Job Order Costing

PROFESSOR: JOHN ANTHONY M. LABAY, CPA, MBA

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I. DISCUSSION

Job order costing system is used in situations where many different products are produced each
period. For example, clothing factory would typically make many different types of jeans for
both men and women during a month. In a job order costing system, costs are traced to the jobs
and then the costs of the job are divided by the number of units in the job to arrive at an average
cost per unit.

The record keeping and cost assignment problems are more complex in a job order costing
system when a company sells many different products and services than when it has only a
single product or service. Since the products are different, the costs are typically different.
Consequently, cost records must be maintained for each distinct product or job. For example,
an attorney in a large criminal law practice would ordinarily keep separate records of the costs
of advising and defending each of her clients. And a clothing factory would keep separate track
of the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing
system requires more effort than a process costing system. Companies classify manufacturing
costs into three broad categories:(1) direct materials, (2) direct labor, (3) manufacturing
overhead.

Job cost sheet is a document used to record manufacturing costs and is prepared by companies
that use job-order costing system to compute and allocate costs to products and services.

The accounting department is responsible to record all manufacturing costs (direct materials,
direct labor, and manufacturing overhead) on the job cost sheet. A separate job cost sheet is
prepared for each individual job.

All necessary details about the job and costs incurred to complete the job are written on the job
cost sheet.

The information about a job or order that is shown on job cost sheet usually includes job
number, product name, starting date, completing date, number of units completed etc.

The information about manufacturing costs that is shown on job cost sheet usually includes
materials requisition number, cost of direct materials issued, time tickets, direct labor hours,
direct labor rate per hour and total cost, manufacturing overhead rate per direct labor or
machine hour and total cost etc.

Job cost sheet is not only used to charge cost to jobs but is also a part of the company’s
accounting record. It is used as a subsidiary ledger to the work in process account because it
contains all details about the job in process.

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Example of Job Cost Sheet Form:

Job Cost Sheet

Job Number: Date Started:

Department: Date Completed:
Item: Units Completed:
Direct Materials Direct Labor Manufacturing Overhead
Ref. No. Amount Ref. No. Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Particulars Amount Date Number Balance
Direct Materials
Direct Labor
Manufacturing Overhead
Total Cost
Cost per Unit

Measuring Direct Materials Cost in Job Order Costing System

Bill of Materials
At the beginning of production process, a document known as bill of materials is used for
standard products. “A bill of materials is a document that lists the type and quantity of each
item of materials needed to complete a unit of standard product”. In case where it is not possible
to use a bill of materials, the production staff determines the materials requirements from the
blueprints submitted by the customer.

Materials Requisition Form

When an agreement is reached with the customer concerning the quantities, price and shipment
date for the order, a production order is issued. The production department then prepares a
materials requisition form. “The materials requisition form is a detailed source document that
specifies the type and quantity of materials to be drawn from the storeroom and identifies the
job to which the costs of the materials are to be charged”. The form is used to control the flow
of materials into production and also for making entries in the accounting records. The
completed form is presented to the storeroom clerk who then issues the necessary raw
materials. The storeroom clerk is not allowed to release materials without such a form bearing
an authorized signature.

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Job Cost Sheet

After being notified that the production order has been issued, the Accounting Department
prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that records
the materials, labor and overhead costs charged to the job. After direct materials are issued, the
Accounting department records their costs directly on the job cost sheet.

In addition to serving as a means for charging costs to jobs, the job cost sheet also serves as a
key part of a firm’s accounting records. The job cost sheets form a subsidiary ledger to the
work in process (WIP) account. They are detailed records for the jobs in process that add up to
the balance in the work in process (WIP).

Measuring Direct Labor Cost in Job Order Costing System

Labor Time Ticket

Direct labor cost is handled in much the same way as direct materials cost. Direct labor consists
of labor charges that are easily traced to a particular job. Labor charges that cannot be easily
traced directly to any job are treated as part of manufacturing overhead. The latter category of
labor cost is known as indirect labor and includes tasks such as maintenance, supervision, and
cleanup. Workers use time tickets to record the time they spend on each job and task. A
completed labor time ticket is an hour-by-hour summary of the employee’s activities
throughout on a specific job, the employee enters the job number on the time ticket and notes
the amount of time spent on that job. When not assigned to a particular job, the employee
records the nature of the indirect labor task (such as cleanup and maintenance) and the amount
of time spent on the task. The daily time tickets are also used as the basis for labor cost entries
into the accounting records.

Job Cost Sheet

At the end of the day, the time tickets are gathered, and accounting department enters the direct
labor hours and costs on individual job cost sheets.

