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Management Accounting
Week 5
Chapter 7

Job costing systems

Learning objectives

After studying this presentation you should be able to:

1.1 recognise the types of decisions managers make for
an organisation
7.1 explain the flow of costs through the
manufacturing process
7.2 calculate the inventoriable product cost for
customised products
7.3 discuss the issues related to the allocation of
overhead to individual jobs

Learning objectives

After studying this presentation you should be able to:

7.4 discuss the issues associated with spoilage, rework
and scrap handled in job costing
7.5 critically analyse the uses and limitations of job
costing for financial reporting.

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The flow of costs through the manufacturing

process

• Inventoriable product costs:

• direct and indirect costs of producing goods
• consist of costs incurred in the manufacturing
process only:
– direct material
– direct labour
– production overhead

The flow of costs through the manufacturing

process

• Inventoriable product costs:

• exclude period costs i.e. costs not directly related to
production that are expensed directly to the
statement of profit or loss in the period in which they
occur. For example:
– selling costs
– administration costs.

The flow of costs through the manufacturing

process

• Job costing is the process of assigning costs to custom

products.
• Cost objects are individual jobs.
• Direct materials and direct labour are traced to
individual jobs.
• Manufacturing overhead is allocated.

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The flow of costs through the manufacturing

process

• When goods are customised, many costs are easily

traced to individual products by source documents.
• Source documents are manual or electronic records
created to capture and provide information about
transactions or events.

Cost flows in a manufacturing job costing

system

The flow of costs through the manufacturing

process

• Job costing systems include a subsidiary ledger.

• This allows direct costs to be traced and overhead
costs to be allocated to each job.
• Total WIP is the sum of the accumulated costs of all
the jobs in the subsidiary ledger.

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Tracing and allocating costs to jobs

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Calculating the inventoriable product cost for

customised products

• Cost and activity information is gathered from source

documents to record cost in a subsidiary ledger for each
new job. This is called a job cost record.

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Job cost record

• Cost per unit of direct materials is obtained from the

raw materials inventory record.
• Hourly rate of pay for each employee is obtained from
payroll records.
• Other entities may use budgeted or standard costs
for direct material and direct labour.
• Indirect costs are allocated.
• Detailed information in the job cost record and the
totals in work in process inventory are updated as new
costs are incurred, until the job is complete.

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Computerised and manual job costing

systems

• Direct labour and direct material data are entered into

electronic source documents (online time records and
material requisitions).
• Specialised software packages are most likely to be used
in large organisations or in entities where jobs are
complex or require many resources.
• In small businesses, a manual job cost record is used.

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Computerised and manual job costing

systems

• Amounts from the job cost sheet are recorded in the

job cost record in the subsidiary ledger on a periodic
basis, when the job is complete, or sometimes as
resources are used.
• Job sheet: physical sheet attached to an individual job,
where material and direct labour amounts are
recorded.

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Allocating manufacturing overhead

• Manufacturing overhead includes all production costs

except direct materials and direct labour.
• Allocating manufacturing overhead is a two-stage
process.
1. In the first stage, a variety of manufacturing
overhead costs are collected in an overhead cost
pool (a group of individual costs that are
accumulated for a particular purpose).
2. In the second stage, costs are allocated from the
cost pool to individual jobs.

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Allocating manufacturing overhead

• Successful completion of the two stages requires four

steps.
1. Identify the relevant cost object.
2. Identify one or more overhead cost pools and
allocation bases.
3. For each overhead cost pool, calculate an overhead
allocation rate.
4. For each overhead cost pool, allocate costs to the
cost object.

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Allocating manufacturing overhead

1. Identify the relevant cost object.

– In a job costing system, the cost object is a job.
– Sometimes a job consists of an individual product.
– Sometimes it consists of a batch of products.

