INTRODUCTION TO THE COST SYSTEM; JOB ORDER COSTING Chapter II Learning Objectives: At the end of this chapter, you should be able to: a. define cost system, cost accounting, perpetual inventory method, applied factory overhead, direct materials, direct labor, job order costing, process costing, cost sheets, factory ledger and other terms given in the chapter; enumerate the purposes of cost accounting and the uses of cost data; state the treatment for factory overhead variances; illustrate the flow of costs under the job order costing procedure; differentiate job order costing from process costing; * make journal entries using general ledger and factory ledger accounts; and, make journal entries under job order costing with corresponding entries for subsidiary records. Rime ee &26 Chapter I! CHAPTER IT INTRODUCTION TO THE COST SYSTEM; JOB ORDER COSTING Management needs prompt cost information in the decision making process. In any type of organization, be it business, political, religious or civic, it is imperative for management to be aware not only of its total costs and expenses, but also of the specific product, department or activity for which they are incurred, costs per unit and per work unit of its products and services, respectively, and of whether the amounts incurred are in accordance with financial plans and standards. Cost Accounting Defined Cost accounting is an area of accounting concerned with cost determination and cost control. Following the flow of costs in a business entity, from purchase of materials to final conversion of finished goods into cash or to rendition of services, cost data are accumulated for the purpose of determining costs per unit and per work unit and estimating appropriate selling price. Cost data are analyzed and reported to manage- ment to serve as a basis in the decision making process. Purposes of Cost Accounting Cost accounting serves the following purposes: * Cost determination. This refers to accumulation of cost data by products, processes or services to be able to arrive at unit cost or cost per work unit*, * Cost control, Standards are set for costs per unit and per work unit and are subsequently compared with the figures per actual operations so that remedial measures may be adopted. Cost accounting facilitates the performance by management of its planning and control functions. Cost standards are established for materials, labor and factory overhead based on product design, time and motion studies, and analysis of factory overhead. ‘These standards subsequently serve as bases in measuring performance and as deterrents to pilferages and unnecessary wastages of materials and inefficiency of manpower. (Refer to Chapter XI, Standard Cost) + A work unit or control factor unit is a variable that can be used as a base in setting standards. Examples of work units and the corresponding cost items are as follows: Work Unit Cost Items No. of units of materials Purchasing department's costs purchased No. of units processed ine department Department's costs No. of units sold Packing and shipping costs No. of radios repaired Service department costs No. ofnew accounts New accounts dept. costsIntroduction to the Cost System; Job Order Costing 27 Cost Accounting, Financial Accounting and Management Accounting. Cost accounting supplements financial accounting by providing breakdowns or details for cost figures contained in all-purpose financial statements. Financial accounting reports are derived from postings to the general ledger while cost accounting reports are Based on cost data as accumulated in subsidiary ledgers for costs and expenses incurred. While financial accounting information is for both internal and external users, cost eccounting information is usually for management use. Thus, by its “nature, cost ‘sccounting facilitates management accounting which is concerned with processing Aiistorical and projected economic data of an entity to assist management in setting up reasonable economic objectives and in makingrational decisions towards the attainment ‘ef these objectives. Uses of Cost Data Cost data, as earlier stated, provides management with a basis in making decisions end these may involve the following: Price setting. Selling prices are set based on desired gross profit and incremen- tal costs. * Choice of product line. A product may be dropped or added based on estimated contribution to company’s income. Make or buy. The company may decide to buy its product instead of continuing to manufacture it depending on the relevant costs involved. Contraction or expansion. A department, agency, branch or an affiliate may be closed or added based on the estimated decrease or increase in revenue, costs and expenses, Temporary shutdown. Management may opt for temporary cessation of opera- tions during slump seasons