Cornerstones: of Managerial Accounting, 6e

CORNERSTONES
of Managerial Accounting, 6e
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
CHAPTER 5:
JOB-ORDER COSTING
Cornerstones of Managerial
Accounting, 6e
Learning Objectives
1. Describe the differences between job-order
costing and process costing, and identify the
types of firms that would use each method.
2. Compute the predetermined overhead rate, and
use the rate to assign overhead to units or
services produced.
3. Identify and set up the source documents used
in job-order costing.
Learning Objectives (cont.)
4. Describe the cost flows associated with job-
order costing.
5. (Appendix 5A) Prepare the journal entries
associated with job-order costing.
6. (Appendix 5B) Allocate support department
costs to producing departments.
The Differences Between
Job-Order and Process Costing
 Companies can be divided into two major types.
 Those firms producing similar products or services can
use a process-costing accounting system.
 On the other hand, if a company’s products/ services
are unique, they require a job-order accounting
system.
LO-1
Characteristics of the
Job-Order Environment
 Customized or built-to-order products fit into this
category, as do services that vary from customer
to customer.
 A job is one distinct unit or set of units.
 Examples: printing, construction, furniture making,
medical and dental services, automobile repair,
beautician services
LO-1
Characteristics of the
Job-Order Environment
 For job-order production systems, costs are
accumulated by job.
 This approach to assigning costs is called a job-
order costing system.
LO-1
Process Production and Costing
 Firms in process industries mass-produce large
quantities of similar or homogeneous products.
 This approach to cost accumulation is known as a
process-costing system.
 Examples of process manufacturers include:
 Food canning and manufacturing
 Cement
 Petroleum
 Pharmaceutical and chemical manufacturing
LO-1
Process Production and Costing
 Process firms accumulate production costs by
process or by department for a given period of
time.
 Unit costs are measured using the following
equation:
Unit costs = Process Costs ÷ Output
LO-1
The Differences Between
Job-Order and Process Costing
LO-1
Normal Costing and
Overhead Application
 Unit costs are important because managers need
accurate cost information on materials, labor, and
overhead when making decisions.
 For example, when a construction company bills
a client at set points throughout the construction,
it is important that unit cost be generated in a
timely manner.
 Job-order costing using a normal cost system will
give the company the unit cost information it
needs.
LO-2
Actual Costing
 Two ways are commonly used to measure the
costs associated with production: actual costing
and normal costing.
 In an actual cost system, only actual costs of
direct materials, direct labor, and overhead are
used to determine unit cost.
 However, there are several issues involved in
using actual costing:
LO-2
Actual Costing (cont.)
 Defining Overhead Costs: Overhead items do not
have the direct relationship with units produced that
direct materials and direct labor do.
 Uneven Overhead Costs: Many overhead costs are
not incurred uniformly throughout the year.
 Waiting until the end of the year to total the actual overhead
costs is typically unrealistic.
 Uneven Production: Distortions can occur if when
averages are used with uneven production.
 Strict actual cost systems are rarely used because accurate
day-to-day unit cost information is needed on a timely basis.
LO-2
Normal Costing
 Normal costing solves the problems associated
with actual costing.
 A normal cost system determines unit cost by
adding actual direct materials, actual direct labor,
and estimated overhead.
LO-2
Normal Costing (cont.)
 Overhead can be estimated by approximating the
year’s actual overhead at the beginning of the
year and then using a predetermined rate
throughout the year to obtain the needed unit
cost information.
 Virtually all firms use normal costing.
LO-2
Importance of Unit Costs
 Unit cost is a critical piece of information for a
manufacturer.
 Unit costs are essential for valuing inventory,
determining income, and making numerous
important decisions.
 Disclosing the cost of inventories and determining
income are financial reporting requirements that a
firm faces at the end of each period.
LO-2
Importance of Unit Costs (cont.)
 In order to report the cost of its inventories, a firm
must know the number of units on hand and the
unit cost.
 The cost of goods sold (COGS), used to determine
income, requires units sold and their unit cost.
 Full cost information is useful as an input for
internal decisions as well as for financial reporting.
LO-2
Importance of Unit Costs (cont.)
 In the long run, for any product to be viable, its
price must cover its full cost.
 Service and nonprofit firms also require unit cost
information.
LO-2
Importance of Unit Costs to Service Firms
 Service and nonprofit firms also require unit cost
information.
 Conceptually, the way companies accumulate
and assign costs is the same whether or not the
firm is a manufacturer.
 The service firm must first identify the service
‘‘unit’’ being provided.
LO-2
Importance of Unit Costs to Service Firms (cont.)
 For example, a hospital would accumulate costs

