Job Order Costing PDF

CHAPTER 20 JOB-ORDER COSTING DR ARAFAT HOSSAIN ASSISTANT PROFESSOR SOUTHEAST BUSINESS SCHOOL 1  JOB-ORDER COSTING ◼ LEARNING OBJECTIVES ◼ After studying Chapter 20, you should be able to: ◼ LO20–1 Compute a predetermined overhead rate. ◼ LO20–2 Apply overhead cost t...

CHAPTER 20 JOB-ORDER COSTING DR ARAFAT HOSSAIN ASSISTANT PROFESSOR SOUTHEAST BUSINESS SCHOOL 1  JOB-ORDER COSTING ◼ LEARNING OBJECTIVES ◼ After studying Chapter 20, you should be able to: ◼ LO20–1 Compute a predetermined overhead rate. ◼ LO20–2 Apply overhead cost to jobs using a predetermined overhead rate. ◼ LO20–3 Compute the total cost and average cost per unit of a job. ◼ LO20–4 Understand the flow of costs in a job order costing system and prepare appropriate journal entries to record costs. ◼ LO20–5 Use T-accounts to show the flow of costs in a job-order costing system. ◼ LO20–6 Prepare schedules of cost of goods manufactured and cost of goods sold and an income statement. ◼ LO20–7 Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts. 2  JOB-ORDER COSTING Job-Order Costing – An Overview ◼ In this chapter we use absorption costing to determine product costs. In absorption costing , all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs. ◼ Job-order costing is used in situations where many different products, each with individual and unique features, are produced each period. For example, a Levi Strauss clothing factory would typically make many different types of jeans for both men and women during a month. ◼ Job-order costing is also used extensively in service industries. For example, hospitals, law firms, movie studios, accounting firms, advertising agencies, and repair shops all use a variation of job-order costing to accumulate costs. 3  JOB-ORDER COSTING Measuring Direct Materials Cost ◼ After accepting a job or order, the first step in a job order costing system is to determine the direct materials requirement to complete the job. The type and quantity of direct materials required to manufacture a product can be determined either by using a bill of materials. ◼ Bill of materials is a document that lists the type and quantity of direct materials required to manufacture a standard product. ◼ After direct materials requirement has been determined, the production process starts with issuance of direct materials. For this purpose, production department prepares a document known as ‘materials requisition form’. Exhibit 3-1. ◼ Job Cost Sheet ◼ A job cost sheet records the materials, labor, and manufacturing overhead costs charged to 4 that job. Exhibit 3-2. JOB-ORDER COSTING 5 JOB-ORDER COSTING 6  JOB-ORDER COSTING Measuring Direct Labor Cost ◼ In job order costing system, the method of measuring and recording direct labor cost is similar to measuring and recording direct materials cost. ◼ Direct labor hours worked, direct labor rate per hour, and total amount in dollars for each individual job or task is recorded on a document known as time ticket or employee time ticket. A separate time ticket is prepared by each worker for every working day. ◼ Accounting department collects all time tickets at the end of the day. These time tickets are used to enter direct labor cost on the job cost sheet of each individual job order. An example/sample of complete time ticket is given in the next slide (Exhibit 3-3). 7 JOB-ORDER COSTING 8  JOB-ORDER COSTING ◼ Manufacturing Overhead Cost ◼ Assigning manufacturing overhead to a specific job involves some difficulties. ◼ There are 4 reasons for this: ◼ 1. Complexity: Manufacturing overhead includes various indirect costs, such as utilities, rent, and supervisor salaries. Many of these costs do not directly relate to specific jobs or products, making it challenging to categorize and allocate them accurately. ◼ 2. Time Consumption: Gathering data, analyzing costs, and applying overhead can be time-consuming, especially in complex manufacturing settings. Delays in determining actual overhead costs can slow down production, and sometimes we must wait until the entire process is finished. ◼ 3. Variability: Manufacturing overhead costs can change significantly over time due to factors like production levels, utility rates, and indirect materials. This makes it difficult to predict and allocate these costs consistently. ◼ 4. Consistency: Manufacturing overhead often includes fixed costs that remain relatively stable, even when production levels fluctuate significantly. This stability can result in variations in the average cost per unit, as fixed 9 costs are distributed over a changing number of units produced.  