchers Payable 104 Accrued Payroll Capital (170-199) 105 Other Accrued Liabilities 171 Preferred Stock 106 SSS Contributions Payable 172 Common Stock 107 Medicare Contributions Payable 172.1 Treasury Stock 108 Pagibig Contributions Payable 176 Premium on Preferred Stock 109 Compensation Insurance Payable 177 Premium on Common Stock 110 Estimated Income Tax Payable 191 Retained Earnings 116 Long- Term Due Within One Year 121 Dividends Payable Income Statement Accounts (200- 699) Sales (200-249) 201 Sales 429 Insurance Expense 201.1 Sales Returns and Allowances 431 Store Supplies 201.2 Sales Discounts 435 Gasoline and Oil 436 Repairs and Maintenance-Buildings Cost of Goods Sold (250-299) 437 Repairs and Maintenance – Delivery Van 251 Cost of Goods Sold 451 Depreciation Expense – Buildings 252 Factory Overhead Variance 452 Depreciation Expense – Delivery Van 499 Miscellaneous Selling Expense Factory Overhead ( 300-399) General and Administrative Expense (500-599) 301 Factory Overhead Control 301.1 Applied Factory Overhead 501 General and Administrative Expense Control 302 Salaries-Factory 502 Salaries-General and Administrative 303 Indirect Materials 503 Salaries – Clerical Help 304 Indirect Labor 504 Overtime Premium 305 Freight In 516 SSS Contributions 306 Overtime Premium 517 Medicare Contributions 316 SSS Contributions 518 Pag-ibig Contributions 317 Medicare Contributions 519 Employees’ Compensation Premiums 318 Pagibig contributions 525 Telephone and Telegraph 319 Employees’ Compensation Premiums 526 Light, Power and Water 325 Telephone and Telegraph 529 Insurance Expense 326 Light, Power and Water 531 Office Supplies 329 Insurance Expense 535 Gasoline and Oil- Buildings 331 Factory Supplies 536 Repairs and Maintenance – Buildings 335 Fuel 537 Repairs and Maintenance – Office Furniture and Fixtures 336 Repairs and Maintenance – Buildings 551 Depreciation Expense – Buildings 337 Repairs and Maintenance – Machinery and 552 Depreciation Expense – office Furniture and Equipment Fixtures 351 Depreciation Expense- Buildings 599 Miscellaneous General and Administrative Expenses 352 Depreciation Expense- Machinery and Other Income (600-619) Equipment 399 Miscellaneous Factory Overhead 601 Income from Investments 602 Interest Income Page | 9 Selling Expenses (400-499) 603 Rental Income 401 Selling Expenses Control 604 Commission Income 402 Salaries – Sales Supervision 605 Miscellaneous Income 403 Salaries – Salesgirls 404 Salaries – Clerical Help Other Expense (620-629) 405 Sales Commissions 621 Interest Expense 411 Delivery Expense 416 SSS Contributions Income Deductions (630-639) 417 Medicare Contributions 631 Provisions for Income Tax 418 Pagibig Contributions 419 Employees’ Compensation Premiums Temporary Account 425 Telephone and Telegraph 700 Payroll 426 Light, Power and Water The Factory Ledger - When transactions are voluminous and/or the factory is far from the main office, manufacturing transactions are preferably recorded in a factory journal and posted to the factory ledger. o This requires the use of reciprocal accounts General Ledger (for the factory) and Factory Ledger (for the main office) when a transaction affects accounts found in both books. - Factory Ledger – refers to the book of final entry for manufacturing operations, or o the account title used by main office in recording transactions affecting accounts found in both the books of the factory and the main office. - The accounts carried on factory books are those used in recording manufacturing operations. - Factory fixed asset accounts – may either be in the books of the factory or the main office. o If the problem is silent, they are assumed to be on factory books. o The accounts that must be on books of the factory are: ▪ Materials ▪ Plant, Property and Equipment ▪ Factory Overhead Control ▪ Work in Process ▪ Accumulated Depreciation ▪ Factory Overhead Variance ▪ Finished Goods ▪ Applied Factory Overhead ▪ General ledger o The factory may have its own petty cash fund so that this account may also be found on its books - All functions other than manufacturing are taken care of by main office so that o Disbursements o collections o sales and the corresponding expenses involved are recorded on the main office books. Transfer Voucher - an intra-company form used to inform the factory when transactions are entered into by the main office but the same affect manufacturing accounts - Example o The main office buys machinery for the factory for P 30,000. Factory fixed assets are carried on factory books. ▪ a transfer voucher is prepared by the main office informing the latter of the transaction and to the effect that the factory ledger is debited by the main office for P 30,000. ▪ Based on this, the entries on both books are: Main Office Books Factory Books Factory ledger P 30,000 Machinery P 30,000 