based on estimated decrease in both revenue and costs. "The Cost System The cost system is one wherein flow of costs is accounted for in detail so that unit ests and inventory costs can be promptly determined. An effective cost system ensures that the company benefits from all its expenditures, that.is, costs ineurred contribute tothe production of the desired quantity of goods and services. The perpetual inventory ‘method is used. The system may be designed to accumulate costs by products or by departments or processes. Perpetual Inventory Method. This method of accounting for inventories in- volves the use of perpetual records showing the flow of costs or resources. For a ‘manufacturing firm, cost of raw materials used, cost of completed units and cost of goods sold can be readily determined and responsibility for inventories can be pinpointed based enrecords kept. The controlling accounts used and the corresponding subsidiary records are as follows:28 Chapter I Controlling Accounts Subsidiary Records Materials (Materials Control) Materials ledger cards ‘Used for all items of materials, whether direct or indirect. Stores Stores ledger cards Used for all items in the storeroom, whether raw materials, factory supplies, store supplies, or office supplies. Work in process Job order cost sheet — under job Used for costs charged to production. order costing Cost of production reports (or departmental cost sheets) — under process costing Finished goods Finished goods ledger cards Used for all goods completed and ready for sale. ‘The postings to the controlling accounts are as shown below and the flow of cost as teflected by postings to both controlling accounts and subsidiary records are shown on the next page. Materials Materials purchases Purchase returns | Freight in Purchase discounts Returns of materjals Materials issued Work in Process Materials, labor and Cost of goods manufactured factory overhead charged previously issued to production | Finished Goods Cost of goods manufactured Gost of goods sold Cost of returned goods Goods returned to which were previously factory for reprocessing sold Other Controlling Accounts. There are other controlling accounts but they may be used under both periodic and perpetual inventory methods becanse they donot affect the inventories. They are Factory Overhead Control, Selling Expenses Control, and General and Administrative Expenses Conirol. These are supported by subsidiary records or analysis sheets.2 si |x uorgonpard psx ers passeu Pearueag Auozoey he 4oget goestpur | <* sBurusce 3 xx soqe f 352059 ‘#2009 peridde Hod Rgeco case qoeutg ndewens oe ce Pee Poe Zs Cs = a ee Wp ee da ee ees ees oc ee 5 7 aan dee ee ee eee “ispaeo sebpat spoch peusrury eq iepues ebpel Sterieqeu aed teapeu= 4605 sepa aol seq j | J Z i bo peeuienc zx -aeu gocarpual” | / ¢ sob / Peages PRET "yeu goeura |/ x *qew sexo ' 1 23 pauunges spoeB 30 4209 I 1 cox pabngse snus ' 1 a Sp006 30 4509 x ‘ ‘ pees eee tesueneer 36 sooaee Pres Spocb Jo 3809 A—yxx — pounjoesnuew Se! syevieqeu qoaut aot suunges 4x Seneis.in, spoo6 3513509 | xx “Bag aoueTed, Epoo8 33 403 | xx *Geq ‘esueteg Secysing | x Béq teaueted TT epoog peusiurg Big GF HoH erets3eu Spoog pousiurs WSUSAS 1503 CHSqMO @0f> SINNOIIY AUUTOIENS GNY ONTTIOAINOD 40 35nee 30 Chapter If Example: The company pays for the following: factory supplies — P600; factory repairs — P500; store supplies — P300; and office supplies — F200. ‘The journal entry and the corresponding postings to be made on subsidiary records would be as follows: Subsidiary _Records” Dr! Factory Overhead Control P1,100 Factory Supplies P600 Factory Repairs 500 Selling Expenses Control 300 Store Supplies 300 General and Adm, Exp. Control 200 Office Supplies 200 Cash P1,600 ‘The footings per subsidiary records must tally with the balanees per controlling accounts in the general ledger. Factory Overhead Charged to Production Accumulation of factory overhead incurred (or actual factory overhead) takes time specially in cases wherein adjustments are done on an annual basis. Thus, instead of charging actual factory overhead to production, the practice of charging overhead based on predetermined rates is adopted. The account used may either be applied factory overhead or factory overhead. At the end of the period both applied factory overhead and factory overhead control are closed and the difference is called the factory overhead variance which may be overapplied (credit) or underapplied (debit). Example: Factory overhead charged to production is P25,760 and factory overhead incurred amounts to P26,000. The entries would be as follows: ‘Bo charge overhead to production: ‘Work in Process 25,760 Applied Factory Overhead 25,760 To take up factory overhead inourred: Factory Overhead Control 26,000 Sundry credits 26,000 ‘To close applied