by patient, patient day, and type of procedure.
 Because service firms do not produce physical
products, they do not need to value work-in-
process and finished goods inventories.
LO-2
Ethical Decisions
 Nonprofit firms must track costs to be sure that
they provide their services in a cost-efficient way.
 Governmental agencies must track costs to use
the funds wisely because they have a fiduciary
responsibility to taxpayers.
LO-2
Ethical Decisions (cont.)
 A cost accounting system that measures and
assigns costs so that the unit cost of a product or
service can be determined which is a critical
piece of information for both manufacturing and
service firms.
 An important part of bidding and charging for
services under Medicaid rules impacts
government agencies and is commonly tied to the
critical determination of unit cost.
LO-2
Normal Costing and Estimating Overhead
 In normal costing, overhead is estimated and
applied to production. The basics of overhead
application can be described in three steps:
 Step 1: Calculate the predetermined overhead
rate
 Step 2: Apply overhead to production throughout
the year
 Step 3: Reconcile the difference between the
total actual overhead incurred during the year
and the total overhead applied to production.
LO-2
Step 1: Calculating the
Predetermined Overhead Rate
 The predetermined overhead rate is calculated
at the beginning of the year by dividing the total
estimated annual overhead by the total estimated
level of associated activity or cost driver:
Overhead Rate = Estimated Annual Overhead ÷
Estimated annual activity level
 Notice that the predetermined overhead rate
includes estimated amounts in both the
numerator and the denominator.
LO-2
Predetermined Overhead Rate (cont.)
 This estimation is necessary because the
predetermined overhead rate is calculated in
advance, usually at the beginning of the year.
 Estimated overhead is the firm’s best estimate of
the amount of overhead (utilities, indirect labor,
depreciation, etc.) to be incurred in the coming
year.
 The number of machine hours could be a good
choice of activity level for overhead of a company
that has automated production.
LO-2
Predetermined Overhead Rate (cont.)
 Estimates may be based on last year’s figures
adjusted for anticipated changes in the coming
year.
LO-2
Step 2: Applying Overhead to Production
Throughout the Year
 Once the overhead rate has been computed, the
company can begin to apply overhead to
production.
 Applied overhead is found by multiplying the
predetermined overhead rate by the actual use of
the associated activity for the period:
Applied overhead = Predetermined overhead
rate x Actual activity level
LO-2
Step 2: Applying Overhead to Production
Throughout the Year (cont.)
 Once this is calculated, the total cost of product
for the period is the actual direct materials and
direct labor, plus the applied overhead:
Total costs = Actual direct materials + Actual

direct labor + Applied overhead
LO-2
Cornerstone 5.1:
Calculating The Predetermined Overhead
Rate and Applying Overhead to Production
LO-2
Step 3: Reconciling Actual Overhead with Applied
Overhead
 Remember that two types of overhead are
recorded:
 Actual overhead: Costs are tracked throughout the year
in the overhead account.
 Applied overhead: Costs are computed throughout the
year and added to actual direct materials and actual
direct labor to get total product cost.
LO-2
Overhead
 At the end of the year, however, it is time to
reconcile any difference between actual and
applied overhead and to correct the cost of goods
sold account to reflect actual overhead spending.
 Applied overhead will rarely equal actual
overhead.
LO-2
Step 3: Reconciling Actual Overhead with
Applied Overhead (cont.)
 The difference between actual overhead and
applied overhead is called an overhead variance.
 If actual overhead is $400,000 for the year but
$390,000 was applied to production, we would
say that the variance is underapplied overhead.
LO-2
Overhead (cont.)
 If actual overhead is $400,000 for the year but
$410,000 was applied to production, we would
say that the variance is overapplied overhead.
 If overhead has been underapplied, then product
cost has been understated.
 If overhead has been overapplied, then product
cost has been overstated.
LO-2
Step 3: Reconciling Actual Overhead with
Applied Overhead (cont.)
 Something must be done with the overhead
variance at year-end to report costs at actual
amounts on the financial statements.
 Generally, the entire overhead variance is
assigned to Cost of Goods Sold, since the
amount is usually small or immaterial.
 Underapplied overhead is added to Cost of Goods Sold.
 Overapplied overhead is subtracted from Cost of Goods
Sold.
LO-2
Overhead (cont.)
 If the overhead variance is material, or large,
another approach would be taken. That approach
is, to allocate the variance among the ending
balances of Work in Process, Finished Goods,
and Cost of Goods Sold.
LO-2
Actual Overhead and
Applied Overhead
 This exhibit illustrates the concepts of over- and