Vouchers Payable P 30,000 General Ledger P 30,000 o The factory effects delivery of goods costing P 50,000 to customers based on sales orders issued by the main office. Page | 10  ▪ Factory issues a transfer voucher informing the main office of such delivery and debits the account general ledger. ▪ Entries would be as follows: Main Office Books Factory Books Cost of Goods Sold P 50,000 General Ledger P 50,000 Factory Ledger P 50,000 Finished Goods P 50,000 - To facilitate the recording of similar transactions, it would be advisable to determine first what entry should be made assuming there is only one journal to be used. If one of the accounts involved is on the other book, then, the reciprocal accounts are used. - Factory Ledger account – appears on main office books o Usually has a debit balance - General ledger account – on factory books o Usually has a credit balance - Prior to preparation of financial statements, a work sheet is prepared to combine the accounts and on this work sheet, the inter-office accounts are eliminated by a working paper entry. o Assuming that the adjusted balance of the inter-office accounts is P 36,000, the elimination per working paper entry would be as follows: General Ledger P 36,000 Factory Ledger P 36,000 JOB ORDER COSTING AND PROCESS COSTING As stated earlier, cost accumulation may be by products, departments or processes. In other words, it may be by job order costing or by process costing. Job order costing - A system for allocating costs to groups of unique product. - Applicable to the production of customer specified products such as the manufacture of special machines. - Each job becomes a cost center for which costs are accumulated. - A subsidiary record (job cost sheet) is needed to keep track of all unfinished job (work in process) and finished jobs (finished goods) - Examples: o Houses o Television sets o Boats o Automobiles o Pianos o Doors o Radios o Furniture Process costing - Refers to the costing procedure whereby costs are accumulated by departments or processes. - Each processing department becomes a cost center. – Adopted for products manufactured under conditions of continuous processing so that they are not distinguishable from one another (or are homogeneous). - Examples: o Beverages o Flour o Chemicals o Minerals - Cost accumulation is done on cost of production reports (or departmental cost sheets) The differences between job order costing and process costing may be summarized as follows: Job order costing Process Costing Nature of products: Heterogeneous Homogeneous Page | 13  Cost accumulation: By job orders By departments or processes Reporting By job orders By departments or processes When is unit cost computed: Upon completion End of costing period (usually a month) Unit cost computation: Production costs per job Departmental costs Number of units Equivalent units of production Subsidiary record for work in process: Job order cost sheets Cost of production reports (or departmental cost sheets) JOB ORDER COSTING Job order costing - costing by products, job or work orders, or by contracts. - The cost unit is the job and each job order is assigned a number for clear and brief identification. - All costs directly traceable to each job (direct materials and direct labor) are charged to it directly. - Factory overhead – charged to each job at a predetermined rate periodically or upon completion. - Cost per unit of the products in each job = accumulated cost / number of units. - Cost accumulation – done with the use of cost sheets (or job order cost sheets). - Each job order is provided with a cost sheet so that if there are ten jobs in process, there must be ten cost sheets. o Each of them provides columns for materials cost and direct labor cost and space or column for factory overhead. ▪ Materials issued (per materials requisition form) and labor hours expended (per labor time tickets) for a job – posted to the corresponding work sheet. Thus, materials requisition and labor time tickets (totalled daily or weekly and tallied with the payroll) should contain the job order numbers to which they pertain. CHARACTERISTICS OF JOB ORDER COSTING 1. It collects all manufacturing costs and assigns them to specific job or batches of product. 2. It measures costs for each completed job, rather than for set time periods. 