factory overhead to factory overhead control: Applied Factory Overhead 25,760 Factory Overhead Control 25,760 After this entry, factory overhead control shall have a debit balance of P240, the factory overhead variance. This is set up in the following entry: Factory Overhead Variance 240 Factory Overhead Control 240Introduction to the Cost System; Job Order Costing 31 In the given example, actual overhead exceeds applied overhead so that the variance is a debit (underapplied, unapplied, underabsorbed or unfavorable). When ectual overheadis|essthan applied overhead, the variance mustbea credit (overapplied, overabsorbed or favorable). The account factory overhead variance is preferably used so that both overapplied and underapplied variances may be posted to the same ledger page. Instead of erediting “applied factory overhead” in charging overhead to production, the credit may be to “factory overhead control”. This practice eliminates the need to close the former to the latter. Disposition of Factory Overhead Variances. Factory overhead, in general, is treated as a period cost and is closed to cost of goods sold or to income and expense summary. However, when it is significant in amount, itimplies an error in costing or that a wrong overhead rate was used. In this case, the variance is treated as an adjustment to cost of goods sold and the inventories of finished goods and work in process. In the example given in the preceding section, the variance is closed to cost of goods sold as follows: Cost of Goods Sold P240 Factory Overhead Variance P240 Based on the given entry, an unfavorable variance increases cost of goods sold and a favorable variance reduces the same. Analysis of variances is taken up in Chapters V and XI. Income Statement with Factory Overhead Variance. The factory overhead variance, as stated earlier, is treated as an adjustment to cost of goods sold, It is shown a3 such in internal reporting as illustrated in the following income statement. Golden Manufacturing Co. Income Statement For the Year Ended December 31, 19C Sales ‘250,000 Less — Cost of goods sold: Factory costs: Direct materials cost 75,000 Direct labor cost 55,000 Factory overhead applied 55,000 P185,000 Work in process, Jan. 1 33,000. Work in process, Dec. 31 (45,000) Cost of goods manufactured P173,000 Finished goods, Jan. 1 29,000 Finished goods, Dec. 31 (22,000) Gost of goods sold, normal 180,000 Underapplied factory overhead 240 Cost of goods sold, actual 180,240 Gross profit on sales P 69,760 Less: Operating expenses 55,000 Net income P_14,760 ,32 Chapter If In the foregoing illustration, cost of goods sold prior to adjustment for factory overhead variance is described as normal, that is, based on what has been estimated or planned. Chart of Accounts, Cost System ‘The chart of accounts under the cost system is similar to that under the non-cost system with the exception of the account titles affecting cost of goods manufactured and cost of goods sold. Thus, the chart of accounts as given under the non-cost system in Chapter I is revised and is shown on the next page. Journal Entries, Perpetual and Periodic Inventory Methods ‘The journal entries under the perpetual inventory method differ from those under the periodic inventory method in the treatment of transactions that affect the invento- ties, namely, those for finished goods, work in process and materials. The entries are illustrated on the following pages. The Factory Ledger When transactions are voluminous and/or the factory is far from the main office, manufacturing transactions are preferably recorded in a factory journal and posted to the factory ledger. This practice requires the use of reciprocal accounts General Ledger (for the factory) and Factory Ledger (for the main office) when a transaction affects accounts found in both books. Factory ledger, therefore, refers to the book of final entry for manufacturing operations or the account title used by main office in recording transactions affecting accounts found in both the books of the factory and the main office. ‘The accounts carried on factory books are those used in recording manufacturing operations. Factory fixed asset accounts may either be in the books of the factory or the main office. Ifthe problem is silent, they are assumed to be on factory books. 