Chapter 3

Product Costing and Cost

Accumulation in a Batch
Production Environment

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Learning
Objective
1

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Product and Service Costing

Financial
Accounting
Product costs are used
to value inventory and
to compute cost of
goods sold.

Managerial
Accounting and
Cost Management
Product costs are used
for planning, control,
directing, and
management decision
making.
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Learning
Objective
2

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Copyright 2011 by The McGraw-Hill Companies, Inc. All

Flow of Costs in Manufacturing

Firm

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Learning
Objective
3

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Types of Product-Costing
Systems
Process
Costing

Job-Order
Costing

Used for production of large, unique, high-cost items.

Built to order rather than mass produced.
Many costs can be directly traced to each job.
TWO TYPES:
Job-shop operations
Products manufactured in very low volumes or
at a time.

one

Batch-production operations
Multiple products in batches of relatively small
quantity.

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Types of Product-Costing
Systems
Process
Costing

Job-Order
Costing

Typical job-order cost applications:

Special-order printing
Building construction
Also used in service industry
Hospitals
Law firms
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Types of Product-Costing
Systems
Process
Costing

Job-Order
Costing

Used for production of small, identical, low cost

items.
Mass produced in automated continuous
production process.
Costs cannot be directly traced to each unit of
product.
Typical process cost applications:
Petrochemical refinery
Paint manufacturer
Paper mill

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Accumulating Costs in a
Job-Order Costing System
The primary document
for tracking the costs
associated with a
given job is the jobcost record.

Lets investigate using

the AFB Company

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Job-Order Cost Accounting

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Job-Order Cost Accounting

A materials requisition
form is used to
authorize the use of
materials on a job.
Lets see one
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Job-Order Cost Accounting

Timothy
Williams
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Job-Order Cost Accounting

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Job-Order Cost Accounting

Accumulate
direct labor
costs by
means of a
work record,
such as a time
ticket, for each
employee.
Lets see one
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Employee Time Ticket

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Job-Order Cost Accounting

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Job-Order Cost Accounting

Apply manufacturing overhead to jobs using a

predetermined overhead rate based on direct
labor hours (DLH).
Lets do it
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Job-Order Cost Accounting

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Job-Order Cost Accounting

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Job-Order Cost Accounting

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Learning
Objective
4

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Manufacturing Overhead Costs

Overhead is applied to jobs using a predetermined
overhead rate (POHR) based on estimates made at
the beginning of the accounting period.
1

POHR =

Budgeted manufacturing overhead cost

2 Budgeted amount of cost driver (or activity base)

Overhead applied = POHR Actual activity

Based on estimates, and
determined before the
period begins

Actual amount of the allocation

base, such as direct labor hours,
incurred during the period
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Manufacturing Overhead Costs

Overhead is applied to jobs using a
predetermined overhead rate (POHR) based on
estimates made at the beginning of the
accounting period.
POHR =

Budgeted manufacturing overhead cost

Budgeted amount of cost driver (or activity base)

Overhead applied = POHR Actual activity

Recall the Aluminum Boat example where:
Overhead applied = $30 per DLH 600 DLH = $18,000
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Learning
Objective
5

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Job-Order Costing
Document Flow Summary

Lets summarize
the document
flow we have
been discussing
in a job-order
costing system.
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Job-Order Costing
Document Flow Summary
Production
Order for Job
Material
Requisition
Labor Time Records

The production order for the job authorizes the start

of the production process.
The materials requisition indicates the cost of
direct material to charge to jobs and the cost of
indirect material to charge to overhead.
Employee time tickets indicate the cost of direct
labor to charge to jobs and the cost of indirect
labor to charge to overhead.