3. It uses just one Work in Process Inventory Control account in the general ledger. This account is supported by a subsidiary ledger of job order cost cards or sheets for each job in process at any point of time. ELEMENTS OF PRODUCT COST IN JOB ORDER COSTING Elements of product cost – materials cost, labor cost and factory overhead. For job order costing, materials and labor costs refer to direct materials cost and direct labor cost, respectively. Direct materials cost – refers to those items that form part of the finished product and which can be measured and directly charged to the product Examples: leather for shoes, lumber for furniture and metal parts for automobiles Direct labor cost – refers to cost of labor expended in the manufacture of a product and which can be directly charged to the product Factory overhead – also known as manufacturing expenses or burden. - Refers to the indirect element of cost - Includes all manufacturing cost not classified as direct materials or as direct labor - Examples: o Indirect materials – those needed for the completion of the product but the consumption of which with regard to the product is either so small or allocation would be too complex so that for convenience, it is treated as an indirect product cost. ▪ Examples: glue, tacks and polish in the manufacture of shoes Page | 14  o Indirect labor – refers to cost of manpower which cannot be identified as pertaining to a particular product. ▪ Examples: salaries and wages of forement, timekeepers and utility men. o Factory supplies o Depreciation of factory building o Factory insurance Note: Distinctions between direct and indirect materials and between direct and indirect labor are not observed in process costing inasmuch as under the latter, costs accumulation is by departments or processes and not by products or jobs. THE JOB ORDER COST SHEET - The subsidiary record for “work in process” so that for all postings to the latter, corresponding postings must also be made to the corresponding cost sheets - Forms of Cost sheets – cost sheets may vary in form depending on desired additional information such as the items, quantity and unit cost of material, number of labor hours, bases used in charging overhead and the departments in which the different cost items are charged. - When overhead is charged to jobs upon completion, there exists a difference between work in process per general and the total of the accumulated costs per cost sheets. This difference is equal to the amount of overhead not so applied on the cost sheets yet. LIGAYA MANUFACTURERS, INC.. O MANUFACTURING CORP. Cost Sheet Cost Sheet Order No. 555 Order No. 171 For: Singalong Furniture For: Juan Medalla Product: Rocking Chais Product: Computer tables Specification: Narra withs long arm rest Specification: Formica finish Quantity: 10 units And with provision for upright CPU Date Ordered: May 11, 2013 Date Wanted: June 16, 1997 Quantity: 20 Date Started: May 16,2013 Date Completed: June 12, 1997 Date Ordered: 1/10/13 Date Wanted: 2/20/13 DIRECT MATERIALS COST DIRECT LABOR Date Started: 1/15/13 Date Completed: 2/18/13 COSTS DIRECT MATERIALS COST DIRECT LABOR FACTORY Date Dept Amount Date Amount No. of Amou COSTS OVEREHAD Req. No Hrs. nt APPLIED May 16 Carpentry P 5,000 5/16-22 Carpentry 96 P 2,880 Date Req Amount Date Amount Date 26 Carpentry 234 2,000 22-28 Carpentry 54 Jan. 15 510 P 20,000 Jan. 15-22 5,500 Feb. Direct June 5 Varnishing 1,500 5/29 to Carpentry 10 1,600 27 687 2,600 23-31 4,700 18 labor cost 311 6/4 360 x 80% = Feb. 10 921 3,500 Feb. 1-7 7,500 6/5-11 Finishing 80 Feb. 15 982 5,000 8-15 5,010 P 21,128 336 2,950 16-18 3,700 Total P 8,500 240 P 7,790 SUMMARY Total P 31,100 P 26,410 P 21,128 Direct materials cost P 8,500 Summary on Job No. 171 Direct labor costs 7,790 Direct materials cost P 31,100 Factory overhead applied Direct labor cost 26,410 Carpentry: Direct labor hours of 160x10 P 1,600 Factory overhead applied 21,128 Total factory cost P 78, 638 Varnishing: Direct labor hours of 80 x 15 1,200 2,800 Gross profit (P 78,638 x 40%) 31,455 Total factory costs @ P 1,904 P 19,090 Selling price P 110,093 Gross profit (30% x P 19,090) 5,727 Selling price @ P 2,481.70 P 24,817 MAJOR SOURCE DOCUMENTS FOR JOB ORDER COSTING 1. Job order cost sheet a. These records accumulate product costs of specific units or small batches of units for both product costing and control purposes. b. The file of job order cost sheets for uncompleted jobs serves as a perpetual book inventory and the subsidiary ledger for Work in Process Control. Page | 15  Example of a Job order cost sheet: Job Cost Sheet Job Number Description Date Started Date Completed Direct Materials Date Requisition No. Quantity Unit Price Cost Direct Labor Date Time Card No. Hours Rate Cost Factory Overhead Date Activity Base Quantity Application Rate Cost Cost Summary Direct Materials Direct Labor Factory Overhead Total Cost 2. Materials stock card a. These records are the perpetual book inventory of costs and quantities of materials on hand b. The file of materials stock cards for unused materials is the subsidiary ledger for Materials Control. Location in Description Storeroom Maximum Minimum Stores Ledger Acct. No. Date Received Issued Balance Unit Unit Qty. Price Amt. Qty. Unit Price Amt. Qty. Price Amt. 3. Finished Goods