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Ruue on co0ts. “aynbs pur Raewfyoen Rustoes — Aaasey aif sy SBrdout socniong <5 eens i sega Site a sekvammisenen: og Gone deans = oat pie Eee BE meng cmon irre Bl wmogpey Re ees Senin, Ss ae een, an Eee ee Se, doy suoyyngEnues s,1ehetdug -4Te a 42. Chapter It that can be physically identified (or are heterogeneous) so that they can be charged with their respective costs. The cost unit is the job (or work) order or the contract for such job. Examples of products costed using job order costing are houses, boats, pianos, radios, television sets, automobiles, doors and furniture. Process Costing, This refers to the costing procedure whereby costs are accumu- lated by departments or processes. This is adopted for products manufactured under conditions of continuous processing so that they are not distinguishable from one another (or are homogeneous). Examples of these products are beverages, flour, chemicals, and minerals. Cost accumulation in process costing is done on cost of production reports (or departmental cost sheets). This is taken up in detail in Chapters VII to X. ‘The differences between job order costing and process costing may be summarized as follows: Job Order Costing Process Costing Nature of products: Heterogeneous Homogeneous Cost accumulation: By job orders By departments or processes Reporting: By job orders By departments or processes When is unit cost computed: Upon completion End of costing period (usually a month) Unit cost computation: Production costs per job Departmental costs Number of units Equivalent units of production* Subsidiary record for work in process: Job order cost sheets Cost of production reports (or departmental cost sheets) JOB ORDER COSTING As stated earlier, job order costing is costing by products, job or work orders, or by contracts. The cost unit is the job and each job order is assigned a number for clear and brief identification. All costs directly traceable to each job (direct materials and direct labor) are charged to it directly. Factory overhead is charged to each job at a predeter- mined rate periodically or upon completion. Cost per unit of the products in each job is computed by dividing its accumulated cost by the number of units. Refinements regarding defective and spoiled goods are taken up in Chapter III. Cost accumulation is done with theuse of cost sheets (or job order cost sheets). Each: job order is provided with a cost sheet so that if there are ten jobs in process, there must beten cost sheets. Each of them provides columns for materials cost and direct labor cost * Houivalent units of production refers to the volume of work done considering the stage of completion. Example: 5,000 units are V6 done. Equivalent units of production must be 1,000 units (or 5,000 x 1/5). ‘Computation for equivalent units is taken up in detail in Chapters VII to IX.Introduction to the Cost System; Job Order Costing 43 ‘end space or column for factory overhead. Materials issued (per materials requisition rm) and labor hours expended (per labor time tickets) for a job are posted to the ‘corresponding cost sheet. Thus, materials requisitions and labor time tickets should ‘contain the job order numbers to which they pertain. Labor time tickets ere totaled daily ex weekly and tallied with the payroll. Elements of Product Cost in Job Order Costing The elements of product cost are materials cost, labor cost and factory overhead. For ‘pb order costing, materials and labor costs refer to direct materials cost and direct labor cost, respectively. Direct materials cost. This refers to those items that form part of the finished product and which can be measured and directly charged to the product. Examples are leather for shoes, lumber for furniture and metal parts for automobiles. Direct labor cost. This refers to cost of labor expended in the manufacture of a product and which can be directly charged to the product. Factory overhead. This is also known as manufacturing expense or burden. It refers to the indirect element of cost. It includes all manufacturing costs not classified as direct materials or as direct labor. Examples are indirect materials, indirect labor, factory supplies, depreciation of factory building, and factory insurance. Indirect materials are those needed for the completion of the product but the ‘soasumption of which with regard to the product is either so small or allocation would ‘Betoo complexso that for convenience, itis treated as an indirect product eost. Examples sre glue, tacks and polish in the manufacture of shoes. Indirect labor refers to cost of manpower which cannot be identified as pertaining sa particular product, Examples are salaries and wages of foremen, timekeepers and tility men. It may be emphasized at this point that the distinctions between direct and indirect ‘materials and between direct and indirect labor are not observed in process costing ‘Seasmuch as under the latter, costs accumulation is by departments or processes and not ‘by products or jobs. Use of Predetermined Factory Overhead Rate The prime costs (direct materials and direct labor) are charged directly to jobs while factory overhead, being the indirect cost, needs to be allocated yet. However, eccumulation of factory overhead is generally completed only. after the