Application of Manufacturing Overhead Cost in Job Order Costing

Manufacturing overhead must be included with direct labor on the job cost sheet since it is also
a product cost. However, assigning manufacturing overhead to units of product can be a
difficult task. There are three reasons for this:
1. Manufacturing overhead is an indirect cost. This means that it is either impossible
or difficult to trace these costs to a particular product or job.

2. Manufacturing overhead consists of many different items ranging from the grease
used in machines to the annual salary of production manager.

3. Even though output may fluctuate due to seasonal or other factors, manufacturing
overhead costs tend to remain relatively constant due to the presence of fixed costs.

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Given these problems, about the only way to assign overhead costs to production is to use an
allocation process. This allocation of overhead cost is accomplished by selecting an allocation
base that is common to all of the company’s products and services. An allocation base is a
measure such as direct labor hours or machine hours that is used to assign overhead costs to
products and services. The most widely used allocation bases are direct labor hours, and direct
labor cost, with machine hours and even units of product (where a company has only a single
product) also used to some extent. The allocation base is used to compute “predetermined
overhead rate“ in the following formula or equation:

Estimated total manufacturing overhead cost

Predetermined Overhead Rate =
Estimated total units in the allocation base

Predetermined overhead rate is based on estimates rather than actual results. This is because
the predetermined overhead rate is computed before the period begins and is used to apply
overhead cost throughout the period. The process of assigning overhead cost to jobs is called
overhead application. The formula for determining the amount of overhead cost to apply to a
particular job is:

Overhead applied to a particular job = Predetermined overhead rate

× Amount of allocation incurred by the job

Non-manufacturing Costs in a Job Order Costing System

In addition to manufacturing costs, companies also incur marketing and selling costs. These
costs should be treated as period expenses and charged directly to the income statement and
therefore should not go into the manufacturing overhead account.

Since the non-manufacturing costs will go directly into expense accounts, they will have no
effect on the costing of the company’s production for the month. The same will be true of any
other selling and administrative expenses incurred during the month including sales
commission, depreciation on sales equipment, rent on office facilities, insurance on office
facilities, and related costs.

Cost of Goods Manufactured and Sold in Job Order Costing

Cost of Goods Manufactured (COGM)

When a job has been completed, the finished output is transferred from the production
department to the finished goods warehouse. By this time, the accounting department will have
charged the job with direct materials and direct labor cost and manufacturing overhead will
have been applied using the predetermined overhead rate.

A transfer of costs is made within the costing system that parallels the physical transfer of the
goods to the finished goods warehouse. The costs of the completed jobs are transferred out of
the work in process (WIP) account and into the finished goods account. The sum of all amounts
transferred between these two accounts represents the cost of goods manufactured for the
period.

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Cost of Goods Sold (COGS)

As units in the finished goods are shipped to the customers, their costs are transferred from the
finished goods account into the cost of goods sold account. If complete job is shipped, as in the
case where a job has been done to a customer’s specification then it is a simple matter to transfer
the entire cost appearing on the job cost sheet into the cost of goods sold account. In most cases,
only a portion of the units involved in a particular job will be immediately sold. In these
situations, the unit cost must be used to determine how much product cost should be removed
from finished goods and charged to cost of goods sold.

Job Order Costing in Service Companies

Job order costing is also used in service organizations such as law firms, accounting firms,
movie studios, hospitals, and repair shops, as well as manufacturing companies. In a law firm,
for example, each client represents a “job,” and the costs of that job are accumulated day by
day on a job cost sheet as the client’s case is handled by the firm. Legal forms and similar
inputs represent the direct materials for the job; the time expended by attorneys represents the
direct labor; and the costs secretaries, clerks, rent, depreciation, and so forth, represent the
overhead.

In a movie studio, each film produced is a “job,” and costs for direct materials (customs, props,
film, etc.) and direct labor (actors, directors and extras) are accounted for and charged to each
film’s job cost sheet. A share of the studio’s overhead costs, such as utilities, depreciation of
equipment, wages of maintenance workers, and so forth, is also charged to each film. However,
the method used by some studios to distribute overhead costs among movies is controversial
and sometimes result in lawsuits.

In sum, the reader should be aware that Job order costing is a versatile and widely used costing
method, and may be encountered in virtually any organization that provides various products
or services.