JOB-ORDER COSTING ◼ We need Predetermined Overhead Rate ◼ Using a predetermined rate to assign manufacturing overhead costs to jobs helps streamline the costing process and enhances accuracy in financial reporting. In this process we focus on only one cost driver (labor cost/machine hours) ◼ 1. Efficiency: Using a predetermined rate to calculate overhead costs saves time compared to tracking actual costs in real-time. This approach enables faster job costing, which is essential for timely decision-making. ◼ 2. Cost Control: Establishing a rate based on estimated overhead costs and a relevant activity (like machine or labor hours) helps companies manage and control overhead expenses better, aiding in budgeting and financial planning. ◼ 3. Predictability: A predetermined rate ensures consistent allocation of overhead costs, making it easier to predict future costs and set pricing strategies ◼ 4. Smoothing Variability: A predetermined rate helps smooth out fluctuations in manufacturing overhead caused by factors like seasonal production changes, making it easier to evaluate job performance over time ◼ 5. Performance Measurement: Using a predetermined rate allows companies to compare estimated costs with actual 10 costs. Variance analysis helps identify areas for improvement in efficiency and cost management. JOB-ORDER COSTING ◼ Computing Predetermined Overhead Rates ◼ Companies assign manufacturing overhead to specific jobs on an estimated basis through the use of a predetermined overhead rate. ◼ The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. ◼ The company may state the activity in terms of direct labor costs, direct labor hours, machine hours, or any other measure that will provide an equitable basis for applying overhead costs to jobs. 11  JOB-ORDER COSTING ◼ Computing Predetermined Overhead Rates (Contd.) ◼ Given these problems, allocation is used to assign overhead costs to products. Allocation is accomplished by selecting an allocation base that is common to all of the company’s products and services. An allocation base is a measure such as direct labor-hours (DLH) or machine-hours (MH) that is used to assign overhead costs to products and services. ◼ Manufacturing overhead is commonly assigned to products using a predetermined overhead rate. The predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost for the period by the estimated total amount of the allocation base as follows: ◼ Predetermined overhead rate = Estimated total manufacturing overhead cost/Estimated total amount of the allocation base. ◼ Note: ABC method is better than using a predetermined overhead rate for allocating manufacturing overhead because it uses multiple cost drivers related to products or services. Overhead costs are assigned based on the actual use of activities like machine setups, inspections, material handling, and 12 product design.  JOB-ORDER COSTING Computing Predetermined Overhead Rates (Contd.) ◼ The cost formula shown below to estimate the total manufacturing overhead cost (the numerator) for the coming period : ◼ Y = a + bx ◼ where, ◼ Y = The estimated total manufacturing overhead cost ◼ a = The estimated total fixed manufacturing overhead cost ◼ b = The estimated variable manufacturing overhead cost per unit of the allocation base ◼ x = The estimated total amount of the allocation base (activity base/activity level). 13  JOB-ORDER COSTING Applying Manufacturing Overhead ◼ To repeat, the predetermined overhead rate is computed before the period begins. The predetermined overhead rate is then used to apply overhead cost to jobs throughout the period. ◼ The formula for determining the amount of overhead cost to apply to a particular job is: ◼ Over head applied to a particular job = Predetermined overhead rate X Amount of the allocation base incurred by the job. ◼ For example, if the predetermined overhead rate is $8 per direct labor-hour, then $8 of overhead cost is applied to a job for each direct labor-hour incurred on the job. When the allocation base is direct labor-hours, the formula becomes: ◼ Overhead applied to a particular job = Predetermined overhead rate X Actual direct 14 labor-hours charged to the job.  