Chapter Two: Job Costing

Product Costing System

A product costing system is a set of procedures used to account for an organizations product
costs and provide timely and accurate unit cost information for pricing, cost planning and
control, inventory valuation and financial statement preparation.

Types of cost accounting systems:

There are three main types of cost accounting systems for manufacturing operations: Job order,
process and operational cost systems. Each of the three systems is widely used and any one
organization may use more than one type.
(a) Job order costing system: A job order costing system is a product costing system used by
both manufacturing companies and service organizations that make large, unique, or special
order products such as customized publications, specially built cabinets, custom printing
business etc. Under such a system, the costs of direct materials, direct labor, and
manufacturing overhead is traced to a specific job order or a batch of products. A job order is
a customer order for a specific number of specially designed, made to order products. Job
order costing measures the cost of each complete unit. It uses one work in process inventory
account to summarize the cost of all jobs. This account is supported by job order cost cards
or a subsidiary ledger of accounts for each job.
(b) Process costing system: A process costing system is a product costing system used by
companies that produce large amounts of similar products or liquids, or that have a
continuous production flow. Makers of paint, soft drinks, bricks, milk or paper would use a
process costing system. Under such a system the cost of direct materials, direct labor and
manufacturing overhead are first traced to processes, departments, or work cells and then
assigned to the products manufactured by those processes, departments or work cells. A
process costing system uses several works in process inventory accounts, one for each
process, department or work cell.
(c) Operational costing system: In reality, few actual production processes perfectly match
either a job order costing system or a process costing system. Thus, the typical product
costing system combines parts of both job order costing and process costing to create a
hybrid system designed specifically for an organizations particular production process.

Characteristics of job order and process costing systems

No. Job order costing system Process costing system
1 Used by companies that make large, unique Used by companies that make large amount of
or special- order products such as customized
similar products using a continuous production
publications, built in cabinets and made to flow such as makers of paint, soft drinks, and
order draperies. candy bricks paper.
2 Measures the cost of each completed unit Measures costs in terms of units completed in a
specific time
3 Collects manufacturing costs and assigns Groups manufacturing costs by process,
them to a specific job order or batch. department, or work cell, and then assigns them to
product manufactured.
4 Uses one work in process inventory account Uses several works in process inventory accounts,
to summaries the cost of all jobs order. one for each process, department or work cell.

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In this chapter, we focus on job costing systems. Chapters 3 discuss process-costing systems.

Job order costing system

A job order costing system emphasizes cost flow, it is important to understand how costs are
incurred, recorded and transferred within the system. This cost flow along with the job order cost
cards and the subsidiary ledgers for materials and finished goods inventory forms the core of the
job order costing system. Familiarity with the flow of costs enables to fully understand how
system works.

a) Cost flow overview

Costs follow the flow of production, starting with materials, and move through work in process,
finished good and cost of goods sold to completion and sale. The costs of materials are first
charged to the materials inventory account and to the respective materials accounts in the
subsidiary ledger. Labor costs are accumulated in the factory payroll account. The various
manufacturing overhead costs are charged to the manufacturing overhead account.

As products are manufactured, the costs of direct materials and direct labor are transferred to the
work in process inventory account and are recorded on the jobs job order cost card.
Manufacturing overhead costs are applied and charged to the work in process inventory account
using a predetermined overhead rate. Those charges are used to reduce the balance in the
manufacturing overhead account. They are also recorded on the jobs job order cost card. When
products and jobs are complete, the costs assigned to them are transferred to the finished goods
inventory account. When the products are sold and shipped, their costs are transferred to the cost
of goods sold account.

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 b) Journal entries
1. When the materials are purchased:
Materials control Debited
Accounts payable control Credited.
2. When materials are sent to manufacturing plant:
Work in Progress Control (for direct material) Debited
Manufacturing overhead control
(for indirect material) Debited
Materials control Credited
3. When labor costs are assigned:
Work in process control (direct labor) Debited
Manufacturing overhead control (indirect labor) Debited
Wages payable control Credited
4. When payment of total manufacturing payroll:
Wages payable control Debited
Cash control Credited.
5. When manufacturing overhead costs are incurred:
Manufacturing Overhead control Debited
Various Accounts Credited
6. When manufacturing overheads is allocated:
Work in process control Debited
Manufacturing overhead control Credited
7. When jobs are completed and transferred to finished goods account:
Finished goods control Debited
Work in process control Credited
8. When transferring finished goods to cost of goods sold:
Cost of goods sold Debited
Finished goods control Credited
9. When marketing and customer service payable and advertising costs accrued:
Marketing and Advertising costs Debited
Customer – service costs Debited
Salaries payable control Credited
Accounts payable control Credited
10. When sales are made on account:
Accounts receivable control Debited
Sales or Revenues Credited

C) Accounting of factory overhead in a job cost system:

Materials requisitions and labor time tickets make it easy to identify direct materials and direct
labor with a specific job. Factory overhead on the other hand, includes a variety of costs that
cannot be linked to a particular job. Overhead costs are recorded as incurred. All the overhead
costs are debited to a single account factory overhead in the general ledger.