underapplied overhead.
LO-2
Cornerstone 5.2:
Reconciling Actual Overhead
with Applied Overhead
LO-2
Cornerstone 5.2:
Reconciling Actual Overhead
with Applied Overhead
LO-2
Departmental Overhead Rates
 A plantwide overhead rate or single overhead
rate has been explained by dividing all estimated
overhead for a factory by the estimated activity
level across the entire factory.
 Some manufacturers and service firms believe
that multiple overhead rates give more accurate
costing information.
LO-2
Departmental Overhead Rates
(cont.)
 Departmental overhead rates are a widely used
type of multiple overhead rate.
 A departmental overhead rate is estimated
overhead for a department divided by the
estimated activity level for that same department.
 The steps involved in calculating and applying
overhead are the same as those involved for one
plantwide overhead rate.
LO-2
Cornerstone 5.3:
Predetermined Dept. Overhead Rates
and Applying Overhead to Production
LO-2
Cornerstone 5.3:
Predetermined Dept. Overhead Rates
and Applying Overhead to Production
LO-2
Cornerstone 5.4:
Converting Dept. Data to Plantwide Data: Calculate
Overhead Rate, Apply Overhead to Production
LO-2
Cornerstone 5.4:
Converting Dept. Data to Plantwide Data: Calculate
Overhead Rate, Apply Overhead to Production
LO-2
Unit Costs in the Job-Order
System
 The unit cost of a job is the total cost of the job
(materials used on the job, labor worked on the
job, and applied overhead) divided by the number
of units in the job:
Unit cost = Total cost ÷ Number of units
 Although the concept is simple, the practical
reality of the computation can be somewhat more
complex because of the recordkeeping involved.
LO-2
Job-Order Cost Sheet
 Accounting for job-order production begins by
preparing the source documents that are used to
keep track of the costs of jobs. The job-order cost
sheet is prepared for every job.
LO-3
Job-Order Cost Sheet (cont.)
 The job-order cost sheet is subsidiary to the
work-in-process account and is the primary
document for accumulating all costs related to a
particular job.
 As more and more jobs are produced, a company
will usually find it convenient to number them.
LO-3
Job-Order Cost Sheet (cont.)
 Work in process consists of all incomplete work.
 In a job-order system, this will be all of the
unfinished jobs.
 The balance in Work in Process at the end of the
month will be the total of all the job-order cost
sheets for the incomplete jobs.
LO-3
Materials Requisition Form
 The cost of direct materials is assigned to a job
by the use of a source document known as a
materials requisition form.
LO-3
(cont.)
 Notice that the form asks for the type, quantity,
and unit price of the direct materials issued and,
most importantly, the number of the job.
 Using this form, the cost accounting department
can enter the cost of direct materials onto the
correct job-order cost sheet.
LO-3
(cont.)
 If the accounting system is automated, this
posting may entail directly entering the data into a
computer, using the materials requisition forms as
source documents.
 No attempt is made to trace the cost of other
materials, such as supplies, lubricants, and the
like, to a particular job.
 Indirect materials are assigned to jobs through
the predetermined overhead rate.
LO-3
Time Ticket
 The means by which direct labor costs are
assigned to individual jobs is the source
document known as a time ticket.
LO-3
Time Ticket (cont.)
 Each day, the employee fills out a time ticket that
identifies his or her name, wage rate, and the
hours worked on each job.
 Time tickets are collected and transferred to the
cost accounting department where the
information is used to post the cost of direct labor
to individual jobs.
LO-3
Time Ticket (cont.)
 Again, in an automated system, posting involves
entering the data into the computer.
 Time tickets are used only for direct laborers.
 All completed job-order cost sheets of a firm can
serve as a subsidiary ledger for the finished
goods inventory.
 Then, the work-in-process account consists of all
of the job order cost sheets for the unfinished
jobs.
LO-3
Creating Source Documents
for Other Activities
 You are the cost accounting manager for a company
that provides photography services for special events,
such as weddings, bar mitzvahs, anniversary parties,
and corporate functions. The cost of the services vary
from job to job. The time of the photographers assigned
to the job is already kept track of using labor time
tickets. However, your company now wants to reimburse
the photographers for mileage, and may want to include
an additional charge to clients for mileage.
 What type of source document could serve to
accumulate miles driven?
LO-3
for Other Activities (cont.)
 In this case, your company needs to know not only the
number of miles each photographer drives, but also
which job the mileage pertains to. A relatively simple
mileage log, listing the date, starting mileage, ending
mileage, and purpose of the trip should suffice. This
will allow you to compute the miles driven (ending
mileage minus beginning mileage) and assign it to the
specific photographic job. In addition, total miles for
each photographer can be computed on a monthly
basis and multiplied by your company’s mileage
reimbursement rate for purposes of reimbursing each
photographer for automotive operating costs. LO-3
for Other Activities (cont.)
 Some companies might have other specific needs. For
example, perhaps the company has a fleet of different
vehicles and wants to compute different rates depending on
the vehicle. Using a van might require a higher rate than
using a small automobile. In this case, an additional column
to record the type of vehicle, or vehicle’s license plate would
be necessary.
 Still other companies may use an overhead application base
other than direct labor hours. Perhaps machine hours may
be used to apply overhead. Then, a new document must be
developed. A source document that will track the machine
hours used by each job can be modeled on job time tickets.
LO-3
Flow of Costs Through a Job-Order Costing Firm
LO-4
Accounting for Materials
 Here is a summary of raw materials cost flow for
Johnson Leathergoods and its two jobs:
Raw material beginning balance + Purchases -