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Allocating manufacturing overhead

2. Identify one or more overhead cost pools and

allocation bases.
• Some organisations use a single entity-wide or plant-
wide cost pool for all fixed and variable overhead
costs.
• Other organisations use separate cost pools for fixed
and variable overhead costs.

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Allocating manufacturing overhead

2. Identify one or more overhead cost pools and

allocation bases (continued).
• Choice of overhead cost pools depends on:
– organisation of production
– nature of overhead costs
– usefulness of different types of overhead
information to management.

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Allocating manufacturing overhead

2. Identify one or more overhead cost pools and

allocation bases (continued).
• For each cost pool, an allocation base is chosen to
assign overhead costs to cost objects. An allocation
base is a measure of activity used to allocate costs to
a cost object.
• Manufacturing job costing systems often allocate
overhead using one of these bases: direct labour
hours, direct labour costs or machine hours.

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Allocating manufacturing overhead

3. For each overhead cost pool, calculate an overhead

allocation rate.
• The allocation rate is the dollar amount per unit of
allocation base used to allocate overhead to each
cost object.
• If total amounts of overhead costs and allocation
base are known, actual allocation rate can be
calculated:
Actual overhead cost
Actual allocation rate =
Actual quantity of allocation base

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Allocating manufacturing overhead

3. For each overhead cost pool, calculate an overhead

allocation rate (continued).
• Alternatively, overhead may be allocated using an
estimated allocation rate.
Estimated overhead cost
Estimated allocation rate =
Estimated quantity of allocation base
• To understand which allocation rate is more
appropriate, it is necessary to understand the
differences in the use of actual and normal costing to
measure costs in the job costing system.

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Actual and normal costing

• Under actual costing, overhead is allocated using the actual

volume of the allocation base times the actual allocation
base.
• When managers need cost information for cost estimation
and pricing before total actual cost and resource use
information is available, estimates calculated at the
beginning of the year are typically used to allocate
overhead.
• Where the estimated allocation rate and the actual quantity
of allocation base are used to allocate overhead, the
method is called normal costing.

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Actual costing versus normal costing

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Allocating manufacturing overhead

4. For each overhead cost pool, allocate costs to the

cost object.
• The assignment of overhead to individual jobs
requires information about each job’s use of the
allocation base.

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Allocating manufacturing overhead

• Under normal costing, periodic adjustments are needed

to reconcile actual overhead with the amount allocated
to jobs.
• Overapplied (underapplied) overhead occurs when
actual overhead costs are less (more) than total amount
of overhead allocated.
• To correct for overapplied or underapplied overhead,
first compare the amount of overhead allocated to
actual overhead cost:
Overapplied (underapplied) overhead = Allocated overhead – Actual overhead

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Recording transactions in the financial

accounting system

• The general ledger in a manufacturer’s job costing

system typically includes separate inventory accounts
for raw materials, work in process and finished goods.
• Purchases of raw materials are recorded in the raw
materials inventory account (debit).
• As direct materials are traced to a job, the cost of
materials is transferred to work in process inventory.
• Indirect materials are not traced to individual jobs;
such costs are transferred into an overhead cost pool.

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Recording transactions in the financial

accounting system

• Many organisations use overhead control accounts to

monitor costs for each overhead cost pool.
– As actual overhead costs are incurred, they are
debited to the control account.
– As overhead is allocated to individual jobs, they
are credited to the control account.
– When a job is complete, total cost for the job is
transferred from work in process to finished goods
inventory.

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Recording transactions in the financial

accounting system

• Where there is an overapplied or underapplied

overhead, an adjusting entry needs to be made so
that the total actual amount of overhead incurred is
recorded as a product cost for the period.
• If the amount of the adjustment is material, it is
allocated on a pro rata basis among work in process,
finished goods, and cost of sales.
• If the amount is immaterial, it is assigned to cost of
sales.

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Recording transactions in the financial

accounting system

• Materiality is evaluated by calculating net over- or

underapplied overhead as a percentage of actual
overhead costs.
• Whether adjustment is considered material or
immaterial zero balances are left in the overhead cost
control account(s) after the adjustment.