Actual Costing and Normal Costing

1. Actual costing means the aggregate of actual direct material costs, actual direct labor cost
and actual manufacturing overhead. The actual manufacturing overhead can be known only

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 at the end of the month or year. Therefore, under this method the managers cannot know the
cost of job before completion of the job. Managers often want to close approximation of the
manufacturing costs of various jobs on a timely basis, not just at the end of the year.
Managers want these costs for various ongoing uses, including choosing which job to
emphasize or de-emphasize, pricing jobs, managing costs and preparing interim financial
statements. Because management benefits from having immediate access to the costs of jobs.

2. Normal Costing: A predetermined or budgeted indirect cost rate is calculated for each cost
pool at the beginning of a fiscal year and overhead costs are allocated to jobs as work in
progresses. Normal costing is a costing method that traces direct costs to a cost object by
using the actual direct cost rate(s) times the actual quantity of the direct cost input(s) and
allocates indirect costs based on the budgeted indirect cost rate(s) times the actual quantity of
cost allocation base(s). Note that both actual costing and normal costing trace direct costs to
jobs in the same way. The only difference between actual costing and normal costing is that
actual costing uses an actual indirect cost rate(s), whereas normal costing uses a budgeted
indirect cost rate(s) to cost jobs.
Distinction between Actual costing and Normal costing

Items Actual costing Normal costing

Direct Actual direct cost rate(s) X Actual direct cost rate(s) X
costs Actual quantity of direct cost Actual quantity of direct cost
input(s) input(s)
Indirect Actual indirect- cost rate(s) Budgeted indirect cost rate(s) X
costs X Actual quantity of cost Actual quantity of cost allocation
allocation bases bases

Example: XYZ product uses a job-costing system with two direct cost categories (direct
materials and direct manufacturing Labor) and one manufacturing overhead cost pool.
XYZ allocates manufacturing overhead cost using direct manufacturing Labor costs. Xyz
provides the following information:
Budget for Actual for
2017 2017
Direct material cost $375,000 $362,500
Direct manufacturing labor cost 250,000 245,000
Manufacturing overhead cost 437,500 465,500

Required:
(a) Compute the actual and budgeted manufacturing overhead rates for 2017.

(b) During June the job cost record for job No. 205, contained the following information:

Direct materials used $ 10,000

Direct manufacturing Labor costs 7,500

Compute the cost of job No 205 using (i) actual costing and (ii) Normal costing

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(c) At the end of 2017, Compute the under- or over allocated manufacturing overhead
under normal costing why is there no under- or over-allocated overhead under actual
costing?

Solution:

a. Computation of manufacturing overhead rate for 2017:

Actual Budgeted
Manufacturing Overheads $ 465,500 $437,500
Manufacturing Labor cost 245,000 250,000
Manufacturing overhead rate = $ 465,500 x 100 $437,500 x 100
245,000 250,000
= 190 % = 175 %

b. Computation of cost of job No 205 under actual costing and normal

costing:
Actual costing Normal costing
Direct Materials used $ 10,000 $ 10,000
Direct manufacturing 7,500 7,500
Labor cost
Allocated manufacturing 14,250 13,125
Overheads

190
(i) Actual= 7,500x
100
175
(ii) normal= 7,500x
100

Total cost of job 205 31,750 30,625

c. Computation of under or over allocated manufacturing overhead

under normal costing at the end of 2017:
Actual manufacturing overhead for the year 2017 = $ 465,500
Less: Allocated manufacturing for the year 2017 = 428,750
Under allocated manufacturing cost = 36,750

Reasons for no under or over allocated overhead under actual costing:

Under actual costing method, allocation of manufacturing overhead costs are based on
actual manufacturing overhead rates. Consequently, the actual manufacturing overheads
and allocated manufacturing overhead costs are equal. Therefore, there will be no under
or over allocation of manufacturing overhead cost under actual costing methods.
d) Disposing of under or over applied overhead:
Factory overhead account is debited for actual cost and credited for applied amounts. The total
debits to factory overhead for the year may not equal the total credits to the account.

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Under applied overhead: The amount by which actual overhead exceeds the applied overhead
is called under applied overhead.
Over applied overhead: If actual overhead had been less than applied overhead, the difference
is called over applied overhead.

Accountants usually ignore over and under applied overhead during the year and dispose of it at
year-end

There are two alternatives for the disposition of under applied or over applied
overhead.

(i) Transfer to cost of goods sold:

If the amount of under or over applied overhead is insignificant (immaterial) it is closed
into cost of goods sold.

Journal entries: -
(a) For under applied:
Cost of goods sold Debited
Manufacturing overhead Credited
(b) For over applied:
Manufacturing overhead Debited
Cost of goods sold Credited

(ii) Transfer to working in process, finished goods Inventory and cost of goods sold.
If the amount of under or over applied overhead is significant (material), it is allocated to
work in process, Finished goods and Cost of goods sold based on their relative balances
before the allocation. When under or over applied overhead is allocated among the three
accounts shown above, the process is called proration.