Stockcard a. These records are the perpetual book inventory of costs and quantities of completed goods held for sale. b. The file of finished goods stock cards for unsold goods is the subsidiary ledger of Finished Goods Control 4. Factory overhead control cost record a. These records accumulate detailed manufacturing overhead costs by department b. The file of these records for the accounting period is the subsidiary ledger for Factory Overhead Control 5. Materials requisition, time ticket and Clock card a. As the source documents for charging costs to jobs and department b. To aid in fixing responsibility for control and usage of materials and labor Page | 16  MATERIALS REQUISITION Date No. To Quantity Description Unit Price Amount Approved by Issued by Received by Charge to Job/ Dept. JOB TIME TICKET Employee Name Date Employee Number Department Time Started Time Stopped Job Number ACCOUNTING PROCEDURES – JOB ORDER COSTING ACCOUNTING PROCEDURES FOR MATERIALS - In manufacturing enterprises, the common practice is to record all materials and supplies in one control account, Materials or Stores. - Procedures that affect the materials account involve the: 1. Purchase of materials and supplies As materials are purchased, the amount is posted on the Material control account and at the same time the purchase is also entered on an individual materials ledger card/ stock card. Entry: Purchase of materials Materials/ Stores xxx Vouchers Payable xxx To record the purchase of materials An entry is made on the stock card under the Received section Entry: Return of materials Vouchers Payable xxx Materials/ Stores xxx To record the return of materials to vendor An entry is made on the stock card under the Received section enclosed in parenthesis to indicate reduction in quantity 2. Issuance of materials and supplies When a job is started, the materials needed for the job are issued based on the materials requisitions prepared by the employees. A copy of the requisition is given to the storekeeper, which will serve as the Page | 17  basis for the materials to be issued. The job order number is shown on the materials requisition together with the specifics on type and quantity of materials required by each job. The quantity, unit cost, and total cost of each of the materials are entered on the issued section of the stock card. Entries: Issuance of Direct materials Work in process xxx Materials xxx To record the issuance of direct materials An entry is made on the stock card under the Issued section and also on the cost sheet – Materials. Entry: Issuance of Indirect Materials Factory overhead control xxx Materials xxx To record the issuance of indirect materials An entry is made on the stock card under the Issued section and also on the overhead analysis sheet. The material control account may be summarized as follows: MATERIALS Inventory beginning Cost of direct materials issued Purchase of materials Cost of indirect materials issued Freight-in Cost of materials returned to supplier Cost of excess materials returned from factory - The balance of the Materials account represents the Materials inventory at the end of the period under consideration. - The amount should be equal to the total of the balances of all the material stock cards. ACCOUNTING PROCEDURES FOR LABOR The accounting procedures for labor may be divided into two distinct phases: 1. Collection of payroll data, computation of earnings, calculation of payroll taxes, and payment of wages 2. Distribution and allocation of labor costs to jobs, departments, and other cost classifications. Clock cards/time records - Used to record the days or hours worked by each employee. - Used as the basis in computing the gross earnings of employees who are paid hourly wages. Time tickets - Prepared for each worker to determine the time spent for each job as basis in determining the amount to be charged to direct labor cost and indirect labor cost. - For various jobs, they are sorted, priced and summarized , and the time ticket hours should be reconciled with the clock card hours. At regular intervals, usually daily or weekly, the labor time and labor cost for each job are entered on the job order cost sheets. For each payroll period – weekly, every two weeks, or monthly – the summary of employees’ earnings and the liability for payment is journalized and posted to the general ledger. - Entry : Payroll and incurrence of liability Payroll xxx Withholding Tax Payable xxx SSS Premium Payable xxx PhilHealth Contribution Payable xxx Pag-ibig Funds Contributions Payable xxx Vouchers Payable xxx Page | 18  - Entry: Payment of Payroll Vouchers Payable xxx Cash xxx - The Work in Process account is used to charge the jobs with the direct labor cost. - Factory overhead control is charged for the indirect labor cost incurred. - Tax withheld is