Materials used = Raw materials ending balance
LO-4
Accounting for Materials (cont.)
LO-4
Accounting for Direct Labor Cost
 Notice that the direct labor costs assigned to the
two jobs exactly equal the total labor costs
assigned to Work in Process.
LO-4
Accounting for Direct Labor
Cost (cont.)
LO-4
Accounting for Overhead
 Overhead costs can be assigned using a single plantwide
overhead rate or departmental rates.
 Typically, direct labor hours is the measure used to
calculate a plantwide overhead rate, and departmental
rates are based on drivers such as direct labor hours,
machine hours, or direct materials dollars.
 In the example of Johnson Leathergoods, plantwide
overhead rate is calculated based on direct labor hours as
shown here.
Overhead rate = $9,600
2,400 = $4 per direct labor hour
LO-4
Accounting for Overhead
 Take a minute to review the summary of
overhead cost flows.
 Notice that the total overhead applied from all
jobs is entered in the work-in-process account.
LO-4
©© 2012
2016 Cengage
Cengage Learning.
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All Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
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license distributed with a certain product or service or otherwise on a password-protected website for classroom
license distributed with a certain product or service or otherwise on a password-protected website for classroom use. use.
Accounting for Overhead (cont.)
LO-4
©© 2012
2016 Cengage
Cengage Learning.
Learning. All
All Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use
use as
as permitted
permitted in
in aa
license distributed with a certain product or service or otherwise on a password-protected website for classroom
license distributed with a certain product or service or otherwise on a password-protected website for classroom use. use.
Accounting for Finished Goods
LO-4
Schedule of Cost of Goods Manufactured
LO-4
Statement of Cost of Goods Sold
 A schedule of cost of goods sold usually is
prepared at the end of each reporting period, as
shown here for Johnson Leathergoods for
January.
LO-4
Cornerstone 5.5:
Preparing Brief Job-Order
Cost Sheets
LO-4
Cornerstone 5.5:
Preparing Brief Job-Order Cost Sheets
LO-4
Cornerstone 5.5:
LO-4
Cornerstone 5.5:
LO-4
Accounting for Nonmanufacturing
Costs
 Manufacturing costs are not the only costs
experienced by a firm. Nonmanufacturing, or
period, costs are also incurred.
 These include selling and general administrative
costs, which are never assigned to the product;
they are not part of the manufacturing cost flows.
 Controlling accounts accumulate all of the selling
and administrative expenses for a period.
 At the end of the period, all of these costs flow to
the period’s income statement.
LO-4
Income Statement
LO-4
Journal Entries For Job-Order
Costing
Purchased raw materials costing $2,500 on

