Job Costing - Chapter 5 PDF

Chapter 5 Job Costing Learning Objectives 5.1 Distinguish between job costing and process costing. 5.2 Understand the flow of production and how di...

Chapter 5 Job Costing Learning Objectives 5.1 Distinguish between job costing and process costing. 5.2 Understand the flow of production and how direct materials and direct labour are traced to jobs. 5.3 Compute a predetermined manufacturing overhead (MOH) rate and use it to allocate MOH to jobs. 5.4 Compute and dispose of overallocated or underallocated manufacturing overhead. 5.5 Determine the cost of a job and use it to make business decisions. 5.6 Prepare journal entries for a manufacturer’s job costing system. 5.7 Analyze job cost and profitability data using data analytics tools. 5.8 Use job costing at a service firm as a basis for billing clients. (Appendix 5A) Chapter 5, “Job Costing,” covers material outlined in Section 3: Management Accounting of the CPA Competency Map. Specifically, this chapter addresses Section 3.3 Cost Management. The Learning Objectives in this chapter have been aligned with the CPA Competency Map to ensure the best coverage possible. While the chapter may address multiple areas of the compe- tency map, the main focus will be on these competencies: 3.3.1 Evaluates cost classifications and costing methods for management of ongoing operations* 3.3.2 Evaluates and applies cost management techniques appropriate for specific costing decisions* 3.4.1 Evaluates sources and drivers of revenue growth* Gorila Fitness is Canada’s largest manufacturer of commercial fitness equipment and a leader in consumer fitness equipment. The company began by focusing on Canadian-made products for a variety of approaches to fitness. Since then, the company has grown to design and manufac- ture hundreds of different products, from cross-trainers and strength equipment to exercise bikes. While the company’s growth has been propelled in part by consumers’ ever-increasing *Reprinted from The Chartered Professional Accountant Competency Map - Understanding the competencies a candidate must demonstrate to become a CPA, © 2018, with permission Chartered Professional Accountants of Canada, Toronto, Canada. Any changes to the original material are the sole responsibility of the author (and/or publisher) and have not been reviewed or endorsed by the Chartered Professional Accountants of Canada. 294 M05_Braun_05_SE_51734.indd 294 09/03/23 12:25 PM  Job Costing 295 Kevin Miller/Alamy Stock Photo zeal for personal fitness, the company has also grown through carefully analyzing the profit margins on each of its products and adjusting its operations accordingly. How do managers determine the profit margins on each of the company’s different models of fitness equipment? Managers first determine how much it costs to manufacture a batch of each model. Each batch of units produced is called a “job.” The company’s job costing system traces the cost of direct materials and direct labour used for each job. It also allocates some manufacturing overhead to each job. By adding up the direct materials, direct labour, and manu­ facturing overhead assigned to each job, the company can determine the cost of the job, as well as the average cost of each unit in the job. The company then uses this information to prepare the company’s financial reports and make vital business decisions. Whether you plan a career in marketing, engineering, production, general management, or accounting, you’ll need to understand how much each of the company’s products cost to produce. This chapter will show you the way companies determine their product costs when they make unique products or products made in relatively small batches. Setting selling prices that will lead to profits on each product Identifying opportunities to cut costs Determining which products are most profitable and therefore deserve the most marketing emphasis Gorila’s managers also use cost information on each job in order to prepare the company’s financial statements. From this information, they determine the following: The cost of goods sold for the income statement The cost of the inventory for the balance sheet Whether you plan a career in marketing, engineering, production, general management, or accounting, you will need to understand how to determine the cost of your company’s products or services, whether it is a production company in the health and fitness industry, like Gorila Fitness discussed above, or a company with mixed revenues in service and production, such as Shaw Group, a health care company principally known for dental appliances. In the case of Shaw Group, its marketing team needs to know how much it costs to produce a gold crown in order to set the selling price high enough to cover costs and provide a profit. Technicians study the materials, labour, and manufacturing overhead that go into each product to pinpoint new cost-cutting opportunities. Production managers need to know whether it is cheaper to produce each unit within the company or to outsource (pay another firm for) manufacturing. General managers use cost data to identify the most profitable products so they can guide marketing to boost sales of those products. The accounting department uses product costs to determine the cost of goods sold and inventory for the financial statements. M05_Braun_05_SE_51734.indd 295 09/03/23 12:25 PM  296 Chapter 5 What Methods Are Used to Determine the Cost of Manufacturing a Product? 5.1 Distinguish between job costing and process costing. Most manufacturers use one of two product costing systems to find the cost of pro- ducing their products: Process costing Job costing The end goal of both product costing systems is the same: to find the cost of manu­f acturing one unit of product. However, the manner in which this goal is achieved differs. Management chooses the product costing system that works best for its particular environment. Process Costing Process costing is used by manufacturing companies that produce extremely large num- bers of identical units through a series of uniform production steps or processes. Because each unit is identical, in theory each unit should cost the same to make. Process costing averages manufacturing costs across all units so that each identical unit bears the same cost. For example, OMG’s Candy uses two processes to make Clodhoppers: (1) prepar- ing the chocolate, graham wafers, and other ingredients; and (2) mixing and packag- ing the candy. First, OMG’s accumulates the costs incurred in the preparation process over a period of time. The costs incurred in this process include the cost of the ingredi- ents as well as any chopping and processing necessary. The company averages these costs over all units passing through the process during the same period of time. For example, let’s say OMG’s spends $2, 000, 000 on purchasing and preparing the ingredients to make 1 million packages of Clodhoppers during a month. The aver- Source: Cindy Charles/PhotoEdit age cost per package of the preparation process, including the cost of the ingredients themselves, is as follows: $2, 000, 000 Preparation process = = $2.00 per package 1, 000, 000 packages That is the unit manufacturing cost for just the first production process. Now the prepared ingredients go through the second production process, mixing and packag- ing, where a similar