computed based on the table provided by the Bureau of Internal Revenue. - For the SSS Premiums and Medicare Contributions, the table is provided by the Social Security System. - The clearing account for the total wages due to the factory personnel is the payroll account summarized as follows: PAYROLL Total wages and salaries earned by factory personnel Total payroll during the payroll period at the same time during the payroll period debiting work in process for direct labor and overhead for indirect labor - The account used to accumulate the liability for payroll or factory overhead is the Accrued Factory Payroll summarized as follows: ACCRUED FACTORY PAYROLL Total amount of wages paid to factory personnel at the Balancing beginning time crediting accounts payable or cash Total amount of wages and salaries due to factory personnel at the same time debiting payroll ACCOUNTING FOR FACTORY OVERHEAD - There are two accounts used: o Factory overhead control – used to accumulate actual overhead incurred o Factory overhead applied – used to accumulate estimated factory overhead applied to production ▪ A predetermined rate is used ad this is computed using any of the following as a base: Units of production Direct materials cost Direct labor hours Direct labor cost Machine hours ▪ A predetermined factory overhead rate computed may be used for all departments in the company (blanket rate) or a rate may be computed for each department to fit the nature of the operations of the department (departmentalized rate) Why do we need to use estimated factory overhead (factory overhead applied)? - Because a the time the overhead is needed for costing of jobs completed, the actual overhead is not yet available (actual will be known only at the end of the month). - The computation of the cost of each job will be done upon the completion of the job and this may be during the first week, second week, or third week of the month, and at this time, the actual overhead is not yet available because of the items included in the actual overhead will be known only at the end of the month. - As items in the factory overhead control account are incurred, the Factory Overhead Control account is debited. Entry: Applied factory overhead entered on the job order cost sheet Work in process xxx Applied Factory Overhead xxx - Some actual overhead costs, such as indirect materials, indirect labor and payroll taxes are debited to Factory Overhead Control as they are incurred. - Other overhead costs, such as depreciation and expired insurance are debited to Factory Overhead Control when adjusting entries are recorded. Page | 19  FACTORY OVERHEAD CONTROL Cost of indirect materials and supplies issued from the Total debit footing at the end of the accounting warehouse at the same time crediting materials period when closing the books Cost of indirect labor at the same time crediting payroll Cost of indirect expense purchased from outsiders Cost of other indirect expense incurred by the company Factory overhead applied – account used for accumulating the total overhead charged to production during period. FACTORY OVERHEAD APPLIED Total credit footings at the end of the accounting period Cost of overhead allocated to production and computed upon closing the books by multiplying the actual factory being used during the period by the predetermined rate, at the same time debiting work in process Over / under applied overhead – the difference between the actual overhead incurred and the applied overhead. OVER/UNDER APPLIED OVERHEAD Difference between the actual factory overhead and the Difference between the actual factory overhead and the applied overhead when actual is more than the applied applied overhead when the applied is more than the actual - Under applied factory overhead (unfavourable) Actual factory overhead > Applied factory overhead - Over applied factory overhead (favourable) Applied factory overhead > Actual factory overhead Deduction from the Cost of Goods Sold in the Income Statement Factory Overhead Charged to Production - Accumulation of factory overhead incurred (or actual factory overhead) takes time especially in cases wherein adjustments are done on an annual basis. - Instead of charging actual factory overhead to production, the practice of charging overhead based on predetermined rates is adopted. o Account used may either be Applied Factory Overhead or Factory Overhead. o At the end of the period, both applied factory overhead and factory overhead control are closed and the difference is called the factory overhead variance which may be overapplied (credit) or underapplied (debit). ▪ Example: Factory Overhead Charged to production is P 25,760 and factory overhead incurred amounts to P 26,000. The entries would be as follows: To charge overhead to production: Work in Process P 25,760 