Advantages and Disadvantages of Job Order Costing System

One of the primary advantages of job order costing system is that the management team has
ready access to all the costs incurred for each job being completed. This allows the team to
examine each cost incurred, finding out why it happened, and determine how it can be
controlled better in the future, thereby contributing to better ongoing levels of profitability. For
example, a proper job record contains any special reworking costs, which a manager can then
use to trace back to the specific reason why the rework was needed. Similarly, overhead
allocations based on machine usage reveal problems with excess use, which might be the result
of lengthy machine setups or break downs as well as longer than expected machine cycle times.

Another reason for using job order costing system is that it yields ongoing results for each job.
In today’s world of fully computerized production tracking data bases, one can use a job order
costing system to track costs as they are added rather than waiting until the job has been
completed. This gives a company several advantages. One is that the accounting staff can
monitor job accounts to see if costs are being posted to the wrong accounts and corrects them
right away, rather than waiting until the job closes and having to frantically review records to

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see why the results are different from expectations. Another advantage is that a company can
monitor the costs incurred for longer jobs and have enough time to make changes before they
close, based on the costing information revealed by the job costing system. For example, a
lengthy new product development project might be over budget after just 25% of the work has
been completed; if the management team is made aware of this costing problem early in the
project, it will still have 75% of the project in which to make corrections and bring costs back
down to budgeted levels. Yet a third advantages is that changes in the cost of a job can result
in negotiations with cost-plus customers who are paying for all the costs incurred, so that they
are fully aware of cost overruns well in advance and are prepared to pay the additional amounts.
All these factors are the main advantages of using job order costing system in a computerized
environment.

There are also several problems with job order costing system. One is that it focuses attention
primarily on products rather than on departments or activities. This is not an issue if there are
supplemental systems in place that record information about these other cost categories, but it
leaves management with inadequate information if this is not the case. Another difficulty is
that overhead is generally allocated based on rates that are changed only about once a year.
Considerable fluctuation in overhead costs over the course of a year can result both in over and
under allocation of overhead costs to jobs during that period. Another problem is specific to
the use of normal costing. This practice involves the use of standards overhead rate rather than
one that is based on actual costs and requires adjustment from time to time. If it is
management’s intention to charge individual jobs for the variance between standard and actual
overhead rates, this may not be possible if some jobs have already been closed by the time the
variance allocation takes place. This is not just a technical accounting issue, for some jobs are
fully reimbursed by customers who pay on a cost-plus basis; if the overhead variance is a
positive one, a company may not be able to charge its customers for the added costs if the
related job has already been closed.

Another issue is that job costing has little relevance in some environments. For example, the
software industries have high development costs but almost zero direct costs associated with
the sale of its products. The use of a job order costing system to records these costs makes little
sense if the associated costs represent only a few percent of the total revenue gained from each
one. The same problem arises in service industries, such as retailing, where there is no
discernible product. These situations limit the most effective use of job order costing system to
two areas–production and professionals services. The first case, production is an obvious use
for the concept since there are high material costs that can be specifically identified with a job.
The same is true of professional services, but here the main cost is direct labor rather than direct
materials. In most other cases job costing does not provide management with sufficient quantity
of information to be useful.

The most important problem with job order costing is that it requires a major amount of data
entry and data accuracy in order to yield effective results. Data related to materials, labor,
overhead, indirect labor, scrap, spoilage, and supplies must be entered into system capable of
accurately assigning these costs to the correct jobs every time. In reality such systems are rife
with mistakes due to the sheer volume of data transactions, keying errors, misidentification of
jobs, and the like. Problems can be resolved with a sufficient amount of error tracing by the
accounting staff, but there may be so many that there are not enough staff members to keep up
with them. Though these issues can to some degree be resolved through the use of

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computerized data entry system outweighs the benefits to be gained from it. A final issue is
that a large proportion of the costs assigned to a job, frequently more 50%, come from allocated
overhead. When there is no fully proven method for accurately allocating overhead, such as
through an activity-based costing system the results of the allocation yield meaningless
information. This has been a particular problem for the companies that persist in allocating
overhead costs based on the direct labor used by each job, since a small amount of labor is
generally being used to allocate a much larger amount of overhead, resulting in large shifts in
overhead allocations based on small amount of labor is generally being used to allocate a much
larger amount of overhead, resulting in large shifts in overhead allocations based on small
changes in labor costs. Some companies avoid this problem by ignoring overhead for job order
costing purposes or by reducing overhead cost pools to include only overhead directly traceable
at the job level. In this way, many costs are not allocated to jobs at all, but those that are
allocated are fully justifiable.