calculation is performed to find the average cost per unit of that process. Again, this process includes any raw materials used, such as the cost of the packaging bags themselves, as well as the cost of mixing the ingredients and filling the packages with the finished candy. Let’s say the average cost to mix and package each bag of Clodhoppers is $0.50. Now OMG’s can figure out the total cost to manufacture each package of Clodhoppers: Preparation: Mixing and Manufacturing packaging: cost: $2.00 per package 1 $0.50 per package 5 $2.50 per package M05_Braun_05_SE_51734.indd 296 09/03/23 12:26 PM  Job Costing 297 Each package of Clodhoppers is identical to every other package, so each bears the same average cost: $2.50. Once managers know the cost of manufacturing each package, they can use that information to help set sales prices and make other busi- ness decisions. To generate a profit, the sales price has to be set high enough to cover the $2.50 per package manufacturing cost, as well as the company’s operating costs incurred along other areas of the value chain (marketing, distribution, and so forth) during the period. We will delve more deeply into process costing in Chapter 6. For now, just remem- ber that any company that mass-produces identical units of product will most likely use process costing to determine the cost of making each unit. The following indus- tries and companies are further examples of companies that use process costing: Oil refining—Nanticoke Refinery (Imperial Oil), St. John Refiners (Irving Oil), BP (British Petroleum) Food and beverages—McCain Foods Ltd., Kellogg’s, Dare Foods Ltd., General Mills, Kraft Canada Inc. Consumer toiletries and paper products—Cascades Tissue Group Inc., Colgate- Palmolive Canada Inc., Kruger Products Ltd. (Scotties tissues) Job Costing Job costing has a different focus from process costing. It is used by companies that produce unique products or services. Job costing is best suited for custom-ordered products or relatively small batches of different products, or for services provided on a contract basis, such as conducting an audit. Each unique service engagement, prod- uct, or batch of units is considered a separate “job.” Different jobs can vary considerably in their use of direct materials, direct labour, and manufacturing overhead costs, so job costing accumulates these costs separately for each individual job. Why is this important? For example, Gorila Fitness manufactures a variety of different Managers need the most accurate cost exercise machines. Gorila Fitness has a limited number of prod- information they can get in order to make good ucts, but it produces them in small, separate batches for each business decisions. They choose a costing system customer. Each batch of exercise machines produced is considered (usually job costing or process costing) based a separate job. The Shaw Group of Dental Laboratories, as discussed on which system best fits their operations. in the opening story, custom manufactures each dental product based on the unique requirements of each patient. Since each unit is unique, Shaw Group treats each unit as an individual job. Job costing would also be used by Bombardier Inc. (airplanes), custom home builders (unique houses), high-end jewellers (unique jewellery), and any other manufacturers that build custom-ordered products. Professional service providers such as law firms, accounting firms, consulting firms, and marketing firms use job costing to determine the cost of serving each client. People working in trades, such as mechanics, plumbers, and electricians, also use job costing to determine the cost of performing separate jobs for clients. In both cases, the job cost is used as a basis for billing the client. In the appendix to this chapter we will study a complete example of how a law firm would use job costing to bill its clients. In summary, companies use job costing when their products or services vary in terms of materials needed, time required to complete the job, and/or the complexity of the production process. Because the jobs are so different, it would not be reason- able to assign them equal costs. Therefore, the cost of each job is compiled separately. This chapter examines how companies compile, record, and use job costs to make business decisions. Exhibit 5-1 summarizes the key differences between job and process costing. M05_Braun_05_SE_51734.indd 297 09/03/23 12:26 PM  298 Chapter 5 Exhibit 5-1 Differences Between Job and Process Costing Job Costing Process Costing Cost object: Job Process Outputs: Single units or small batches with Large quantities of identical units large difference between jobs Extent of averaging: Less averaging—costs are More averaging—costs are averaged over the small number of averaged over the many identical units in a job (often 1 unit in a job) units that pass through the process STOP & THINK Do all organizations use job costing or process costing systems? Answer: Some manufacturers use a hybrid of these two costing systems if neither “pure” system mirrors their operational environment very well. For example, clothing manufac- turers often mass produce the same product over and over (dress shirts) but use different materials in different batches (cotton fabric in one batch and silk fabric in another). Another example might be a software company that produces standard enterprise resource management software (same service) but provides unique implementation con- sultation services (a custom service) for each client. A hybrid costing system has some elements of a process costing system (averaging labour and manufacturing overhead costs equally across all units) and some elements of a job costing system (tracing differ- ent fabric costs to different batches). How Do Manufacturers Determine a Job’s Cost? 5.2 Understand the flow of production and how direct materials and direct labour are traced to jobs. As we have just seen, manufacturers use job costing if they produce unique products or relatively small batches of different products. Shaw Group is a dental laboratory that manufactures products, such as retainers, dentures, mouthguards, crowns, bridges, and veneers. The laboratory receives an impression of a patient’s teeth from the patient’s dentist. From that impression, dental technicians create a product for the patient. For example, a gold crown starts when a technician, using the impression, prepares a model of the patient’s teeth using a stone product. The technician then carves a mock-up of the new tooth in wax, making sure that the wax crown fits appropriately in size and shape with the rest of the teeth on the stone model. The technician then makes a casting of the mock-up in gold. The gold crown is polished, packaged, and sent to the dentist for the patient. The cost of each gold crown depends on the size, shape, and complexity of the job. The company’s job costing system traces the direct materials (gold) and direct labour (technician’s wages) required by each job. The company also allocates some manufacturing overhead (other manufacturing costs) to each job. By summing the direct materials, direct labour, and manufacturing overhead assigned to each job, the company can calculate how much it costs to make each gold crown. Shaw produces each of its products indi- vidually, so each unit is a unique job. In this section, we will show you how