Applied Factory Overhead P 25,760 To take up factory overhead incurred: Factory Overhead Control P 26,000 Sundry credits P 26,000 To close Applied factory overhead to Factory Overhead Control Applied Factory Overhead P 25,760 Factory Overhead Control P 25,760 After this entry, Factory overhead control shall have a debit balance of P 240, the factory overhead variance. This is set up in the following entry: Page | 20  Factory Overhead Variance P 240 Factory Overhead Control P 240 In the given example, Actual Factory overhead exceeds applied overhead so that the variance is a debit ( underapplied, underabsorbed, or unfavourable). When Actual Overhead is more than Applied overhead, the variance must be a debit (underapplied, underabsorbed or unfavourable). When Actual Overhead is less than Applied overhead, the variance must be a credit (overapplied, overabsorbed or favourable). Factory Overhead Variance- preferably used so that both overapplied and underapplied variances may be posted to the same ledger page. Instead of crediting “Applied Factory Overhead” in charging overhead to production, the credit may be to “Factory Overhead Control”. This practice eliminates the need to close the former to the latter. o Disposition of Factory Overhead Variances. ▪ Factory overhead, in general, is treated as a period cost and is closed to cost of goods sold or to income and expense summary. However, when it is significant in amount, it implies an error in costing or that a wrong overhead rate was used. In this case, the variance is treated as an adjustment to cost of goods sold and the inventories of finished goods and work in process. ▪ In the example given in the preceding section, the variance is closed to cost of goods sold as follows: Cost of Goods Sold P 240 Factory Overhead Variance P 240 ▪ Based on the given entry, an unfavourable variance increases cost of goods sold and a favourable variance reduces the same. Income Statement with Factory Overhead Variance – Illustration Golden Manufacturing Co. Income Statement For the Year Ended December 31, 2013 Sales P 250,000 Less – Cost of Goods Sold Manufacturing costs: Direct materials cost P 75,000 Direct labor cost 55,000 Factory overhead applied 55,000 P 185,000 Work in process, Jan. 1 33,000 Work in process, Dec. 31 (45,000) Cost of Goods Manufactured P 173,000 Finished Goods, Jan. 1 29,000 Finished Goods, Dec. 31 (22,000) Cost of goods sold, normal P 180,000 Underapplied factory overhead 240 Cost of goods sold, actual 180,240 Gross profit on sales 69,760 Less: Operating expenses 55,000 Net income 14,760 In the foregoing illustration, cost of goods sold prior to adjustment for factory overhead variance is described as normal, that is, based on what has been estimated or planned. Work in process - a controlling account used to record the flow of the elements of cost through the factory during a given period - Used to accumulate during the month the total cost of materials placed in process, labor used and factory overhead applied. Page | 21  - Amounts entered on the cost sheet should equal the amounts debited to the work in process account during the month. - As jobs are completed, the cost sheets for the corresponding jobs are totalled and the amount is now transferred to the finished goods account. Entry: Transfer from Work in process to Finished Goods account Finished Goods xxx Work in process xxx , WORK IN PROCESS - Cost of beginning inventory - Cost of materials, labor and factory overhead applied - Cost of direct materials issued to production at the to jobs completed during the period at the same time same time crediting materials debiting finished good - Cost of direct labor applied to production during the - Cost of direct materials returned to the warehouse at period at the same time crediting the payroll account the same time debiting materials - Amount of overhead applied to production at the same time crediting applied overhead - Entry: When the finished goods are delivered to customers Accounts receivable xxx Sales xxx Cost of Goods Sold xxx Finished Goods xxx Finished goods – a controlling account used to record the flow of the cost of goods completed and transferred to the finished goods storeroom during the period. FINISHED GOODS - Cost of inventory at the beginning - Cost of finished goods sold during the period at the same tie debiting cost of goods sold - Factory cost of job order completed at the same time crediting work in process - Cost of goods returned by the customer at the same time crediting cost of goods sold Cost of Goods Sold – an account used to accumulate he cost of finished goods disposed through sale to customers. COST OF GOODS SOLD - Cost of finished goods disposed through sale to - Cost of finished goods returned by customers at customers at the same time crediting finished the same time debiting the finished goods goods account - Adjustment for under applied factory overhead - Adjustment of over applied factory overhead - Balance of the account at the end of the period at the same time debiting income summary ILLUSTRATION: The following information is provided by Bacolor Corp. For 2014: 2014 a. Direct materials issued: Job order No. 14................................................ P 9,000 15................................................. 12,000 16................................................. 8,000 P 29,000 b. Direct labor costs: Job order No. 14................................................ P 3,500 15............................................... 5,400 16............................................... 3,300 P 12,200 Page | 22  c. Factory overhead is charged to production at 60% of direct labor cost. d. Job orders nos. 14 and 15 are completed. The entries and corresponding postings to the work in process account and the cost sheets would be as follows: a. Work in Process P 29,0000 Materials P 29,000 Direct materials issued. b. Work in Process 12,200 Payroll 12,200 Direct labor costs c. Work in Process 7,320 Applied Factory Overhead 7,320 Overhead charged at 60% of direct labor costs d. Finished Goods 35,240 Work in Process 35,240 Jobs 14 and 15 completed Per general ledger; the work in process account should have the following postings: Work In Process Direct materials 29,000 Cost of completed jobs 14 and 15 35,240 Direct labor 12,200 Factory overhead applied 7,320 Per cost sheets: JOB ORDER NO. 14 15 16 Direct materials costs P 9,000 P 12,000 P 8,000 Direct labor costs 3,500 5,400 3,300 Applied factory overhead 2,100 3,240 Total factory costs P 14,600 P 20,640 - The ending balance of work in process is P 13,280 (or P 48,520 minus P 35,240). This must be the accumulated cost of Job No. 16. However, per cost sheet for said job, the total is only P 11,300 (that is, P 8,000 + 3,300) because of the non-application yet of factory overhead of P 1,980 (or 60% x P 3,300). - Assuming that job order no. 16 is completed during the next period (or in 2015) after incurring additional direct materials and direct labor costs of P 4,000 and P 2,000, respectively, the total factory cost of the job would be as follows: Job Order No. 16 Direct materials costs 2014 P 8,000 2015 4,000 12,000 Direct labor costs 2014 P 3,300 2015 2,000 5,300 Factory overhead applied (60% of labor cost of P 5,300) 3,180 Total factory cost P 20,480 The journal entries for 2015 would be as follows: Work in Process P 6,000 Materials P 4,000 Payroll 2,000 Materials and labor costs , Work In Process 1,200 Applied Factory Overhead 1,200 Overhead charged at 60% of P 2,000 labor cost Page | 23  Finished Goods 20,480 Work in Process 20,480 Competed job order no. 16. - It should be emphasized that although the total overhead charged to job order no. 16 in 2015 is the total of P 3,180, the journal entry is only for P 1,200 which is based on the current labor cost of P 2,000. Applied overhead that corresponds to the 2013 labor cost is included in the 2014 entries. Journal Entries, Perpetual and Periodic Inventory Methods The journal entries under the perpetual inventory method differ from those under the periodic inventory method in the treatment of transactions that affect the inventories, namely, those for finished goods, work in process and materials. The entries are illustrated on the following pages: Illustration of Entries Under Perpetual and Periodic Inventory Methods Perpetual Inventory Method Periodic Inventory Method a. Raw materials purchases, P 100,000 Materials (Stores) 100,000.00 Purchases 100,000.00 Vouchers Payable 100,000.00 Vouchers Payable 100,000.00 b. Purchase returns, P 5,000 Vouchers Payable 5,000.00 Vouchers Payable 5,000.00 Materials (Stores) 5,000.00 Purchase Returns 5,000.00 c. Issuance of materials: direct materials - P 60,000; indirect materials, P 15,000. Work in Process 60,000.00 Factory Overhead Control 15,000.00 No entry Materials (Stores) 75,000.00 d. Returns of direct materials previously issued, P 2,500 Materials (Stores) 2,500.00 No entry Work in Process 2,500.00 e. Breakdown of payroll includes factory labor cost of P 35,000. Work in Process 35,000.00 Labor cost 35,000.00 Payroll 35,000.00 Payroll 35,000.00 f. Factory overhead is charged to production Work in process 60,000.00 No entry Factory overhead 60,000.00 g. Cost of goods manufactured, P 125,000. Finished Goods 125,000.00 No entry Work in Process 125,000.00 h. Cost of goods sold, P 105,000. Cost of goods sold 105,000.00 No entry Finished goods 105,000.00 i. Cost of goods returned by customers, P 15,000 Finished Goods 15,000.00 No entry Cost of Goods Sold 15,000.00 Instead of " Factory Overhead" the account " Applied Factory Overhead" may be used. MODIFIED COST ACCOUNTING SYSTEM - Some companies adopt a modified cost accounting system wherein subsidiary records are maintained for materials, work in process and finished goods although journal entries are based on the periodic inventory method. Page | 24 ILLUSTRATION OF ENTRIES UNDER COST AND NON-COST SYSTEM The following transactions are journalized under both the cost and the non-cost systems: COST SYSTEM NON-COST SYSTEM a. Materials purchases, P 60,000 Materials 60,000.00 Purchases 60,000.00 Vouchers Payable 60,000.00 Vouchers Payable 60,000.00 b. Purchase returns, P 2,000 Vouchers Payable 2,000.00 Vouchers Payable 2,000.00 Materials 2,000.00 Purchase Returns 2,000.00 c. Payment for payroll: Gross earned............................. P 50,000.00 Deductions: SSS 1,500.00 Medicare 500.00 Pagibig 1,000.00 W/H taxes 800.00 3,800.00 Net P46,200 Payroll 50,000.00 Same entry SSS and Medicare Premiums Payable 2,000.00 Pagibig Premiums Payable 1,000.00 Withholding taxes payable 800.00 Vouchers Payable 46,200.00 d. Breakdown of payroll: direct labor - P 25,000; indirect labor - P 5,200; sales - P 10,000; and office - P 9,800. Work in process 25,000.00 Labor cost (Factory Salaries and wages) 30,200.00 Factory Overehead control 5,200.00 Selling expenses control 10,000.00 Selling expenses control 10,000.00 Gen and adm. Expenses control 9,800.00 Gen and adm. Expenses control 9,800.00 Payroll 50,000.00 Payroll 50,000.00 Page | 25 e. Rentals (factory, sales and office, 50:30: 20), P 12,000. Factory Overhead Control 6,000.00 same entry Selling Expenses Control 3,600.00 General and Adm. Expenses control 2,400.00 Vouchers Payable 12,000.00 f. Payment for vouchers, P 55,000. Vouchers Payable 55,000.00 same entry Cash 55,000.00 g. Factory supplies bought, P 2,000. Factory overhead control 2,000.00 same entry Vouchers Payable 2,000.00 h. Incurred the following: factory repairs - P 3,500; store supplies - P 600; office supplies - P 900; light power and water (factory, sales and office, 60:30:10), P 4,200. Factory Overhead Control 6,020.00 Selling Expenses Control 1,860.00 same entry General and Adm. Expenses Control 1,320.00 Vouchers Payable 9,200.00 i. Remittance of payroll deductions including counterpart contribuutions and workmen' compensation premiums amounting to P 2,000 (factory - P 1,000; sales - P 600; office - P 400) Factory Overhead Control 1,000.00 Selling Expenses Control 600.00 General and Adm. Expenses control 400.00 SSS and Medicare Premiums Payable 2,000.00 Pag-ibig Premiums Payable 1,000.00 same entry Vouchers Payable 5,000.00 Withholding Taxes Payable 800.00 same entry Vouchers Payable 800.00 Page | 26  Vouchers Payable 5,800.00 same entry Cash 5,800.00 j. Factory overhead charged to production, 120% of direct labor cost Work in Process 30,000.00 no entry Applied Factory Overhead 30,000.00 k. Cost of goods manufactured, P 80,000 Finished Goods 80,000.00 no entry Work in Process 80,000.00 l. Sales on account, P 130,000; cost of goods sold, P 65,000. Accounts Receivable 130,000.00 same entry Sales 130,000.00 Cost of Goods Sold 65,000.00 no entry Finished goods 65,000.00 m. Sales returns, P 2,000; cost of returned goods, P 1,100. Sales Returns and Allo. 2,000.00 same entry Accounts Receivable 2,000.00 Finished Goods 1,100.00 no entry Cost of Goods Sold 1,100.00 n. Provision for depreciation: factory machinery and equipment - P 5,500; factory office furniture - P 3,000; store furniture - P 2,800; and, office furniture and equipment, P 2,000. Factory Overhead Control 8,500.00 same entry Selling Expenses Control 2,800.00 General and Adm. Expenses Control 2,000.00 Accum. Deprn. - Fcty. Mach. & Equip 5,500.00 Accum. Deprn. - Fcty. Off. Furn 3,000.00 Accum. Deprn. - Store Furniture 2,800.00 Accum. Deprn. - Office Furniture 2,000.00 Page | 27 o. Expired insurance is P 1,500 out of the total premiums charged to prepaid insurance. Distribution: Factory, sales and office, 60:30:10. Factory overhead control 900.00 same entry Selling expenses control 450.00 General and Adm. Expenses Control 150.00 Prepaid insurance 1,500.00 Closing Entries: The factory overhead variance is set up Applied Factory Overhead 30,000.00 The closing entries, as taken up in Chapter 1, are made by setting up the closing Factory Overhead Variance 380.00 inventories and closing the beginning inventories and nominal accounts. Factory Overhead Control 29,620.00 The variance is closed to cost o goods sold Factory Overhead Variance 380.00 Cost of Goods Sold 380.00 The nominal amounts are closed to income and expense summary. Sales 130,000.00 Sales Returns 2,000.00 Cost of Goods Sold 63,520.00 Selling Expenses Control 19,310.00 General and Adm. Expenses Control 16,070.00 Income and Expense Summary 29,100.00 To transfer net icome to retained earnings Income and Expense Summary 29,100.00 Retained Earnings 29,100.00 Page | 28 Page | 29