II. PROBLEMS

1. Jeje Corporation, which began operations on January 1 of the current year, reported the
following information:

Estimated manufacturing overhead P 600,000

Actual manufacturing overhead 639,000
Estimated direct labor cost 480,000
Actual direct labor cost 500,000
Total debits in the Work-in-Process account 1,880,000
Total credits in the Finished-Goods account 920,000

Jeje applies manufacturing overhead to jobs on the basis of direct labor cost and adds a 60%
markup to the cost of completed production when finished goods are sold. On December 31,
job no. 88 was the only job that remained in production. That job had direct-material and
direct-labor charges of P16,500 and P36,000, respectively.

Required:
A. Determine the company’s predetermined overhead rate.

B. Determine the amount of under- or overapplied overhead. Be sure to label your answer.

C. Compute the amount of direct materials used in production.

D. Calculate the balance the company would report as ending work-in-process inventory.

E. Prepare the journal entry(ies) needed to record Brickman’s sales, which are all made on
account.

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2. Eva Manufacturing Company employs a job order cost accounting system and keeps
perpetual inventory records. The following transactions occurred in the first month of
operations:

a. Direct materials requisitioned during the month:

Job 101 P22,000
Job 102 16,000
Job 103 24,000
P62,000

b. Direct labor incurred and charged to jobs during the month was:
Job 101 P30,000
Job 102 26,000
Job 103 20,000
P76,000

c. Manufacturing overhead was applied to jobs worked on using a predetermined overhead

rate based on 75% of direct labor costs.

d. Actual manufacturing overhead costs incurred during the month amounted to P66,000.

e. Job 101 consisting of 1,000 units and Job 103 consisting of 200 units were completed
during the month.

Required:
A. How much manufacturing overhead was applied to Job 103 during the month?

B. Compute the unit cost of Jobs 101 and 103.

C. What is the balance in Work in Process Inventory at the end of the month?

D. Determine if manufacturing overhead was under- or overapplied during the month. How
much?

3. Isabel, Inc., which uses a job-costing system, is a labor-intensive firm, with many skilled
craftspeople on the payroll. Job no. C89 was the only job in process on January 1, having costs
of P22,500 as of that date. Direct materials used and direct labor incurred during January were:

Direct Direct
Job No.
Materials Labor
C89 P 2,000 P 6,000
C90 9,000 10,000
C91 14,000 8,000

Job no. C91 was the only job in production as of January 31.

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Required:
A. Should Isabel use direct labor or machine hours as a cost driver. Why?

B. Assume that the company decided to use direct labor as its cost driver. If the budgeted
amounts of direct labor and manufacturing overhead are anticipated to be P200,000 and
P300,000, respectively, what is the firm's predetermined overhead rate?

C. Compute the cost of work-in-process inventory as of January 31.

D. Compute the cost of jobs completed during January.

E. Suppose that the company sold all of its completed jobs, adding a 40% markup to cost. How
much would the firm report as sales revenue?

4. Milet Corporation uses a job-cost system and applies manufacturing overhead to products
on the basis of machine hours. The company's accountant estimated that overhead and machine
hours would total P800,000 and 50,000, respectively, for 2020. Actual costs incurred follow.

Direct material used P250,000

Direct labor 300,000
Manufacturing overhead 816,000

The manufacturing overhead figure presented above excludes P27,000 of sales commissions
incurred by the firm. An examination of job-cost records revealed that 18 jobs were sold during
the year at a total cost of P2,960,000. These goods were sold to customers for P3,720,000.
Actual machine hours worked totaled 51,500, and Athens adjusts under- or overapplied
overhead at year-end to Cost of Goods Sold.

Required:
A. Determine the company's predetermined overhead application rate.

B. Determine the amount of under- or overapplied overhead at year-end. Be sure to indicate

whether overhead was under- or overapplied.

C. Compute the company's cost of goods sold.

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5. The Magdalena Corporation, began operations on October 1. It employs a job order costing
system. Overhead is charged at a normal rate of P2.50 per direct labor hour. The actual
operations for the month of October are summarized as follows:

a. Purchases of raw material, 25,000 pieces @ P1.20/piece.

b. Material and labor costs charged to production:
Direct Direct
Job No. Units Material
labor cost labor hours
101 10,000 P4,000 P6,000 3,000
102 8,800 3,600 5,400 2,700
103 16,000 7,000 9,000 4,500
104 8,000 3,200 4,800 2,400
105 20,000 8,000 3,600 1,800
c. Actual overhead costs incurred:
Variable P18,500
Fixed 15,000
d. Completed jobs: 101, 102, 103, and 104
e. Sales-P105,000. All units produced on Jobs 101, 102, and 103 were sold.