Apply Manufacturing Overhead

Actual Cost Driver (or Activity Base)

X
Predetermined Overhead Rate
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Job-Order System Cost Flows

Lets examine the

cost flows in a
job-order costing
system. We will
use T-accounts
and start with
materials.
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Job-Order System Cost Flows

Raw Materials
Direct
Material
Purchases Material
Indirect
Material

Work in Process
(Job-Cost Record)
Direct
Material

Mfg. Overhead
Indirect
Material

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Job-Order System Cost Flows

Next lets add

labor costs and
applied
manufacturing
overhead to the
job-order cost
flows. Are you
with me?
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Job-Order System Cost Flows

Wages Payable
Direct
Labor
Indirect
Labor

Work in Process
(Job-Cost Record)
Direct
Material
Direct
Labor

Mfg. Overhead
Indirect
Material
Indirect
Labor
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Job-Order System Cost Flows

Wages Payable
Direct
Labor
Indirect
Labor

Mfg. Overhead
Indirect Overhead
Material Applied to
Work in
Indirect
Process
Labor

Work in Process
(Job-Cost Record)
Direct
Material
Direct
Labor
Overhead
Applied
If actual and applied
manufacturing overhead are
not equal, a year-end
adjustment is required. We
will look at the procedure to
accomplish this later.
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Job-Order System Cost Flows

Now lets
complete the
goods and sell
them. Still with
me?

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Job-Order System Cost Flows

Work in Process
(Job-Cost Record)
Direct
Cost of
Material
Goods
Direct
Mfd.
Labor
Overhead
Applied

Finished Goods
Cost of
Goods
Mfd.

Cost of
Goods
Sold

Cost of Goods Sold

Cost of
Goods
Sold
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Job-Order System Cost Flows

Lets return to
AFB Company
and see what we
will do if actual
and applied
overhead are not
equal.
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Overhead Application Example

Actual Overhead costs for the year: $5,050,000
Actual direct labor hours worked for the year: 170,000
Applied Overhead = POHR Actual Direct Labor Hours
Applied Overhead = $30.00 per DLH 170,000 DLH = $5,100,000

Applied overhead exceeds actual overhead by $50,000

This difference is called overapplied overhead.

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Overapplied and Underapplied

Manufacturing Overhead
$50,000
may be allocated
to these accounts.

$50,000 may be
closed directly to
cost of goods sold.

OR
Work in
Process

Finished
Goods

Cost of
Goods Sold

Cost of
Goods Sold
AFB Companys
Method
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Overapplied and Underapplied

Manufacturing Overhead
AFBs Cost
of Goods Sold
for the year
Unadjusted
Balance

Actual Overhead
overhead Applied
costs
to jobs
$50,000

Adjusted
Balance

AFBs
Mfg. Overhead
for the year

$5,050,000

$50,000

$5,100,000

$50,000
overapplied
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Overapplied and Underapplied

Manufacturing Overhead - Summary
Alternative 1
If Manufacturing
Overhead is . . .
UNDERAPPLIED
(Applied OH is less
than actual OH)
OVERAPPLIED
(Applied OH is greater
than actual OH)

Allocation

Alternative 2
Close to Cost
of Goods Sold

INCREASE
Work in Process
Finished Goods
Cost of Goods Sold

INCREASE
Cost of Goods Sold

DECREASE
Work in Process
Finished Goods
Cost of Goods Sold

DECREASE
Cost of Goods Sold

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Learning
Objective
6

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Schedule of Cost of Goods

Manufactured

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Schedule of Cost of Goods Sold

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Actual and Normal Costing

Actual direct material
and direct labor
combined with
actual overhead.

Actual direct material

and direct labor
combined with
predetermined overhead.

Using a predetermined rate makes it

possible to estimate total job costs sooner.
Actual overhead for the period is not
known until the end of the period.
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Learning
Objective
7

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Two-Stage Cost Allocation

Stage One:
Costs assigned
to pools
Cost pools

Indirect
Labor

Indirect
Materials

Other
Overhead

Department
1

Department
2

Department
3

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Departmental Overhead Rates

Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products

Indirect
Labor

Indirect
Materials

Other
Overhead

Department
1

Department
2

Department
3

Direct
Labor
Hours

Machine
Hours

Raw
Materials
Cost

Products
Departmental Allocation Bases
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Learning
Objective
8

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All

Job-Order Costing in
Nonmanufacturing Organizations
THE JOB

Cases

Missions
Programs

Contracts
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Changing Technology in
Manufacturing Operations
Computerized data
interchange has eliminated
much of the paperwork
associated with job-order
cost systems.
Scanning devices have
simplified data entry to
record material and labor
use.
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End of Chapter 3

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