Journal entries:
A. For under applied:
Work in process Inventory Debited
Finished goods inventory Debited
Cost of goods sold Debited
Manufacturing overhead Credited
B. For over applied:
Manufacturing overhead Debited
Work in process inventory Credited
Finished goods inventory Credited
Cost of goods sold Credited

Example 2: XYZ Company incurred $314,000 of manufacturing overhead costs during 2017.
However, only $282,000 of overhead was applied to production. At the conclusion, Inventory
balances on December 31, 2017, were as follows:

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 Inventory balances on
December 31, 2017
Work in process inventory $ 70,500
Finished goods inventory 98,700
Cost of goods sold 112,800

Required: Prepare a journal entry to close out the balance in the manufacturing overhead
account and prorate the balance to the three manufacturing accounts.

Solution:

Computation of under applied or over applied overhead:

Actual manufacturing overhead to the jobs = $ 314,000
Applied manufacturing overhead to the jobs = $ 282,000
Under applied overhead = 32,000

Statement showing proration of under applied overhead:

Account Amount Percentage Under applied Amount

Overhead x % age Added to Account
25
Work in process $ 70,500 25% 32000 x $ 8,000
100
35
Finished goods 98,700 35% 32000 x 11,200
100
40
Cost of goods sold 112,800 40% 32000 x 12,800
100
282,000 100% 32,000

Journal entries:
Work in process inventory $ 8,000
Finished stock inventory 11,200
Cost of goods sold 12,800
Manufacturing overhead control 32,000
(For under applied overhead charged to work in process, finished goods inventory and
cost of goods sold on proration basis)

e) Multiple overhead cost pools

The multiple overhead cost rate may be followed in the existence of multiple overhead
cost pools. Some overhead costs can be allocated to jobs based on labor cost or labor
hour basis if it is labor oriented job. On the other hand, machine hour rate may be used if
the jobs are undertaken using automated machines.

To implement a normal costing system with multiple overhead cost pools, it is required to
determine the budgeted total manufacturing labor hours and the budgeted total machine
hours and identity the associated budgeted indirect total cost for each cost pool. It would

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then calculate two indirect cost rates, one based on direct manufacturing labor hours and
the other based on machine hours. Indirect costs would be allocated to jobs using these
indirect cost rates and the direct manufacturing labor hours and machine hours used by
various jobs. The general ledger would contain manufacturing overhead control and
manufacturing overhead-allocated amounts for each cost pool. End of period adjustments
for under or over allocated indirect costs would then need to be made separately for each
cost pool.

Example: The Lucas Incorporation uses a job – costing system. The plant has a
machining department and an assembly department. Its job costing system has two direct
cost categories (direct materials and direct manufacturing labor) and two manufacturing
overhead cost pools (the machining department overhead, allocated using actual machine
hours, and the Assembly Department overhead, allocated using actual direct
manufacturing labor cost).

The 2017 budget for the plant is as follows:

Machining Assembly
Department Department
Manufacturing overhead $ 900,000 $ 1,800,000
Direct manufacturing labor Cost $ 700,000 $ 1,000,000
Direct manufacturing labor Hours 50,000 100,000
Machine hours 25,000 100,000

Required:
(a) Compute the budgeted manufacturing overhead rate for each department.
(b) During March 2017, the job cost record for job No. 555 contained the following.
Machining Assembly
Department Department
Direct Materials used $22,500 $ 35,000
Direct manufacturing Labor costs $ 7,000 $ 7,500
Direct manufacturing Labor hours 500 750
Machine hours 1,000 500
Compute the total manufacturing costs of job 555.
(c) At the end of 2017, the actual manufacturing overhead costs were $1,050,000 in
machining and $1,850,000 in Assembly. Assume that 27,500 actual machine hours
were used in machining and that actual direct manufacturing labor costs in Assembly
were $1,100,000. Compute the over- or- under allocated manufacturing overhead for
each department.

Solution:
a) Budgeted Manufacturing overhead rate:
(i) Machining Department: $36 per machine hour [$ 900,000/ 25,000) hours.
(ii) Assembly Department: 180% of direct manufacturing labor cost:
1,800,000
($ x 100)
1,000,000

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b) Computation of manufacturing overhead cost of job No. 555 and total job cost No 555:
(i) Total manufacturing cost of job No. 555:
Machining department - ($36 per machine hour for 1,000 machine hours) = $36,000
Assembly department - (180% of direct manufacturing labor cost of $7,500) = $13,500
Total manufacturing overhead cost of job No. 555 = $ 49,500

Total cost of job No. 555

Machining Assembly Total
Dept. Dept.
Direct material cost $ 22,500 $ 35,000 $ 57,500
Direct manufacturing labor 7,000 7,500 14,500
Manufacturing overhead
Allocated 36,000 13,500 49,500

Total job cost $65,500 $56,000 $121,500

c) Computation of over or under allocated manufacturing overhead of machining and

assembly department:
Machining Assembly
Department Department
Actual manufacturing
Overhead costs $ 1,050,000 $ 1,850,000

Allocated manufacturing
Overhead costs 990,000 1,980,000
(i) Machining – 27,500hrs x $36
(ii)Assembly – 180% of 1,100,000
Under or (over) allocated 60,000 (130,000)

The End!