STUDY GUIDE 1

JOB COSTING

Costing- is the process of accumulating, classifying, and assigning direct materials, direct labor,
and factory overhead costs to cost objects, which most commonly are products, services, or
projects.
In developing the particular costing system to fit a specific firm, the management
accountant must make three choices, one for each of the three following characteristics of
costing methods: (1) the cost accumulation method—job costing or process costing; (2) the cost
measurement method—actual, normal, or standard costing; and (3) the overhead application
method—volume-based or activity-based.
Cost Accumulation: Job or Process Costing?
Costs can be accumulated by tracing costs to a specific product or service or by
accumulating costs at the department level and then allocating these costs from the departments
to the products or services. The first type is called job costing and the latter is process costing. In
a job costing system, the jobs consist of individual products or batches of products or services.
Job costing system- is appropriate when most costs incurred for the job can be readily identified
with a specific product, batch of products, customer order, contract, or project.
Types of companies that use job costing include those in construction, printing, special
equipment manufacturing, shipbuilding, custom furniture manufacturing, professional services,
medical services, advertising agencies, and others.
Examples of companies that could use job costing systems include FedEx , Paramount
Pictures ,Jiffy Lube International and Accenture
In job costing, the job might consist of a single product or multiple products in a batch.
Process costing - is likely to be found in a firm that primarily produces homogenous products or
services. These firms often have continuous mass production.
. Industries where process costing is common include the chemical industry, bottling
companies, plastics, food products, and paper products.
Examples of companies using process costing systems include The CocaCola Company and
International Paper
Cost Measurement: Actual, Normal, or Standard Costing?
Costs in either a job or process costing system can be measured in their actual, normal, or
standard amount.
Actual costing system- uses actual costs incurred for all product costs, including direct materials,
direct labor, and factory overhead.
Normal costing system- uses actual costs for direct materials and direct labor, and normal costs
for factory overhead. Normal costing involves estimating a portion of overhead to be assigned to
each product as it is produced. A normal costing system provides a timely estimate of the cost of
producing each product or job.
A costing process that uses actual costs for direct materials and direct labor and applies
factory overhead to various jobs using a predetermined application rate.
Standard costing system- uses standard costs and quantities for all three types of manufacturing
costs: direct materials, direct labor, and factory overhead. Standard costs are expected costs the
firm should attain. Standard costing systems provide a basis for cost control, performance
evaluation, and process improvement.
Overhead Application under Normal Costing: Volume-Based or Activity-Based?
Volume-based product costing systems - allocate overhead to products or jobs using only
volume-based cost drivers, such as units produced. This approach relies heavily on the
assumption that each product uses the same amounts of overhead because each product is
charged the same amount.
Activity-based costing (ABC) systems - allocate factory overhead costs to products using cause-
and-effect criteria with multiple cost drivers. ABC systems use both volume-based and non-
volume-based cost drivers to more accurately allocate factory overhead costs to products based
on resource consumption during various activities.

