Quick Guide

Chapter 5

Chapter highlights: The main objectives of this chapter include (1) understanding the two types
of product cost systems used by companies to compute product costs, and then (2) learning how
companies track manufacturing costs (DM, DL, OH) to products under a job costing system. Omit
the journal entries section in Chapter 5.

1) Differentiate between job costing and process costing.

Process costing is used by companies that manufacture identical units using a series of production
processes (e.g, food and beverage companies). Job costing is used by companies that produce
distinct products, or products made according to customer specifications (e.g., electricians,
lawyers, accountants, auto repair shops, …etc).

2) How are manufacturing costs assigned to jobs in a job cost system?

- Direct material costs are assigned to jobs based on the actual direct materials consumed on the
job as determined from the materials requisition form.
- Direct labour costs are assigned to jobs based on the actual direct labour used on the job (hours
x wage rate) as determined from the labour time sheet.
- Overhead costs are estimated at the beginning of the period and then allocated to jobs using the
following steps:
1) Compute a predetermined overhead rate by dividing the total estimated overhead by the
estimated quantity of an allocation base (cost driver).
2) Compute the overhead allocated to jobs by multiplying the overhead rate by the actual
quantity of the allocation base used on the job.

3) What is meant by allocation base?

Allocation base or the cost driver is the factor that causes (drives) the overhead costs. For example,
in a labour-intensive manufacturing setting, the number of labour hours or labour cost would be
an appropriate allocation base for overhead costs because most work is driven by labour, while in
a capital-intensive setting, the number of machine hours would be a more appropriate base.

4) How is overhead reconciled at the end of the period?

Because overhead is allocated to jobs based on an estimated rate developed at the beginning of the
period, it’s likely that overhead allocated to jobs during the period and charged to cost of goods
sold will deviate from the actual overhead known at year-end. Therefore, over- or under-allocated
overhead is determined at the end of the period to adjust cost of goods sold. Underallocated OH
will increase cost of goods sold, whereas overallocated OH will decrease cost of goods sold.