Required: Compute the following balances on October 31:

A. Material inventory

B. Work in process inventory

C. Finished goods inventory

D. Cost of goods sold

E. Under- or overapplied overhead

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III. ASSESSMENT

1. The following inventory information is available for Narcisa Manufacturing Corporation for
the year:
Beginning Ending
Inventories:
Raw materials P17,000 P19,000
Work in process 9,000 14,000
Finished goods 11,000 8,000
Total P37,000 P41,000

In addition, the following transactions occurred:

a. Raw materials purchased on account, P75,000.
b. Incurred factory labor, P80,000, all is direct labor. (Credit Factory Wages Payable).
c. Incurred the following overhead costs during the year: Utilities P6,800, Depreciation on
manufacturing machinery P8,000, Manufacturing machinery repairs P6,200, Factory insurance
P9,000 (Credit Accounts Payable and Accumulated Depreciation).
d. Assigned P80,000 of factory labor to jobs.
e. Applied P32,000 of overhead to jobs.

Required
From an analysis of the accounts, compute the following:
A. Raw materials used.
B. Completed jobs transferred to finished goods.
C. Cost of goods sold.
D. Under- or overapplied overhead.

2. Len, Inc., which uses a job-costing system, began business on January 1, 20XX and applies
manufacturing overhead on the basis of direct-labor cost. The following information relates to
20XX:

• Budgeted direct labor and manufacturing overhead were anticipated to be P200,000 and
P250,000, respectively.
• Job nos. 1, 2, and 3 were begun during the year and had the following charges for direct
material and direct labor:
Job Direct Direct
No. Materials Labor
1 P145,000 P35,000
2 320,000 65,000
3 55,000 80,000
• Job nos. 1 and 2 were completed and sold on account to customers at a profit of 60% of cost.
Job no. 3 remained in production.
• Actual manufacturing overhead by year-end totaled P233,000. Len adjusts all under- and
overapplied overhead to cost of goods sold.

Required:
A. Compute the company's predetermined overhead application rate.
B. Compute the company's ending work-in-process inventory.

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C. Determine the company's sales revenue.

D. Was manufacturing overhead under- or overapplied during 20XX? By how much?
E. Present the necessary journal entry to handle under- or overapplied manufacturing overhead
at year-end.

3. Joven Manufacturing, Inc. uses a job order costing system. The company uses predetermined
overhead rates in applying manufacturing overhead to individual jobs. The predetermined
overhead rate in Department A is based on direct labor hours, the rate in Department B is based
on machine hours, and the rate in Department C is based on direct labor cost. At the beginning
of the most recent year, members of Joven's management team made the following estimates
for the year:
Department .
A B C
Direct labor hours 80,000 26,000 60,000
Machine hours 50,000 85,000 23,000
Direct labor cost P400,000 P150,000 P800,000
Direct materials P200,000 P 26,000 P 42,000
Manufacturing overhead P560,000 P340,000 P240,000

Required”
A. Compute the predetermined overhead rates for Departments A, B, and C.

B. Joven Manufacturing's records show the following information for Job #1234, which was
entered into production on January 17 and completed on March 7.
Department
A B C
Direct labor hours 420 54 375
Machine hours 200 120 125
Direct labor cost P2,400 P1,080 P1,390
Direct materials P 842 P1,260 P2,065

Compute the total manufacturing overhead applied to Job #1234.

C. On December 31, Stoll showed the following actual costs and operating data for all jobs
worked on during the year:
Department
A B C
Direct labor hours 76,000 28,920 63,000
Machine hours 54,000 87,200 21,000
Direct labor cost P395,200 P138,000 P815,000
Direct materials P215,900 P 24,380 P 39,080
Manufacturing overhead P540,000 P345,000 P254,000

Compute the amount of under- or overapplied overhead in each department at the end of the
year and indicate whether it is under- or overapplied.

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4. Gemma Company uses a job order costing system and has the following information for the
first week of June:

a. Direct labor and direct materials used:

Job No. Direct Material Direct Labor Hours
A98 P1,500 116
B06 960 16
B07 415 18
B08 345 42
B09 652 24
B11 308 10
B12 835 30
Total P5,015 256
b. The direct labor wage rate is P4 per hour.
c. The overhead rate is P5 per direct labor hour.
d. Actual overhead costs for the week, P1,480.
e. Jobs completed: Nos. A98, B06, and B09.
f. The factory had no work in process at the beginning of the week.

Required:
A. Determine the total cost assigned to each job.
B. Compute the amount of overhead over- or underapplied during the week.
C. Calculate the cost of the work in process at the end of the week.

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