UNIT 2: COST AND MANAGEMENT ACCOUNTING

MODULE 2: COSTING SYSTEMS

Topic: JOB-ORDER COSTING

Objectives
1. describe the use of various costing systems;
2. allocate materials, labour and overhead costs to specific jobs;
3. prepare job-cost sheets;
4. calculate the value of work-in-progress;
5. compute over and under-absorbed overhead;

Focus:
1. Costing Systems
a) Job costing.
b) Activity-based costing.
c) Process costing

2. Job Costing – (This content relates to Specific Objectives 2 – 5)

(a) Characteristics of job costing, including batch production.
(b) Job-cost sheets.
(c) Flow of costs.
(d) Evaluation of work-in-progress.
(e) Prime costs, factory costs.
(f) Pre-determined overhead rates.
(g) Over and under-absorption of overhead.

(c) Process
A cost costing.
accounting system (also called product costing system or costing system) is a framework
used by firms to estimate the cost of their products for profitability analysis, inventory valuation
and cost control.

Estimating the accurate cost of products is critical for profitable operations. A firm must know
which products are profitable and which ones are not, and this can be ascertained only when it
has estimated the correct cost of the product. Further, a product costing system helps in
estimating the closing value of materials inventory, work-in-progress and finished goods
inventory for the purpose of financial statement preparation.

Types of Costing Systems are Job costing, Activity-based costing and Process Costing.

JOB COSTING

Firms operating in job order industries produce a wide variety of products or jobs that are usually
quite distinct from each other or distinct groups or batches of unique products. Customized or
built-to-order products fit into this category, as do services that vary from customer to customer.
Examples of job-order processes include printing, construction, furniture making, automobile
repair, beautician services, Hospital care, law firms, accounting firms and advertising agencies.
Because the output of firms involved in the industries mentioned above tends to be
heterogeneous (different), managers need a costing system in which costs can be accumulated by
job (or by client or by customer) and in which distinct unit costs can be determined for each job
completed.
In manufacturing, a job may be a single unit such as a house, or it may be a batch of units such as
eight (8) tables.
Often however, a job is associated with a particular customer order. The key feature of job-order
costing is that the cost of one (1) job differs from that of another job and must be monitored
separately.
For job-order production systems, costs are accumulated by job. This approach to assigning
costs is called a job-order costing system. In a job-order firm, collecting costs by job provides
vital information for management. Once a job is completed, the unit cost can be obtained by

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 Unit Costs = Total Manufacturing Costs
Number of units produced
Once the unit cost information is available, a manager can determine whether the prevailing
market price provides a reasonable profit margin. If not, then this may signal to the manager that
the costs are out of line with other firms and action can be taken to reduce costs.

In illustrating job-order costing, the actual costs of direct materials and direct labour are
assigned to jobs along with overhead applied using a predetermined overhead rate.
In order to assign these costs, we must identify each job and the direct materials and direct labour
associated with it. Additionally, some mechanism must exist to allocate overhead costs to each
job.
The document that identifies each job and accumulates its manufacturing costs is the job-order
cost sheet.
The cost accounting department creates such a cost sheet upon receipt of a production order.
Orders are written up in response to a specific customer order. Each job-order cost sheet has a
job order number that identifies the new job.
NOTE: The collection of all job cost sheets defines a work-in-process file.
A job costs system must have the capability to identify the quantity of direct materials, direct
labour, and overhead consumed by each job. This is satisfied through the use of materials
requisition for direct material, time tickets for direct labour and predetermined rates for
overhead. The Job cost sheet is also a means for computing unit costs.

Materials Requisition
The cost of direct materials is assigned to a job by the use of a source document known as a
materials requisition forms. This form asks for the description, quantity and unit cost of the
direct materials issued and, most importantly, for the job number. Using this form, the cost
accounting department can enter the total cost of direct materials directly onto the job-order cost
sheet.
NOTE that no attempt is made to trace the costs of other materials, such as supplies, lubricants
and so on, to a particular job. This is because indirect materials are assigned to jobs through the
predetermined overhead rate.
Job Time Tickets
When an employee works on a particular job, she/he fills out a time ticket or time sheet that
identifies his/her name, wage rate, hours worked on specific jobs and tasks and the job number.
These time tickets are collected daily and transferred to the cost accounting department, where
the information is used to post the cost of direct labour to individual jobs.
Time tickets are used only for direct labours, that is labors or employees spent working directly
on specific job. Since indirect labour is common to all jobs, such as maintenance and janitorial,
these costs belong to overhead and are allocated using the predetermined overhead rate
(Overhead Absorption Rate).

Overhead Applications
Jobs are assigned overhead costs with the predetermined overhead rate. Typically, direct labour
hours and machine hours are the measures used to calculate overhead.
For example, assume a firm has estimated overhead costs for the coming year of $900,000 and
expected activity is 90,000 direct labour hours.
Step 1: The predetermined overhead rate = Budgeted Total Overheads
Budgeted total # of units of absorption base (cost driver)

= 900,000/90,000 (direct labour hours) = $10 per D/L hour.