JOB-ORDER COSTING ◼ Manufacturing Overhead—A Closer Look ◼ To illustrate the steps involved in computing and using a predetermined overhead rate, let’s return to Yost Precision Machining and make the following assumptions. In step one, the company estimated that 40,000 direct labor-hours would be required to support the production planned for the year. In step two, it estimated $220,000 of total fixed manufacturing overhead cost for the coming year and $2.50 of variable manufacturing overhead cost per direct labor-hour. Given these assumptions, in step three the company used the cost formula shown below to estimate its total manufacturing overhead cost for the year: ◼ Y = a + bx ◼ Y = $220,000 + ($2.50 per direct labor-hour X 40,000 direct labor-hours) ◼ Y = $220,000 + $100,000 ◼ Y = $320,000. 15 JOB-ORDER COSTING 16 JOB-ORDER COSTING ◼ In step four, Yost Precision Machining computed its predetermined overhead rate for the year of $8 per direct labor-hour as shown below: ◼ Predetermined overhead rate = Estimated total manufacturing overhead cost/Estimated total amount of the allocation base = $320,000/40,000 direct labor-hours = $8 per direct labor-hour ◼ The job cost sheet in Exhibit 3–4 indicates that 27 direct labor-hours (i.e., DLHs) were charged to Job 2B47. Therefore, a total of $216 of manufacturing overhead cost would be applied to the job: ◼ Overhead applied to Job 2B47 = Predetermined overhead rate X Actual direct labor-hours charged to Job 2B47 = $8 per DLH X 27 DLHs ◼ = $216 of overhead applied to Job 2B47. (This amount of overhead has been entered on the job cost sheet in Exhibit 3–4). 17  JOB-ORDER COSTING ◼ Choice of an Allocation Base for Overhead Cost ◼ Ideally, the allocation base in the predetermined overhead rate should drive the overhead cost. A cost driver is a factor, such as machine-hours, beds occupied, computer time, or flight-hours, that causes overhead costs. Most companies use direct labor-hours or direct labor cost as the allocation base for manufacturing overhead. ◼ Computation of Unit Costs ◼ With the application of Yost Precision Machining’s $216 of manufacturing overhead to the job cost sheet in Exhibit 3–4 , the job cost sheet is complete except for two final steps. First, the totals for direct materials, direct labor, and manufacturing overhead are transferred to the Cost Summary section of the job cost sheet and added together to obtain the total cost for the job. 1 Then the total product cost ( $1,800 ) is divided by the number of units (2) to obtain the unit product cost ( $900 ). This unit product cost information is used for valuing unsold units in ending inventory and for determining cost of goods sold. 18 JOB-ORDER COSTING 19  JOB-ORDER COSTING ◼ Job-Order Costing—The Flow of Costs ◼ Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs. ◼ Product costs flow through inventories on the balance sheet and then on to cost of goods sold in the income statement. More specifically, raw materials purchases are recorded in the Raw Materials inventory account. ◼ Raw materials include any materials that go into the final product. When raw materials are used in production, their costs are transferred to the Work in Process inventory account as direct materials. ◼ Work in process consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer. Notice that direct labor costs are added directly to Work in Process—they do not flow through Raw Materials inventory. Manufacturing overhead costs are applied to Work in Process by multiplying the predetermined overhead rate by the actual quantity of the allocation base consumed by each job. When goods are completed, their costs are transferred from Work in Process to Finished Goods. 20 JOB-ORDER COSTING ◼ Job-Order Costing—The Flow of Costs (Contd.) ◼ Finished goods consist of completed units of product that have not yet been sold to customers. The amount transferred from Work in Process to Finished Goods is referred to as the cost of goods manufactured. ◼ The cost of goods manufactured includes the manufacturing costs associated with the goods that were finished during the period. As goods are sold, their costs are transferred from Finished Goods to Cost of Goods Sold. ◼ At this point, the various costs required to make the product are finally recorded as an expense. Until that point, these costs are in inventory accounts on the balance sheet. Period costs (or selling and administrative expenses) do not flow through inventories on the balance sheet. They are recorded as expenses on the income statement in the period incurred. 