The Strategic Role of Costing

To compete successfully, firms need accurate cost information, regardless of their competitive
strategies. This is even more likely to be true for cost leadership firms that rely on a high level of
manufacturing efficiency and quality to succeed. Effective management of manufacturing costs
requires timely and accurate cost information. Getting this information requires that the firm
choose a cost system that is a good match for its competitive strategy. Many firms’ competitive
environments are changing rapidly, especially in the increasingly global economy. To provide
useful information, a costing system must keep up with the constantly changing environment. To
be competitive, the firm needs accurate cost information—for product pricing, profitability
analysis of individual products, profitability analysis of individual customers, evaluation of
management performance, and refinement of strategic goals.
Job Costing: The Cost Flows
Job costing - is a costing system that accumulates costs and assigns them to specific jobs,
customers, projects, or contracts.
The basic supporting document (usually in electronic form) in a job costing system is the
job cost sheet.
Job cost sheet- a cost sheet that records and summarizes the costs of direct materials, direct
labor, and factory overhead for a particular job.
Job costing is typically done by a database software system that collects all relevant job
cost data and then prepares a variety of reports, such as the job cost sheet, reports of cost by
department, listing of jobs by customer, and many others, including the firm’s financial
statements and tax return.
A job cost sheet includes all three cost elements (direct materials, direct labor, and
overhead) as well as other detailed data required by management. The job cost sheet follows the
product as it goes through the production process; all costs are recorded on the sheet as
direct materials and direct labor are added.
The total of all costs recorded on the job cost sheet is the total cost of the job.
The Application of Factory Overhead in Normal Costing
Predetermined factory overhead rate- is an estimated rate used to apply factory overhead cost
to a specific cost object or job.
The predetermined overhead rate is so-called because it is determined from estimates of
overhead costs and cost drivers for the upcoming operating period, usually the coming fiscal year.
To obtain the predetermined overhead rate, use these four steps:
1. Estimate total factory overhead costs for the planned production for the upcoming
operating period, usually a year.
2. Select the most appropriate cost driver(s) for applying the factory overhead costs.
3. Estimate the total amount of the chosen cost driver(s) for the upcoming operating
period.
 4. Divide the estimated factory overhead costs by the estimated amount of the chosen
cost driver(s) to obtain the predetermined overhead rate.
Factory overhead applied - The amount of overhead assigned to a cost object using a
predetermined factory overhead rate.
Disposition of Underapplied and Overapplied Overhead
Using a predetermined factory overhead rate to apply overhead cost to products can
cause total overhead applied to the units produced to exceed the actual overhead incurred in
periods when production is higher than expected. Alternatively, applied overhead might exceed
actual overhead incurred if the amount actually incurred is less than the estimated amount.
Overapplied overhead- is the amount of factory overhead applied that exceeds the actual
factory overhead cost incurred.
- The excess of applied overhead over actual factory overhead cost for a period.
On the other hand, it is possible that applied overhead will be less than the incurred
amount of overhead, due either to the fact that the actual amount of incurred overhead
was greater than expected and/or the actual production level was smaller than expected.
Underapplied overhead- is the amount by which actual factory overhead exceeds factory
overhead applied.
If the predetermined overhead rate has been determined carefully, and if actual
production is similar to expected production, the overapplied or underapplied difference should
be small.
Underapplied or overapplied overhead can be disposed of in two ways:
1. Adjust the Cost of Goods Sold account.
2. Adjust the production costs of the period; that is, allocate (often called “prorate”) the
underapplied or overapplied overhead among the ending balances of Work-in-Process
Inventory, Finished Goods Inventory, and Cost of Goods Sold.
When the amount of underapplied or overapplied overhead is not significant, it generally
is adjusted to Cost of Goods Sold because all product costs eventually become cost of good sold.
On the other hand, if the amount is significant, it is often prorated to Work-inProcess Inventory,
Finished Goods Inventory, and Cost of Goods Sold.
Job Costing in Service Industries; Project Costing
Job costing is used extensively in service industries such as advertising agencies, hospitals,
and repair shops, as well as consulting, architecture, accounting, and law firms. Instead of using
the term job, accounting and consulting firms use the term client or project, hospitals and law
firms use the term case, and advertising agencies use the term contract or project.
Many firms use the term project costing to indicate the use of job costing in service
industries. Project costing is also used to track the costs and progress of nonrecurring tasks that
take place within companies—for example, projects to develop a new marketing plan or to
improve operating efficiency, projects to implement a new strategic direction for the company, or
projects to introduce a new software system. These projects also have the characteristics that are
suitable for job costing.
Job costing in service industries uses recording procedures and accounts similar to those
illustrated earlier in this chapter except for direct materials involved (there could be none or an
insignificant amount). The primary focus is on direct labor. The overhead costs are usually applied
to jobs based on direct labor cost.
Operation Costing
Operation costing- is a hybrid costing system that uses a job costing approach to assign direct
materials costs to jobs and a process costing approach to assign conversion costs to products or
services.
Manufacturing operations whose conversion activities are very similar across several
product lines, but whose direct materials used in the various products differ significantly, use
operation costing. After direct labor and factory overhead costs have been accumulated by
operations or departments, these costs are then assigned to products. On the other hand, direct
materials costs are accumulated by jobs or batches, and job costing assigns these costs to
products or services. Industries suitable for applying operation costing include food processing,
textiles, shoes, furniture, metalworking, jewelry, and electronic equipment.
Spoilage, Rework, and Scrap in Job Costing
In today’s manufacturing environment, firms adopt various quality-improvement
programs to reduce spoilage, rework, and scrap.
Spoilage - refers to unacceptable units that are discarded or sold for disposal value.
The two types of spoilage are normal and abnormal.
Normal spoilage- occurs under normal operating conditions; it is uncontrollable in the
short term and is considered a normal part of production and product cost. That is, the cost of
spoiled unit costs is absorbed by the cost of good units produced.
- An unacceptable unit that occurs under efficient operating conditions; spoilage that
is inherent in the manufacturing process.
 Normal spoilage is of two types: (1) specific normal spoilage, which is particular
to a given job and is not due to factors related to other jobs, and (2) common normal spoilage,
which is due to factors that affect two or more jobs, such as a machine malfunction that affected
parts used in several jobs.
Normal spoilage that is specific to a job is treated as a cost of that job so that, in effect,
the cost of spoilage is spread over the cost of the good units in the job. Normal spoilage that is
common to two or more jobs is charged to factory overhead and, in this way, affects the costs of
all jobs
Abnormal spoilage- is an excess over the amount of normal spoilage expected under
normal operating conditions; it is charged as a loss to operations in the period detected.
` Waste in excess of what is expected to occur under normal operating conditions.
Abnormal spoilage is charged to a special account, such as Loss from Abnormal Spoilage
so that management attention can be given to spoilage of this type and because product cost
should not include abnormal elements such as abnormal spoilage.
Rework— is the additional work performed to make nonconforming goods into good units that
can be sold in regular channels.
- The additional work that must be done to make a nonconforming good acceptable so
that it can be sold in regular channels.
REWORK There are three types of rework: (1) rework on normal defective units for a
particular job, (2) rework on normal defective units common with all jobs, and (3)
rework on abnormal defective units not falling within the normal range.
The cost of rework units is charged to one of three accounts depending on its nature.
Normal rework for a particular job is charged to the Work-in-Process account and also the
specific job’s subsidiary account or job cost sheet. Normal rework common to all jobs is
charged to the Factory Overhead account, and abnormal rework is charged to the Loss
from Abnormal Rework account.
Scrap- is the material left over from the manufacture of the product; it has little or no value.
- can be classified according to its application to a specific job or whether it is common
to all jobs.
Material Requisition- it is an online data entry or a source document that the production
department supervisor uses to request materials for production.
Time Ticket- it shows the time an employee worked on each job, the pay rat, and total labor cost
chargeable to each job.
Overhead Application- it is a process of allocating overhead cost to jobs.
Actual Factory Overhead- these are costs incurred each month for indirect materials, indirect
labor, and other indirect overhead for jobs.