Since the number of Direct Labour hours charged to a job is known from time tickets, the
assignment of overhead costs to jobs is simple once the predetermined rate has been computed.
For instance, Ann Wilson worked a total of eight (8) hours on job 16.

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Step 2: From this time ticket, overhead totaling ($10 per direct labour hour * 8hrs = $80)

Unit Cost Calculation

Once a job is completed, its total manufacturing cost is computed by first totaling the costs of
direct materials, direct labour and overhead and then summing these individual totals.
Unit Costs = Total manufacturing cost
Number of units produced
All completed job-order cost sheets of a firm can serve as a subsidiary ledger for the finished
goods inventory.

As explained earlier manufacturing overhead is an indirect cost and therefore must be allocated in
order to be assigned to units of product. This allocation is carried out with a predetermined
overhead rate.
1. The predetermined overhead rate is computed before a year begins and is based entirely on
estimated data. Ordinarily, the rate is computed for an entire year to eliminate seasonal
fluctuations. The formula is:

An allocation base is some measure of activity, such as direct labor-hours, direct labor cost, or
machine-hours. Ideally, a base should be selected that causes overhead. Such a base is called a cost
driver. It is most common, however, to use direct labor hours or cost as an allocation base even
though it is no longer clear that direct labor has much to do with causing overhead costs.
2. To assign overhead costs to a job, the predetermined overhead rate is multiplied by the number
of direct labor hours worked on the job. This figure is entered on the job cost sheet and is recorded
with the following journal entry:
Work in Process XXX
Manufacturing Overhead XXX
3. Assigning overhead to jobs is known as the application or absorption of overhead.

Flow of Cost (for Job costing)

• Direct material and Direct labour are assigned and manufacturing overhead is allocated
using a predetermined overhead rate.

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 • Jobs to which cost are assigned or allocated are considered work in process (WIP).
• All jobs that are completed at the end of the period are finished goods and incomplete
jobs are ending WIP inventory.
• Finished goods that are sold are called cost of goods sold and unsold finished jobs at the
end of the period are called ending finished goods inventory.

Job Cost Sheet to assign costs to Work in Process

Assigning manufacturing costs to work in process results in the following entries.
1. Debits made to work in process inventory
2. Credits made Jerome material inventory, Factory labor and Manufacturing overhead

An essential accounting record in assigning costs to jobs is the job cost sheet.
Companies keep a separate job cost sheet for each job. The job cost sheet constitutes the
subsidiary ledger for the work-in-process inventory account. a subsidiary ledger consists of
individual records for each individual item in this case, each job. The work-in-process account is
referred to as a control account because it summarizes the detail data regarding specific jobs
contain in the job cost sheets. each entry to the work-in-process inventory must be accompanied
by corresponding posting for one or more job cost sheet

Periodically, the company journalizes the requisitions. For example, is Wallace uses $24,000 of
direct material and $6,000 of indirect material in January the entry:

Jan 31 Work in Process Inventory 24,000

Manufacturing Overhead 6,000
Raw Materials Inventory 30,000
(to assign materials to jobs and overhead)

This entry reduces Raw Materials Inventory by $30,000, increases Work in Process Inventory by
$24,000, and increases Manufacturing Overhead by $6,000, as shown below:

Under or overapplied manufacturing overhead

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 Overhead is applied based on an estimate total annual overhead cost. This estimate would rarely
be exactly equal to actual overhead incurred. Therefore, at the end of the year, after overhead has
been applied to specific jobs, the manufacturing overhead account will likely have a remaining
balance.
When manufacturing overhead has a debit balance, overhead is said to be under applied.
Underapplied overhead means that the overhead assigned to work in process is less than the
overhead incurred. Conversely, when manufacturing overhead has a credit balance overhead is
overapplied. Overapplied overhead means that the overhead assigned to work in process is
greater than the overhead incurred.

At the end of the year, the balance in manufacturing overhead is address. Under or overapplied
overhead is considered an adjustment to Cost of Goods Sold. They would debit underapplied
overhead to Cost of Goods Sold or credit over applied overhead to Cost of Goods Sold.

Additional Information
Plant-wide overhead rate - A single predetermined overhead rate that is used in all departments
of the company, rather than each department having its own separate predetermined overhead
rate.
Departmental Overhead rate - This occurs when each department have its own separate
predetermined overhead rate.
Batch costing - A batch is a cost unit which consists of a separate readily identifiable group of
units, which maintain their separate identity throughout the production process. OR
Batch costing is a form of specific order costing, which applies where similar articles are
manufactures in batches.

Reference
Obaidullah J. (2013). Cost Accounting Systems. Retrieved on Jan 4, 2021 from
https://xplaind.com/360325/cost-systems-Cost Accounting Systems
Weygandt, J., Kimmel, P. & Kiesco, D. (2015). Accounting Principles. 12th E.d. John Wiley &
Sons Inc: United States of America

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 Questions

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