end of the ‘eccounting period, thatis, after all adjusting entries are made. Inasmuch as prompt cost Snformation is required, factory overhead is preferably charged to production at a predetermined rate. The latter is based on estimated or budgeted factory overhead for gn accounting period and the budgeted base. The bases used in the allocation are: direct ~ iebor hours, machine hours, direct labor cost, materials cost, and units of production. Using direct labor cost as the base, the formula is as follows:44° Chapter It Factory Budgeted or estimated factory overhead Dee iperliea (et ae ere eee Budgeted or estimated direct labor cost Example: Estimated factory overhead for 19B is P60,000 and estimated total direct labor cost for all jobs to be processed is P120,000. Job order no. 001, for 500 pairs of shoes, is completed with direct materials cost of P25,000 and direct labor cost of P20,000. The factory overhead rate must be 50% of direct labor cost arrived at as follows: P 60,000 120,000 Factory overhead rate = = 50% of direct labor cost ‘The costs of job order 001 and per pair of shoes are arrived at as follows: dob001 Direct materials P 25,000 Direct labor 20,000 Factory overhead applied (50% x F20,000) _ 10,000 Total production cost P.55,000 Cost per pair of shoes (P55,000/500 prs.) P__110 With prompt information on unit cost, the company can set its selling price by adding the desired margin. Without the predetermined factory overhead rate, it is apt to set its selling price blindly and possibly incur a loss. The Job Order Cost Sheet The job order cost sheet is the subsidiary record for “work in process” so that for all postings to the latter, corresponding postings must also be made to the corresponding cost sheets. The use of controlling accounts and subsidiary records is illustrated on page 29. Forms of Cost Sheets. Cost sheets may vary in form depending on desired additional information such as the items, quantity and unit cost of materials, number of labor hours, bases used in charging overhead and the departments in which the different cost items are charged. Cost sheets are illustrated on the next page. Work in Process and Cost Sheets For postings made to the account “work in process” in the general ledger, corre- sponding charges and credits are alsomade on cost sheets sothat the balanceper general ledger should be equal to the total of accumulated costs per cost sheets. Journal entries are made in strict observance of cut-off dates so that both applied and actual factory overhead for a period must be reflected in the books for the same period. It is for this reason that factory overhead are be charged to jobé at the end of each month and upon completion.ry < O2*ter*za B eotad Surztes, cogotsia x Zoey | atsoud 2049 OS "td B 4209 Rungoes TexOL (HOb * Begtaee> 414048 sz015 4s0o Rudsoes tes0l. pertdde peaiierc Russe 'qe02 deqer 3ossta ysoo steraeqew So08g ON Gor US Auswuns Gogey 3oea7g deqeu 320435 9203 21s} eurustur, Putusines Buguedues fatosde3 te-ez yoaet a00sFaler-esioos‘s i 2e-st eat iday ausHesao 1 ~~ S50 Rsosus | 26/9172, tpezordves oxen de/0zv2 fpequen e3eg | i I I 1 i deer 1p $03L=sNdO> S140 dest ‘91 feu ioziuis a1u0 ' ect “31 sunk saaiNeM Sud 2éet ‘Ti_heu iGassoas 3180 i 1 t t I i ! east Of tal TLNONO ase wie Buor usin euseN, TONOTANST SENS Bateys eutooy. 1 3naoud Stispen vent S55 “ON 3a0x0 ung juing Bud eb5uts ged Ter en depp yeeus 3209 aocus 3205 CONT ‘SSaNLSHIANEL UAuOI *a09 ONTEAToSaNNUH oxo SL33HS 1503 aqwO Gor 40 sumo4, 46. Chapter il When overhead is charged to jobs upon completion, there exists a difference between workin process per general ledger and the total of the accumulated costs per cost sheets. These difference is equal to the amount of overhead not so applied on the cost sheets yet. Example: The following information is provided by Bacolor Corp. for 19A: 19A a. Direct materials issued: Job Order No. 14 15 16 b. Direct labor costs: Job Order No. 14 ¢. Factory overhead is charged to production at 60% of direct labor cost. @. Job orders nos. 14 and 15 are completed. The entries and corresponding postings to the work in process account and the cost sheets would be as follows: ; a. Work in Process ‘P29,000 Materials 29,000 Direct materials issued. b. Work in Process 12,200 Payroll 12,200 Direct labor costs. ¢, Work in Process 7,320 Applied Factory Overhead 1.320 Overhead charged at 60% of direct labor costs. d. Finished Goods 35,240 Work in Process 35,240. Jobs 14 and 15 completed. Pergeneral ledger; the work in process account should have the following postings: Work in Process Direct materials 29,000 | Cost of completed Direct labor 12,200 jobs 14 and 15 35,240 Factory overhead applied 7,320Introduction to the Cost System; Job Order Costing 47 Per cost sheets: 7 JOB ORDER NO. 14 15. 