21 JOB-ORDER COSTING 22  JOB-ORDER COSTING The Purchase and Issue of Materials ◼ On April 1, Ruger Corporation had $7,000 in raw materials on hand. During the month, the company purchased on account an additional $60,000 in raw materials. The purchase is recorded in journal entry (1) below: ◼ Raw Materials Dr 60,000 ◼ Accounts Payable Cr 60,000 ◼ Issue of Direct and Indirect Materials ◼ During April, $52,000 in raw materials were requisitioned from the storeroom for use in production. These raw materials included $50,000 of direct and $2,000 of indirect materials. Entry (2) records issuing the materials to the production departments. The raw materials charged to Work in Process represent direct materials for specific jobs. ◼ Work in Process Dr 50,000 ◼ Manufacturing Overhead Dr 2,000 23 ◼ Raw Materials Cr 52,000  JOB-ORDER COSTING Labor Cost ◼ In April, the employee time tickets included $60,000 recorded for direct labor and $15,000 for indirect labor. The following entry summarizes these costs: ◼ Work in Process Dr 60,000 ◼ Manufacturing Overhead Dr 15,000 ◼ Salaries & Wages Payable Cr 75,000. ◼ Only the direct labor cost of $60,000 is added to the Work in Process account. At the same time that direct labor costs are added to Work in Process, they are also added to the individual job cost sheets. 24  JOB-ORDER COSTING Manufacturing Overhead Costs ◼ Manufacturing Overhead: ◼ Utilities = $21,000 ◼ Rent on factory equipment = 16,000 ◼ Miscellaneous factory overhead costs = 3,000 ◼ Total Manufacturing Overhead = $40,000. ◼ The following entry records the incurrence of these costs: ◼ Manufacturing Overhead Dr $40,000 ◼ Accounts Payable Cr 40,000 ◼ Applying Manufacturing Overhead ◼ Work in Process Dr $40,000 ◼ Manufacturing Overhead Cr 40,000. 25  JOB-ORDER COSTING Nonmanufacturing Costs ◼ Ruger Corporation incurred $30,000 in selling and administrative salary costs during April. The following entry summarizes the accrual of those salaries: ◼ Salaries Expense Dr $30,000 ◼ Salaries & Wages Payable Cr 30,000 ◼ Assume that depreciation on office equipment during April was $7,000. The entry is as follows: ◼ Depreciation Expense Dr $7,000 ◼ Accumulated Depreciation Cr 7,000. 26 JOB-ORDER COSTING ◼ Cost of Goods Manufactured ◼ When a job has been completed, the finished output is transferred from the production departments to the finished goods warehouse. By this time, the accounting department will have charged the job with direct materials and direct labor cost, and manufacturing overhead will have been applied using the predetermined overhead rate. ◼ The costs of the completed job are transferred out of the Work in Process account and into the Finished Goods account. ◼ Finished Goods Dr $150,000 ◼ Work in Process ($50,000+$60,000+$40,000) Cr 150,000. 27 JOB-ORDER COSTING ◼ Cost of Goods Sold ◼ As finished goods are shipped to customers, their accumulated costs are transferred from the Finished Goods account to the Cost of Goods Sold account. ◼ Cost of Goods Sold Dr 150,000 ◼ Finished Goods Cr 150,000. 28 JOB-ORDER COSTING Underapplied and Overapplied Overhead—A Closer Look ◼ Computing Underapplied and Overapplied Overhead ◼ Because the predetermined overhead rate is established before the period begins and is based entirely on estimated data, the overhead cost applied to Work in Process will generally differ from the amount of overhead cost actually incurred. ◼ In the case of Ruger Corporation, for example, the predetermined overhead rate of $6 per hour, and total machine hours was 15,000, it was used to apply $90,000 of overhead cost to Work in Process, whereas actual overhead costs for April proved to be $95,000 (see Exhibit 3–8 ) ◼ The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is called either underapplied or overapplied overhead. For Ruger Corporation, overhead was underapplied by $5,000 because the applied cost ($90,000) was $5,000 less than the actual cost ($95,000). 29 JOB-ORDER COSTING 30 JOB-ORDER COSTING Home Exercises EXERCISE 3–6 Schedules of Cost of Goods Manufactured and Cost of Goods Sold EXERCISE 3–7 Underapplied and Overapplied Overhead EXERCISE 3–8 Applying Overhead; Computing Unit Product Cost EXERCISE 3–10 Applying Overhead to a Job EXERCISE 3–11 Schedules of Cost of Goods Manufactured and Cost of Goods Sold; Income Statement EXERCISE 3–12 Applying Overhead; Cost of Goods Manufactured 31