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Spoilage, rework and scrap in job costing

• Spoilage refers to units of product that are unacceptable

and are discarded, reworked or sold at a reduced price.
• Spoilage is often identified through some type of
inspection process.
• To calculate cost of partially complete spoiled units,
direct materials and labour used and overhead allocated
is added before unit was removed from production.
• How spoilage cost is handled depends on whether the
spoilage is considered normal or abnormal.

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Normal and abnormal spoilage

• Normal spoilage consists of defective units that arise as

part of regular operations.
• Cost of normal spoilage common to all jobs is:
• charged to overhead
• allocated with other overhead costs to all jobs.

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Normal and abnormal spoilage

• Abnormal spoilage is spoilage that is not part of

everyday operations.
• It occurs for reasons such as:
• out-of-control manufacturing processes
• unusual machine breakdowns
• unexpected electrical outages that result in a number
of spoiled units.
• Since abnormal spoilage is considered avoidable it is:
• excluded from product costs
• recorded in ‘loss from abnormal spoilage’ account.

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Spoilage, rework and scrap in job costing

• Rework consists of spoiled units that are repaired and

sold as if they were originally produced correctly.
• Reworked units may be:
• sold at regular price through regular marketing
channels
• sold at reduced price if reworked units remain flawed.

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Spoilage, rework and scrap in job costing

• Scrap consists of bits of direct material left over from

normal manufacturing processes.
• Sometimes it has value and can be sold and
sometimes it is discarded.
• Some manufacturers track scrap to measure whether
resources are being used efficiently.
• If scrap can be traced to specific jobs, revenue from
the scrap is credited to the specific job in work in
process.

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Spoilage, rework and scrap in job costing

• If scrap is common to all jobs, or it is not worth

tracing, the scrap revenue offsets overhead costs for
the period.
• If scrap is held before it is reused or sold, net
realisable value needs to be estimated to offset
overhead costs in the same period in which overhead
costs and associated revenues are recognised.

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Spoilage, rework and scrap in job costing

• Spoilage opportunity costs can be large due to:

• foregone profit
• loss of reputation and market share.
• Forgone profit is a bigger problem when capacity limits
are involved.
• As number of spoiled units increase, a larger number of
spoiled units will inevitably be sold to customers, again
leading to a loss of market share and reputation.
• These opportunity costs, often greater than the cost of
spoiled units, are not tracked by the accounting system.

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Uses and limitations of job cost information

• The information from a job costing system can be used

for several purposes, including:
• reporting inventory and cost of sales values on
financial statements and income tax returns
• developing cost estimates to assist in bidding on
potential future jobs
• measuring actual costs to compare to estimated costs
• developing cost estimates for short-term or long-term
decisions.

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Uncertainties in measuring job costs

• Judgement used to decide which direct costs will be traced.

• Changes in technology sometimes allow accountants to
trace costs that were previously too costly to trace.
• When deciding whether to use department or plant-wide
cost pools, the benefit gained from gathering information
about department costs and the use of department
resources by other departments must be worth the cost of
tracking them.
• Ideally, the overhead allocation process should reflect the
flow of overhead resources to each product.

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Uncertainties in estimating future job costs

• Actual job costs will almost certainly be different from

estimated job costs.
• Actual costs and activity levels are affected by many
unforeseen events including:
• unanticipated cost inflation or deflation
• economic downturn
• unexpected improvements or deterioration in
production efficiency.
• Judgement is also necessary in the way in which the
adjustments are made.

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Summary

• Explain the flow of costs through the manufacturing

process.
• Calculate the inventoriable product cost for customised
products.
• Discuss the issues related to the allocation of overhead
to individual jobs.
• Discuss the issues associated with spoilage, rework and
scrap handled in job costing.
• Discuss the uses and limitations of job costing for
financial reporting.

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