Shaw Group determines the cost of producing Job 603, a single gold crown. Gold is used to make crowns, or “caps,” to replace damaged portions of teeth because gold does not tarnish or change and wears down in a similar fashion to natural teeth. M05_Braun_05_SE_51734.indd 298 09/03/23 12:26 PM  Job Costing 299 Exhibit 5-2 Flow of Inventory Through a Manufacturing System FACTORY RM FG Cost of WIP inventory inv. inv. goods sold (materials kept in (all products currently (all finished, (when products storeroom being worked on unsold products) are sold) until needed) in the factory) Overview: Flow of Inventory Through a Manufacturing System As you learned in Chapter 2, manufacturers such as Shaw Group maintain three separ­ate types of inventory: raw materials, work in process, and finished goods. The cost of each of these inventories is reflected on the company’s balance sheet. As shown in Exhibit 5-2, raw materials (RM) inventory is maintained in a store- room within the manufacturing facility until the materials are needed in production. As soon as these materials are transferred to the production area, they are no longer considered raw materials because they have become part of the work in process. Work in process (WIP) inventory consists of all products that are partway through the pro- duction process. As soon as the manufacturing process is complete, the products are moved out of the manufacturing area and into a finished goods (FG) inventory stor- age area, where they await sale and shipment to a customer. Finally, when the prod- ucts are shipped to customers, the cost of manufacturing those products becomes the cost of goods sold (CGS) shown on the company’s income statement. Scheduling Production Job costing begins with management’s decision to produce a batch of units. Sometimes companies produce a batch of units just to meet a particular customer order; however, most companies also produce stock inventory for products they sell on a regular basis. By forecasting demand for the product, the manufacturer is able to estimate the num- ber of units that should be produced during a given time period. For Shaw Group, forecasting is not possible as they do not know what is actually needed until the orders arrive from the dental offices. As these orders arrive, the jobs are added to the current month’s production schedule. (Quite often, the production is done in two stages: First, the models are prepared so that the impressions of the patient’s teeth do not dry out or shrink, and second, a technician creates the product when it is scheduled.) As shown in Exhibit 5-3, the production schedule indicates the number and types of inventory that are scheduled to be manufactured during the period. You should note that, for simplicity, only a portion of the scheduled jobs have been included. Depending on the company, the types of products it offers, and the production time required, production schedules may cover periods of time as short as one day (Shaw Group, producing customized gold crowns) or as long as one year or more (Bombardier Inc., manufacturing Challenger 650 airplanes). In an environment such as a dental laboratory, scheduling the jobs can become quite complex. Since the nature of the work to be completed isn’t known until the job arrives from a dental office, the individual in charge of scheduling needs to continually update the production schedule with each new delivery. At the end of the month (December in Exhibit 5-3), any unfinished jobs are noted on the schedule; they will be the first entries for the next month’s production schedule. M05_Braun_05_SE_51734.indd 299 09/03/23 12:26 PM  300 Chapter 5 Exhibit 5-3 Monthly Production Schedule Production Schedule (partial) For the Month of December Employee Scheduled Scheduled Job Description Customer # # Start Date End Date 603 Gold crown 17 Dr. Waja 3 12/22 12/23 604 Sports mouthguard × 2 8 Dr. Joseph 1 12/22 12/24 605 Full upper denture 34 Dr. Clissold 5 12/23 12/24 606 Retainer 19 Dr. Mah 3 12/23 12/24 FACTORY CLOSED 12/25 12/31 FOR HOLIDAYS and ANNUAL MAINTENANCE New jobs in January are added to the schedule as they are received. The schedule must be updated whenever production is delayed for any reason (perhaps a technician is ill or machinery needs repairs) or when jobs are completed ahead of schedule. The production schedule is very important in helping management determine the direct labour and direct materials that will be needed during the period. To complete production on time, management must ensure an appropriate number of available workers with the specific skill sets required for each job. At Shaw Group, technicians are usually specialized by product type, based on the materials that are used to create the dental product, which must be factored into the schedule. Management also needs to make sure it has all of the raw materials needed for each job. The next section shows how this is accomplished. Purchasing Raw Materials For products that involve more than one raw material, production engineers prepare a bill of materials for each job. The bill of materials is like a recipe card: It lists the raw materials required to complete the job. At Shaw Group, the technician assigned to the job is responsible for recording the materials used in its creation. Exhibit 5-4 illustrates a bill of materials for Job 603. Exhibit 5-4 Bill of Materials (Partial Listing) Bill of Materials Job: 603 Model: Gold crown, 3-6 Quantity: Single Date Item Quantity Used Requisitioned 12/23 HL 5 2.3 g M05_Braun_05_SE_51734.indd 300 09/03/23 12:26 PM  Job Costing 301 Exhibit 5-5 Raw Materials Record Raw Materials Record Item No.: HL 5 Description: dental gold Minimum Balance: 25 g Received Used Balance Job Date g Cost Total g Cost Total g Cost Total Number 11-25 30 $60 $1,800 30 $60 $1,800 11-30 580 1.8 $60 $108 28.2 $60 $1,692 12-02 586 2.7 $60 $162 25.5 $60 $1,530 12-10 591 1.9 $60 $114 23.6 $60 $1,416 After the bill of materials has been prepared, the Purchasing Department checks the raw materials inventory to determine what raw materials are currently in stock, and what raw materials must be purchased. Each type of raw material has its own raw materials record. As shown in Exhibit 5-5, a raw materials record provides detailed information about each item in stock: the number of units received, the number of units used, and the balance of units currently in stock. Additionally, the raw materials record shows how much each unit costs to purchase, as well as the cost of the units used and the cost of the units still in raw materials inventory. By looking at the raw materials record pictured in Exhibit 5-5, the Purchasing Department sees that only 28.2 g of HL 5 dental gold are currently in stock, and the bill of materials for Job 603 (Exhibit 5-4) shows that 2.3 g are needed for the job. There is sufficient HL 5 for the current job; however, the company requires a minimum bal- ance of 25 g of HL 5, and the new balance is 23.6 g. Therefore, the Purchasing Depart- ment needs to buy additional HL 5. The Purchasing Department also needs to consider other jobs that will use HL 5 in the near future, as well as the time it takes to obtain the dental gold from the company’s suppliers. According to the production schedule, Job 603 is scheduled to begin production on December 22; therefore, the Purchasing Department must make sure all necessary raw