16 Direct materials costs P 9,000 P12,000 F8,000 Direct labor costs 3,500 5,400, 3,300 Applied factory overhead (60% of labor cost) 2,100 _ 3,240 Total factory costs The ending balance of work in process is 13,280 (or P48,520 minus P35,240), This st be the accumulated cost of Job No. 16. However, per cost sheet for said job, the total only P11,300 (that is, P8,000 + 3,300) because of the non-application yet of factory head of P1,980 (or 60% x P3,300). Assuming that job order no. 16 is completed during the next period (or in 19B) after ing additional direct materials and direct labor costs of P4,000 and P2,000, respec- , the total factory cost of the job would be as follows: Job Order No. 16 Direct materials costs 19A P8,000 19B 4,000 12,000 Direct labor costs 19A P 3,300 19B 2,000 5,300 Factory overhead applied (60% of labor cost of P5,300) 3,180 Total factory cost 20,480 The journal entries for 19B would be as follows: Work in Process P.6,000 Materials P 4,000 Payroll 2,000 Materials and labor costs. Work in Process 1,200 Applied Factory Overhead 1,200 Overhead charged at 60% of 2,000 labor cost. Finished Goods 20,480 e* Work in Process 20,480. Completed job order no, 16,48. Chapter it It should be emphasized that although the total overhead charged to job order no. 16 in 19Bis the total of P3,180, the journal entry is only for P1,200 which is based on the current labor cost of P2,000. Applied overhead that corresponds to the 19A labor cost is included in the 19A entries, Finished Goods Journal, When a company completes somany jobs every month, bookkeeping work may be minimized by using a finished goods journal. If it is not registered with the BIR, it serves as a summary only to support the journal entry for all completed jobs every month. Modified Cost Accounting System Some companies adopt a modified cost accounting system wherein subsidiary records are maintained for materials, work in process and finished goods although journal entries are based on the periodic inventory method. ASSIGNMENT MATERIAL Questions: a, Although cost acsounting provides information for use in financial accounting, its output is used more in management accounting. Explain. b, Management makes use of cost information in the decision making process. Give examples of decision problems that require cost information. ¢. Acost system, by itsnature, can minimize pilferages, wastages and inefficiency of manpower. Explain. d. What are the controlling accounts and the corresponding subsidiary records used in a cost system? Explain the use of each. e. A factory overhead variance arises when factory overhead charged to produc- tion differs from whatis incurred, How are factory overhead variances treated? £. Job order costing and process costing procedures differ in the control of items charged to work in process. Explain, g. The distinction between direct and indirect materials and between direct and indirect labor is observed in job order costing and not in process costing. Explain,Introduction to the Cost System; Job Order Costing 49 EXERCISES ‘True or false. Explain your answer if itis false. Cost accounting is synonymous to management accounting. . The perpetual inventory method is used in cost accounting so that cost of materials used, cost of goods manufactured and cost of goods sold can be determined without a physical count of inventories. . Controlling accounts for factory overhead, selling and general expenses may be used under both cost and non-cost systems. . The voucher system is not used under a non-cost system. . When applied factory overhead exceeds actual factory overhead, the variance is a credit or unfavorable, . The amount of factory overhead absorbed in costing is equal to what is charged to production, Thus, the variance is considered overabsorbed when applied factory overhead exceeds factory overhead incurred. . In general, factory overhead variance is treated as a period cost so that it is closed to cost of goods sold or to income and expense summary. . When factory overhead variance is significant in amount, it implies an error in costing so that it is treated as an adjustment to cost of goods sold and the inventories of work in process and finished goods. i, Factory ledger refers to the ledger kept for factory transactions so that the account “Factory Ledger” is used by main office to indicate thatthe correspond- ing debit or credit in an entry must be found in the books of the factory. i, The chart of accounts under a cost system differs from that under a non-cost system with respect to the account titles that affect cost of goods manufactured and cost of goods sold. ise 2. Cost Flow - Cost System You are required to compute for the unknowns in the following accounts: Materials Inventory 15,900 | Purchase returns 1,500 Purchases 55,000 | Direct materials e Indirect materials (e) Inventory 10,200