JOB ORDER COST SYSTEMS

Dr. George A Gekas

These notes are posted on blackboard to high light and complement certain aspects of the topic, facilitate
those students who may have missed my lecture, balance traditional with internet based learning and overall
enhance student=s learning. The notes are not meant to suggest what may be in the exams, replace textbook
studying and/or problem solving.

There are two distinct types of cost accounting systems:

1. Job order cost system

2. Process cost system

Both systems produce the same results: calculate manufacturing costs, unit cost, cost of inventories
on hand and cost of goods sold.

Job order cost systems are used by companies that manufacture “one of a kind” products or
products that tailor to the specifications of individual customers. In a job order cost system the cost
of direct costs and manufacturing costs are accumulated separately for each job. If each job contains
more than one unit of product the unit costs are determined by dividing the total accumulated job
cost by the number of units produced.

Job order cost systems are used by construction firms, ship builders, motion picture studios, furniture
makers, print shops, repair shops, hospitals (each patient represents a job), law firms, accounting
firms and others.

Under a job order cost system manufacturing costs are charged ─ separately for each job ─ to the
work in process inventory (WIP) account. This controlling account is supported by a subsidiary
ledger of job cost sheets for each job performed.

The job cost sheets are completed when the job is done. It shows the cost of direct materials (D/M)
the direct labour (D/L) (e.g. hours times the hourly rate), the manufacturing overhead (O/H) (e.g.
rate times hours) and the total of all three. The total of D/M, D/L and O/H divided by the number of
units produced shows the total cost per unit.

Accounting for Direct Material (D/M)

Accounting for D/M is simple. Purchases of raw material inventories are recorded to the purchases
journal then posted to the subsidiary ledger of materials.

To obtain material for the production process a materials requisition form is issued from the
production to the warehouse. At the end of the month, a summary entry is made. A debit to WIP
inventory and a credit to material inventory, for all materials issued from the warehouse.
 -2-
Accounting for Direct Labour (D/L)

The direct labour costs applicable to each specific job are calculated from the time cards of each
employee. As employees do specific jobs we debit D/L and credit payroll payable.

As payments to direct factory workers are made we debit D/L and credit cash.

At the end of the month, a summary entry is made debiting WIP and crediting D/L.

Since the D/L account is debited when work is done and credited when workers are paid the cost
charged to jobs (credited) is most of the times greater to the payments (debit). The difference
represents wages payable. Payments to indirect factory workers (e.g., security guards) are debited to
manufacturing overhead.

Accounting for Overhead (O/H)

Manufacturing overhead is a controlling account that includes all manufacturing costs other than
D/M and D/L. In order to calculate the total manufacturing costs we need to apply (add)
manufacturing costs to Direct Material and Direct Labour costs. Since we do not know in advance
what the Overhead costs are going to be we need to estimate them. This is done by calculating the
predetermined O/H rate.

The predetermined O/H is calculated as: the total Budgeted O/H costs over the total Budgeted
units in the activity base.
The predetermined rate times the total number of units produced provides the total applied
manufacturing O/H.

Applied (Estimated manufacturing Overhead costs are credited.

Actual manufacturing costs, (when they are determined at the end of the accounting period) are
debited.

Example:

Total budgeted manufacturing costs = $360,000

Total budgeted production hours = 10,000
Total number of units produced = 2,000

Predetermined O/H Rate: $360 000/ 10 000 hrs = $36

Applied O/H: $36 x 2,000 units = $72,000

To provide reliable results ─ accurate applied O/H ─ the activity bases must be a true driver of
overhead costs.

At the end of the month, a summary entry debiting WIP and crediting manufacturing O/H is needed.
 -3-
Thus, WIP account is debited with D/M, D/L and applied O/H.

Over/Underapplied O/H

At the end of the month, a Debit Balance in the manufacturing O/H account indicates that the actual
O/H costs were greater than the O/H costs applied (underapplied O/H).
A credit balance (applied Overhead is greater than Actual Overhead) indicates the opposite
(overapplied O/H).

At the end of the year if the balance of the overhead account is not material is closed directly to the
cost of goods sold account (CGS) on the grounds that most of the error is applicable to the goods
sold during the year. Underapplied O/H results into debiting (increasing) CGS and overapplied O/H
results into crediting (decreasing) CGS account. If the under applied or over applied balance is
material it should be apportioned among the WIP finished goods inventory, and CGS accounts.

Accounting for Completed Units

As each job is completed the total costs of completing the job in the WIP account is transferred to
the finished goods inventory (F/G) account. This is done by debiting F/G account and crediting the
WIP account.

Actual, Normal and Standard Cost Systems

Actual Normal Standard

D/M Actual Actual Standard Price x Standard
Quantity
D/L Actual Actual Standard Rate x Standard Hours
O/H Actual Applied O/H: Applied O/H:
Actual Activity x Predeter- Standard Activity x Predeter-
mined O/H Rate mined O/H Rate at Standard
Hours
TOTAL Total Actual Total Normal Total Standard

The actual cost system does not generate over or underapplied O/H, the Normal and Standard Cost
System does.

A) PLANT WIDE VS. DEPARTMENTAL OVERHEAD RATE

Example:
Dept. A Dept. B Company
 -4-
Budgeted Overhead $100,000 $90,000 $180,000
DL hours 10,000 5,000 15,000
Overhead Rates $10.00 $16.00 $12.00
If Labour hours worked:
Labour Time 6 hours 10 hours 16 hours
Overhead allocation $60.00 ($10 x 6) $160.00 ($16 x 10) $192.00 ($12 x 16)
OR 10X$12=120
$220.00 vs. 6X$12=$72

Which of the two O/H rates is more accurate?

Departmental rate
As a rule the departmental O/H rate is more accurate. In this case it measures the relative heavier use of the more
expensive department, B. The company wide rate is not so accurate. It allocates 6 hours x $12.00 = $72 to
Department A and 10 hours x $12.00=120 to Department B.

The Volume Variance

Over or underapplied O/H arises when actual spending for O/H items differs from Budget. The
difference is due to poor spending controls, errors in the estimation of budgetary figures or to the
actual volume produced been different from the volume planned in the Master Budget. The latter is
called volume capacity or denominator variance. It can be defined as:

Volume variance = (Actual volume - Budgeted volume) x Fixed O/H Rate

Underapplied fixed O/H variances are unfavourable because indicate failure to achieve the planned
volume. Because not enough costs have been applied to the job the correction will be to increase the
costs which have an unfavourable effect on earnings.

Overapplied fixed O/H variables are favourable because indicate that the planned volume level was
suppressed. Too many costs were applied to the job and the correction will be to decrease the costs
which have a favourable effect on earnings.

The volume variance arises because we apply fixed O/H to jobs as if they were variable costs.