materials are on hand by that date. When raw materials are needed, Shaw Group’s Purchasing Department issues a purchase order to its suppliers. For control purposes, incoming shipments of raw materials are counted and Why is this important? recorded on a receiving report, which is typically a duplicate of Intentionally leaving the quantity ordered blank on the purchase order but without the quantity prelisted on the the RECEIVING REPORT acts as a control to form. Shaw Group’s Accounting Department will not pay the double check amounts ordered, received, and invoice (bill from the supplier) unless it agrees with the quantity paid because it requires dock personnel to count of materials both ordered and received. By matching the purchase and record the quantity of materials. order, receiving report, and invoice, Shaw Group ensures that it pays for only those materials that were ordered and received, and nothing more. In addition to tracking the current level of individual inventory items and what raw materials to buy, the raw materials records also form the basis for valuing the raw materials inventory account found on the company’s balance sheet. On a given date, by adding together the balances in the individual raw materials records, the company is able to substantiate the total raw materials inventory shown on the balance sheet. For example, as shown in Exhibit 5-6, on November 30, Shaw Group had in stock $1, 692 of M05_Braun_05_SE_51734.indd 301 09/03/23 12:26 PM  302 Chapter 5 Exhibit 5-6 Individual Raw Materials Records Sum to the Raw Materials Inventory Balance HL 5 Dental Gold Date Received Used Balance 11-30 $1,692 HL 8 Dental Gold Balance Sheet Date Received Used Balance November 30 11-30 $4,000 PF 32 Porcelain Fibre Assets: Liabilities and Owners’ Equity: Date Received Used Balance Cash Accounts Payable 11-30 $1,200 Accounts Receivable Wages and Salaries Payable Raw Materials Inventory Other Liabilities DA 2 Denture Acrylic Work in Process Inventory Common Shares Date Received Used Balance Finished Goods Inventory Retained Earnings 11-30 $500 Property and Equipment Total Liabilities and Owners’ Equity Total Assets DA 3 Denture Acrylic Date Received Used Balance 11-30 $3,000 43-55 Model Stone Date Received Used Balance 11-30 $1,000 HL 5 dental gold, $4, 000 of HL 8 dental gold, $1, 200 of PF 32 porcelain fibre, and so forth. When combined, these individual balances sum to the raw materials inventory balance shown on the Shaw Group’s November 30 balance sheet. Using a Job Cost Record to Keep Track of Job Costs Once the necessary raw materials have arrived and production is ready, the technician begins Job 603. A job cost record, as pictured in Exhibit 5-7, is used to accumulate all of the direct materials and direct labour used on the job, as well as the manufacturing overhead allocated to the job. Each job has its own job cost record. Note that the job cost record is merely a form (electronic or hard copy) for tracking the costs associated with each job: direct materi- als, direct labour, and manufacturing overhead. As we saw in the last section, the indi- vidual raw materials records sum to the total raw materials inventory shown on the balance sheet. Similarly, as shown in Exhibit 5-8, the job cost records on all incomplete jobs sum to the total work in process inventory shown on the balance sheet. As shown near the bottom of Exhibit 5-7, job cost records usually also contain details about what happens to the units in the job after it has been completed and sent to the finished goods warehouse or delivered to the customer. These details include the date and quantity of units shipped to customers, the number of units remaining in finished goods inventory, and the cost of these Why is this important? units. The balance of unsold units from completed job cost records Job cost records keep track of all manufacturing sum to the total finished goods inventory on the balance sheet. For costs assigned to individual jobs so that Shaw Group, the only units in finished goods inventory are those managers know how much it costs to make that must still be delivered, because units are not put into produc- each product. tion unless they are ordered by the customer. That means that they do not make additional units as inventory to await sale. M05_Braun_05_SE_51734.indd 302 17/03/2023 14:48  Job Costing 303 Exhibit 5-7 Job Cost Record Job Cost Record Job Number: 603 Customer: Dr. Waja Job Description: HL 5 dental gold crown 3-6 Date Started: Dec. 22 Date Completed: Manufacturing Cost Information: Cost Summary Direct Materials $ Direct Labour $ Manufacturing Overhead $ Total Job Cost $ Number of Units ÷ 1 unit Cost per Unit $ Shipping Information: Date Quantity Shipped Units Remaining Cost Balance Exhibit 5-8 Job Cost Records on Incomplete Jobs Sum to the WIP Inventory Balance JOB 560- Direct Materials Direct Labour MOH Total Job Cost Balance Sheet JOB 561- November 30 Direct Materials Direct Labour Assets: Liabilities and Owners’ Equity: MOH Cash Accounts Payable Total Job Cost Accounts Receivable Wages and Salaries Payable Raw Materials Inventory Other Liabilities JOB 562- Work in Process Inventory Common Shares Direct Materials Finished Goods Inventory Retained Earnings Direct Labour Property and Equipment Total Liabilities and Owners’ Equity MOH Total Assets Total Job Cost JOB 563- Direct Materials Direct Labour MOH Total Job Cost M05_Braun_05_SE_51734.indd 303 17/03/2023 14:49  304 Chapter 5 TRY IT! 5-1 Match the following concepts to their descriptions: 1. Document specifying when jobs will be manufactured a. Process costing 2. Product costing system used by mass manufactures b. Stock inventory 3. Bill from supplier c. Raw materials record 4. Document specifying parts needed to produce a job d. Production schedule 5. Product costing system used by manufacturers of e. Receiving report unique products f. Invoice 6. Document containing the details and balance of each g. Bill of materials part in stock h. Job costing 7. Document for recording incoming shipments 8. Products normally kept on hand in order to fill orders quickly Please see the end of the chapter for solutions. Tracing Direct Material Costs to a Job Once production is ready to begin Job 603, it will need the materials shown on the bill of materials (Exhibit 5-4). According to the production schedule (Exhibit 5-3), this job is scheduled to take two days to complete (the 22nd and the 23rd). The production crew will work on the preparatory steps on the 22nd, and the technician will want the requisitioned raw materials (the HL 5 gold) for the 23rd. If production can be com- pleted in one day, the raw materials may be wanted at the beginning of the job. For longer production schedules, a materials requisition is filled out each time produc- tion needs some raw materials. As shown in Exhibit 5-9, the materials requisition is a form itemizing the raw materials currently needed from the storeroom. For large manufacturing operations, as soon as the materials requisition is received by the raw materials storeroom, workers pick the appropriate materials and send them to the factory floor. Picking is just what it sounds like: Storeroom workers pick the needed materials off the storeroom shelves. For Shaw Group, the technician responsible for producing each job is also responsible for retrieving the materials from storage. However, materials requisition forms are still used to account for all materials Exhibit 5-9 Materials Requisition Materials Requisition Date: 12/22 Number: #7568 Job: 603 Date Description Quantity Unit Cost Amount 12/22 HL 5 dental gold 2.3 g $60 $138 Total $138 M05_Braun_05_SE_51734.indd 304 09/03/23 12:26 PM  Job Costing 305 Exhibit 5-10 Raw Materials Record Updated for Materials Received and Used Raw Materials Record Item No.: HL 5 Description: dental gold Minimum Balance : 25 g Received Used Balance Job Date g Cost Total g Cost Total g Cost Total Number 11-25 30 $60 $1,800 30 $60 $1,800 11-30 580 1.8 $60 $108 28.2 $60 $1,692 12-02 586 2.7 $60 $162 25.5 $60 $1,530 12-10 591 1.9 $60 $114 23.6 $60 $1,416 12-15 30 $60 $1,800 53.6 $60 $3,216 12-22 603 2.3 $60 $138 51.3 $60 $3,078 used. The unit cost and total cost of all materials picked are posted to the materials requisition based on the cost information found in the individual raw materials records. As shown in Exhibit 5-10, the individual raw materials records are also updated as soon as the materials are picked. In many companies, scanning a bar code on the product can replace the manual recording. Finally, the raw materials requisitioned for the job are posted to the job cost record, as shown in Exhibit 5-11. If materials need to be requisitioned more than once for the Exhibit 5-11 Posting Direct Materials Used to the Job Cost Record Job Cost Record Job Number: 603 Customer: Dr. Waja Job Description: 1 HL 5 dental gold crown Date Started: Dec. 22 Date Completed: Manufacturing Cost Information: Cost Summary Direct Materials Req. #7568: 2.3 g HL 5 $ 138 $ 138 Direct Labour $ Manufacturing Overhead $ Total Job Cost $ Number of Units ÷ 1 unit Cost per Unit $ M05_Braun_05_SE_51734.indd 305 09/03/23 12:26 PM  306 Chapter 5 Exhibit 5-12 Labour Time Record Labour Time Record Employee: Hannah Smith Week: 12/21 – 12/27 Hourly Wage Rate: $20 Record #: 324 Job Date Start Time End Time Hours Cost Number 12/21 598 8:00 10:00 2 $40 12/21 602 10:00 4:00 6 $120 12/22 603 8:00 4:00 8 $160 12/23 603 8:00 9:00 1 $20 12/23 etc. same job number (for example, two separate teeth were being created for the same customer), the raw materials are posted to the direct materials section of the job cost record each time. They are considered direct materials as they can be traced specific­ ally to Job 603. By using this system to trace direct materials to specific jobs, managers know the exact cost of direct materials incurred for each job. Tracing Direct Labour Cost to a Job Direct labour costs are traced to individual jobs through labour time records. As shown in Exhibit 5-12, a labour time record simply records the time spent by each employee on each job throughout the day. These records are usually kept electronic­ ally, rather than using old-fashioned time tickets and punch clocks. The direct labour cost to be charged to the job is calculated based on each employee’s unique hourly wage rate and time spent on the job. For example, in Exhibit 5-12, we see that Hannah Smith, who is paid a wage rate of $20 per hour, worked on Jobs 598, 602, and 603 during the week. Hannah spent 8 hours working on Job 603 on December 22. Therefore, $160 of direct labour cost ( $20 × 8 ) will be charged to Job 603 for Hannah’s work on that date. On December 23, Hannah’s hour of work on Job 603 resulted in another $20 of direct labour being charged to the job. The cost of each direct labourer’s time is computed using one employee’s unique wage rate, just as is done with Hannah Smith’s time. Then, as shown in Exhibit 5-13, the information from the individual labour time records is posted to the direct labour section of the job cost record. As you can see, by tracing direct labour cost in this fashion, jobs are charged only for the direct labour actually incurred in producing the job. What about employee benefits, such as employee-sponsored retirement plans, health insurance, payroll taxes, and other benefits? As discussed in Chapter 2, these payroll-related benefits often add another 30% or more to the cost of gross wages and salaries. Some companies factor, or “load,” these costs into the hourly wage rate charged to the jobs. For example, if a factory worker earns a wage rate of $18.00 per hour, the job cost records would show a loaded hourly rate of about $23.40 per hour, which would include all benefits associated with employing that worker. However, since coming up with an accurate loaded hourly rate such as this is difficult, many companies treat these extra payroll-related costs as part of manufacturing overhead, rather than loading these costs into the direct labour wage rates. We will talk about how all manufacturing overhead costs are handled in the next section. M05_Braun_05_SE_51734.indd 306 09/03/23 12:26 PM  Job Costing 307 Exhibit 5-13 Posting Direct Labour Used to the Job Cost Record Job Cost Record Job Number: 603 Customer: Dr. Waja Job Description: 1 HL 5 dental gold crown Date Started: Dec. 22 Date Completed: Manufacturing Cost Information: Cost Summary Direct Materials Req. #7568: 2.3 g HL 5 $ 138 $ 138 Direct Labour No. #324 (9 hours): $160, $20, etc. No. #327* (1 hour): $ 15 No. #333* (1.5 hours): $ 30 Etc. (a total of 11.5 direct labour hours) $ 225 Manufacturing Overhead $ Total Job Cost $ Number of Units ÷ 1 unit Cost per Unit $ *The additional cost cards would be from other people who had worked on the job even though they were not on the production schedule. This would be the case if other employees had worked on doing some of the preparation work prior to the technician receiving the job or some of the finishing work after the technician had completed the job (for example, cleaning, spraying with an anti-bacterial spray). Note the hourly rate of the employees submitting job record numbers #327 and #333 was $15, and $20, respectively. Allocating Manufacturing Overhead to a Job 5.3 Compute a predetermined manufacturing overhead (MOH) rate and use it to allocate MOH to jobs. So far, we have traced the direct materials cost and direct labour cost to Job 603. Recall, however, that Shaw Group incurs many other manufacturing costs that cannot be directly traced to specific jobs. These indirect costs, otherwise known as manufactur- ing overhead, include depreciation on the factory plant and equipment, utilities to run the plant, property taxes and insurance on the plant, equipment maintenance, the sal- aries of plant janitors and supervisors, machine lubricants, and so forth. Because of the nature of these costs, we cannot tell exactly how much of these costs is attributable to producing a specific job. Why is this important? Therefore, we cannot trace these costs to jobs, as we did with direct Managers use the predetermined MOH rate as a materials and direct labour. Rather, we have to allocate some rea- way to “spread” (allocate) indirect manufacturing sonable amount of these costs to each job. Why bother? IFRS and costs, like factory utilities, among all products ASPE mandate that manufacturing overhead must be treated as an produced in the factory during the year. inventoriable product cost for financial reporting purposes. M05_Braun_05_SE_51734.indd 307 09/03/23 12:26 PM  308 Chapter 5 The rationale is that these costs are a necessary part of the production process: Jobs could not be produced without incurring these costs. What Does Allocating Mean? Allocating manufacturing overhead1 to jobs simply means that we “split up” or “divide” the total manufacturing overhead costs among the jobs we produced during the year. There are many different ways to “split up” the total manufacturing over- head costs among jobs. Think about the different ways you could split up a pizza among friends. You could give equal portions to each friend, you could give larger portions to the largest friends, or you could give larger portions to the hungriest friends. All in all, you have a set amount of pizza, but you can come up with several different reasonable bases for your decisions. Likewise, a manufacturer has a total amount of manufacturing overhead (MOH) that must be split among all of the jobs produced during the year. Since each job is unique in size and resource requirements, it would not be fair to allocate an equal amount of manufacturing overhead to each job. Rather, management needs some other reasonable basis for splitting up the total manufacturing overhead costs among jobs. In this chapter, we will discuss the most basic method of allocating MOH to jobs. This method has traditionally been used by most manufacturers. Steps to Allocating Manufacturing Overhead Manufacturers follow four steps to implement this basic allocation system. The first three steps are taken before the year begins: STEP 1: The company estimates its total manufacturing overhead costs for the coming year. This is the total “pie” to be allocated. For Shaw Group, let us assume management estimates total manufacturing overhead costs for the year to be $1 million. STEP 2: The company selects an allocation base and estimates the total amount that will be used during the year. This is the basis management has chosen for “dividing up the pie.” For Shaw Group, let us assume management has selected direct labour hours as the allocation base. Furthermore, management estimates that 62,500 hours of direct labour will be used during the year. Ideally, the allocation base should be the cost driver of the manufacturing over- head costs. As the term implies, a cost driver is the primary factor that causes a cost. For example, in many companies (like Shaw Group), manufacturing overhead costs rise and fall with the amount of work performed. Because of this, most companies in the past have used either direct labour hours or direct labour cost as their allocation base. This information was also easy to gather from the labour time records or job cost records. However, for manufacturers who have automated much of their production process, machine hours may be a more appropriate allocation base, because the amount of time spent running the machines drives the utility, maintenance, and equip- ment depreciation costs. As you will learn in Chapter 7, some companies even use multiple allocation bases to more accurately allocate MOH costs to individual jobs. The important point is that the allocation base selected should bear a strong relation- ship to the MOH costs. 1 The term “applying” manufacturing overhead is often used synonymously with “allocating” manufacturing overhead. M05_Braun_05_SE_51734.indd 308 09/03/23 12:26 PM  Job Costing 309 STEP 3: The company calculates its predetermined manufacturing overhead rate using the information estimated in Steps 1 and 2: Total estimated manufacturing overhead costs Predetermined MOH rate = Total estimated amount of the allocation base Shaw Group would calculate its predetermined manufacturing overhead rate as follows: $1, 000, 000 Predetermined MOH rate = = $16 per direct labour hour 62, 500 DL hours This rate will be used throughout the coming year. It is not revised unless the company finds that either the MOH costs or the total amount of the allocation base being used (direct labour hours for Shaw Group) has substantially shifted away from the estimated amounts. Why does the company use a predetermined MOH rate, based on estimated or bud- geted data, rather than an actual MOH rate based on actual data for the year? In order to get actual data, the company would have to wait until the end of the year to set its MOH rate. By then, the information is too late to be useful for making pricing and other decisions related to individual jobs. Managers are willing to sacrifice some accur­acy in order to get timely information on how much each job costs to produce. Allocating Manufacturing Overhead to Individual Jobs During the year, as jobs are produced, companies take the following step to calculate the amount of MOH to allocate to each job. STEP 4: The company allocates some manufacturing overhead to each individual job as follows: MOH allocated to a job = Predetermined MOH rate × Actual amount of allocation base used by the job Let’s see how this works for Shaw Group’s Job 603. Since the predetermined MOH rate is based on direct labour hours ($16 per DL hour), we will need to know how many direct labour hours were used on Job 603. From Exhibit 5-13, we see that Job 603 required a total of 11.5 DL hours. This information was collected from the indi- vidual labour time records and summarized on the job cost record. Therefore, we cal- culate the amount of MOH to be allocated to Job 603 as follows: MOH to be allocated to job 603 = $16 per direct labour hour × 11.5 direct labour hours = $184 The $184 of MOH allocated to Job 603 is now posted to the job cost record, as shown in Exhibit 5-14. WHEN IS MANUFACTURING OVERHEAD ALLOCATED TO JOBS? The point in time at which manufacturing overhead is allocated to the job depends on the sophisti- cation of the company’s computer system. In most sophisticated systems, some MOH is allocated to the job each time some of the allocation base is posted to the job cost record. In less sophisticated systems, manufacturing overhead is allocated only once: as soon as the job is complete and the total amount of allocation base used by the job is known (as shown in Exhibit 5-14). However, if the balance sheet date (for example, December 31) arrives before the job is complete, Shaw Group would need to allocate some MOH to the job based on the number of direct labour hours used on the job thus far. Only by updating the job cost records will the company have the most accurate work in process inventory on its balance sheet. M05_Braun_05_SE_51734.indd 309 09/03/23 12:26 PM  310 Chapter 5 Exhibit 5-14 Posting Manufacturing Overhead and Completing the Job Cost Record Job Cost Record Job Number: 603 Customer: Dr. Waja Job Description: 1 HL 5 dental gold crown Date Started: Dec. 22 Date Completed: Dec. 28 Manufacturing Cost Information: Cost Summary Direct Materials Req. #7568: 2.3 g HL 5 $ 138 $ 138 Direct Labour No. #324 (9 hours): $ 160, $ 20, etc. No. #327 (1 hour): $ 15 No. #333 (1.5 hours): $ 30 Etc. (a total of 11.5 direct labour hours) $ 225 Manufacturing Overhead $16/ DL hour × 11.5 DL hours = $184 $ 184 Total Job Cost $ 547 Number of Units ÷ 1 unit Cost per Unit $ 547 How Do Managers Deal with Underallocated or Overallocated Manufacturing Overhead? 5.4 Compute and dispose of overallocated or underallocated manufacturing overhead. In job order costing, managers calculate the cost of producing a job by tracing actual direct materials and direct labour to each job using materials requisitions and labour time records, while manufacturing overhead is allocated to each job using a predetermined overhead rate. The predetermined rate is calculated using estimates of the company’s total annual manufacturing costs and estimates of the total annual allocation base (such as direct labour hours). However, by the end of the period the actual manufacturing overhead costs incurred by the company will be known and will no doubt differ from the total amount allocated to jobs during the period. Invariably, they will have either underallocated manufacturing overhead (esti- mated too little) or overallocated manufacturing overhead (estimated too much), as shown in Exhibit 5-15. M05_Braun_05_SE_51734.indd 310 09/03/23 12:26 PM  Job Costing 311 Exhibit 5-15 Underallocated vs. Overallocated Manufacturing Overhead MOH has been Jobs have been If MOH allocated < actual MOH incurred, then... underallocated, so… undercosted MOH has been Jobs have been If MOH allocated > actual MOH incurred, then... overallocated, so… overcosted Suppose Shaw Group incurred the following actual manufacturing overhead costs in December: Manufacturing Overhead Incurred Actual MOH Costs Indirect materials used (janitorial supplies, machine lubricants, etc.)....................................................................................... $ 2,000 Indirect labour (janitors’ and supervisors’ wages, etc.)........................................................................................................... 13,000 Other indirect manufacturing costs (Plant utilities, depreciation, property taxes, insurance, etc.)............................................................................................... 10,000 Total actual manufacturing overhead costs incurred........................................................................................................... $25,000 Now let’s look at the total amount of MOH that was allocated to specific jobs dur- ing the month using the predetermined overhead rate of $16 per direct labour hour. For simplicity, we will detail Job 603 and combine all other jobs worked on in December into one total. Amount of MOH Job Allocated to Job 603 (from Exhibit 5-14) ($16 per DL hour × 11.5 DL hours)................................................................................................... $ 184 604 (not shown) ($16 per DL hour × 1,488.5 DL hours)......................................................................................................... 23,816 Total MOH allocated to jobs ($16 per hour × 1,500 DL hours)............................................................................................... $24,000 Notice that we do not need to have the individual job cost records available to figure out the total amount of MOH allocated to jobs during the period. Rather, we only need to do the following: Total MOH allocated = Predetermined MOH rate × Actual total amount of allocation base used on all jobs = $16 per DL hour × 1, 500 direct labour hours = $24, 000 total MOH allocated to jobs during the period The difference between the actual MOH costs incurred and the amount of MOH allocated to jobs shows that Shaw Group underallocated MOH by $1, 000 during December: Actual manufacturing overhead costs incurred........................................................................... $25,000 Manufacturing overhead allocated to jobs................................................................................... (24,000) Underallocated manufacturing overhead....................................................................................... $ 1,000 By underallocating MOH, Shaw Group did not allocate enough MOH cost to the jobs worked on during the period. In other words, management should have allocated M05_Braun_05_SE_51734.indd 311 09/03/23 12:26 PM  312 Chapter 5 Exhibit 5-16 Correcting Cost of Goods Sold for Underallocated or Overallocated MOH If jobs have been undercosted due Increase cost of goods sold for to underallocation of MOH, then the amount of the underallocation cost of goods sold is too low, so… If jobs have been overcosted due Decrease cost of goods sold for to overallocation of MOH, then the amount of the overallocation cost of goods sold is too high, so… a total of $1, 000 more MOH cost than the job cost records indicated to jobs worked on during the period. These jobs have been undercosted, as shown in Exhibit 5-15. If, on the other hand, a manufacturer finds that the amount of MOH allocated to jobs is greater than the actual amount of MOH incurred, we would say that MOH has been overallocated, resulting in overcosting these jobs. What do manufacturers do about this problem? Assuming that the amount of under- or overallocation is immaterial, or that most of the inventory produced during the period has been sold, manufacturers typically adjust the cost of goods sold shown on the income statement for the total amount of the under- or overallocation. Why? Because the actual cost of producing these goods differed from what was initially reported on the job cost records. Since the job cost records were used as a basis for recording cost of goods sold at the time the units were sold, the cost of goods sold will be wrong unless it is adjusted. As shown in Exhibit 5-16, by increasing cost of goods sold when MOH has been underallocated, or by decreasing cost of goods sold when MOH has been overallocated, the company actually corrects the error that exists in cost of goods sold. What if the amount of under- or overallocation is large, and the company has not sold almost all of the jobs it worked on during the period? Then the company will prorate the total amount of under- or overallocation among work in process inventory, finished goods inventory, and cost of goods sold, based on the amount of applied MOH in each of the three accounts (WIP, FG, and COGS). This can be quite complex because the amount of applied MOH becomes hidden once it moves to the FG and COGS accounts. Therefore, for simplicity, the total amount in each of the three accounts is typically used for calculating the distribution of the over- or underallocated overhead. For example, assume the three accounts had balances as follows: WIP:............................................................................................................................................. $14,250 FG:............................................................................................................................................... $10,700 COGS:......................................................................................................................................... $17,300 In this case, the total amount of underallocation ($1, 000 in the case of Shaw Group) would be roughly allocated as follows: $337 to work in process inventory ( 14, 250 ( 14, 250 + 10, 700 + 17, 300 ) ÷ 1, 000 ) ; $253 to finished goods inventory ( 10, 700 ( 14, 250 + 10, 700 + 17, 300 ) ÷ 1, 000 ) ; and $409 to cost of goods sold ( 17, 300 ( 14, 250 + 10, 700 + 17, 300 ) ÷ 1, 000 ). You will note that rounding has meant that the total amount to be allocated equals $999 rather than the full $1, 000. M05_Braun_05_SE_51734.indd 312 09/03/23 12:26 PM  Job Costing 313 STOP & THINK Assume Shaw Group’s managers had chosen direct labour cost as its MOH allocation base, rather than direct labour hours. Furthermore, assume management estimated direct labour would cost $1,200,000 for the year. 1. Assuming direct labour cost as the allocation base, calculate the company’s pre­ determined MOH rate. 2. How much MOH would have been allocated to Job 603? Answer: $1,000,000 0.8333 or 83.33% 1. Predetermined MOH rate = = $1,200,000 of DL cost of direct labour cost $225 direct labour cost 2. MOH allocated to Job 603 = 83.33% × ( from Exhibit 5-14 ) = $187.50 Note that this allocation differs from that shown in Exhibit 5-14 ( $184 ). That is because the amount of MOH allocated to an individual job depends upon the allocation base chosen by management. While there is no one “correct” allocation, the most accurate and equitable allocation occurs when the company uses the MOH cost driver as its allocation base. Completing the Job Cost Record and Using It to Make Business Decisions 5.5 Determine the cost of a job and use it to make business decisions. Remember, there is more than one way to determine the cost of a product, and job cost- ing is just one of them. Some methods determine different total costs for each job, and other approaches may include more or exclude some of the costs that have been dem- onstrated with job costing. The method used to determine the cost will affect decision making within an organization. Other methods will be demonstrated in later chapters (ABC costing and variable costing, for example), and your first decision as a manager will be to determine which costing method is most appropriate for your own situation. Control Concepts Cost and inventory controls should be based on what the organization has purchased. Cost accounting determines the costs of products/processes to report in financial statements. Tracing costs is a method of precisely assigning a cost to a particular activity, product, or service. Job costing compiles materials, labour, and overhead costs for an individual unit or job. This approach works well for unique products, such as custom- designed machines or consulting projects. Internal controls that all entities should con- sider putting in place include: 1. Authorization procedures for ordering goods 2. A process to match goods received against authorized purchase orders 3. Match supplier invoices to a goods received report As shown in Exhibit 5-14, now that all three manufacturing costs have been posted to the job cost record, Shaw Group can determine the total cost of Job 603 ( $547 ). If there were more than one unit in the batch, or job, Shaw Group would also M05_Braun_05_SE_51734.indd 313 09/03/23 12:26 PM  314 Chapter 5 calculate the cost of producing each of the identical units in the job by dividing the total cost by the number of units. For example, if a dentist orders two athletic mouthguards for the same patient, the costs of fabricating both mouthguards would be accumulated in the job cost card. Shaw Group would then take the total costs and divide by two to get an individual cost for each mouthguard. Reducing Future Job Costs Management uses the job cost information to control costs. By examining the exact costs traced to the job, management might be able to determine ways of reducing the cost of similar jobs produced in the future. For example, is the HL 5 dental gold cost- ing more than it did on previous jobs? Perhaps management can renegotiate its con- tract with its primary suppliers or identify different suppliers that are willing to sell the materials more cheaply without sacrificing quality. What about direct labour costs? By examining the time spent by various workers on the job, management may be able to improve the efficiency of the process so that less production time is required. Management will also examine the hourly wage rates paid to the individuals who worked on the job to determine if less skilled, and there- fore less costly, workers could accomplish the same production tasks, freeing up the more highly skilled employees for more challenging work. Assessing and Comparing the Profitability of Each Model Management also uses job cost information to determine the profitability of the various models. Assume that a single gold crown (a molar, for example) is listed at a sales price of $1, 000.2 That means the company can expect the following gross profit on this job: Unit sales price............................................................................................................................ $1,000 Unit cost (computed on job cost record in Exhibit 5-14)............................................................... (547) Gross profit................................................................................................................................. $ 453 This profit analysis shows that the company generates a gross profit of $453 for this unit.3 Keep in mind that Shaw Group incurs many operating costs, outside of its manufacturing costs, that must be covered by the gross profit earned by product sales. For example, Shaw Group needs to cover the costs of advertising, training for the technicians, and costs from the head office and training location in downtown Toronto. Managers compare the gross profit on this unit to the gross profit of other models to determine which products to emphasize selling. Management will concentrate on marketing those models that yield the higher profit margins. Dealing with Pricing Pressure from Competitors Management can also use this information to determine how it will deal with pricing pressure. If a competitor drops the price of a similar gold crown to $950, according to the profit analysis, Shaw Group could drop its sales price of a gold crown to $950 and still generate $403 of gross profit on the sale. In fact, Shaw Group could undercut the competitors, by charging less than $950, to generate additional sales and perhaps increase its market share. 2 Because the products made at this organization are all customized for a particular customer, it is abnormal to have one price for all versions of the same product (for example, one price for any gold crown made). We will deal with the customized situations later in the chapter; for this example, you can assume that a single selling price is used for a product. 3 Since the cost figures used in this chapter are hypothetical, the gross profit on unit sales is also hypothetical. M05_Braun_05_SE_51734.indd 314 09/03/23 12:26 PM  Job Costing 315 Allowing Discounts on High-Volume Sales Customers often expect discounts for high-volume sales. For example, perhaps Dr. Waja has proposed that she will send all of her orders to the Shaw Group. In exchange for this exclusive arrangement, she has asked for a 25% volume discount off the regu- lar sales price. If Shaw Group does not agree to the discount, the dentist will take her business to a competitor. Can Shaw Group agree to this discount and still earn a profit on the sale? Let us see: Discounted sales price (75% of $1,000)......................................................................................... $750 Unit cost (computed on job cost record in Exhibit 5-14)................................................................. (547) Gross profit................................................................................................................................... $203 These calculations show that the discounted sales price will still be profitable. We will talk more about special orders like this in Chapter 8. Bidding for Custom Orders Management also uses product cost information to bid for custom orders. For Shaw Gro