account.
De s c riptio n De bit Cre dit

1. Raw Materials 2,500
Accounts Payable 2,500
LO-5
Costing (cont.)
Requisitioned materials costing $1,500 for

use in production.

2. Work in Process 1,500
Raw Materials 1,500
LO-5
Costing (cont.)
Recognized direct labor costing $1,530.

3. Work in Process 1,530
Wages Payable 1,530
LO-5
Costing (cont.)
Applied overhead to production at the rate of

$4 per direct labor hour. A total of 85 direct
labor hours were worked.

4. Work in Process 340
Overhead Control 340
LO-5
Costing (cont.)
Incurred actual overhead costs of $415.

5. Overhead Control 415
Lease Payable 200
Utilities Payable 50
Accumulated Depreciation 100
Wages Payable 65
LO-5
Costing (cont.)
Completed the backpack job and transferred

it to Finished Goods.

6. Finished Goods 2,320
Work in Process 2,320
LO-5
Costing (cont.)
Sold the backpack job at cost plus 50%.

7. Cost of Goods Sold 2,320
Finished Goods 2,320

Accounts Receivable 3,480
Sales Revenue 3,480
LO-5
Costing (cont.)
Closed underapplied overhead to Cost of

Goods Sold.

8. Cost of Goods Sold 75
Overhead Control 75
LO-5
Posting of Journal Entries
to the Accounts
LO-5
Producing and Supporting
Departments
 Nearly every company or factory has producing
departments and support departments.
 Producing departments are directly responsible
for creating the products or services sold to
customers.
 Example: A public accounting firm might have producing
departments devoted to auditing, tax, and management
advisory services.
 In a factory, producing departments are those that work
directly on the products being manufactured, such as the
grinding and assembly departments.
LO-6
Producing and Supporting
Departments (cont.)
 Support departments provide essential services
for producing departments, but they do not
actually make the product or service being sold.
 Examples include the maintenance, grounds,
engineering, housekeeping, personnel, and
photocopying departments.
LO-6
Steps for Determining Product Costs:
Predetermined Departmental Overhead Rates
 Once the direct overhead costs of each
department are determined, the next step is to
assign the support department costs to producing
departments using causal factors (drivers).
LO-6
Assigning Costs of
Multiple Support Departments
 The three methods of assigning costs of multiple
support departments to producing departments
are:
 the direct method
 the sequential method
 the reciprocal method
 Companies must determine the extent of support
department interaction and weigh the individual
costs and benefits of each method.
LO-6
Assigning Costs of Multiple Support Departments
Using the Direct Method
LO-6
Cornerstone 5.6:
Assigning Support Department Costs by Using the Direct Method
LO-6
Cornerstone 5.6:
Assigning Support Department Costs by
Using the Direct Method
LO-6
Assigning Costs of Multiple Support
Departments Using the Sequential Method
 The sequential (or step) method of allocation

recognizes that interactions among support
departments occur.
 The sequential method does not fully account for
support department interaction.
LO-6
(cont.)
 Cost allocations are performed in a step-down
fashion, following a predetermined ranking
procedure.
 The sequence is defined by ranking the support
departments in order of the amount of service
rendered, from the greatest to the least.
 Where degree of service is measured by the
direct costs of each support department.
(cont.)
LO-6
Cornerstone 5.7:
Assigning Support Department Costs
by Using the Sequential Method
LO-6
Cornerstone 5.7:
Assigning Support Department Costs
by Using the Sequential Method
LO-6
The Reciprocal Method
 The reciprocal method of allocation recognizes
all interactions among support departments.
 Under the reciprocal method, one support
department’s use by another figures in
determining the total cost of each support
department, where the total cost reflects
interactions among the support departments.
LO-6
The Reciprocal Method (cont.)
 Then, the new total of support department costs
is allocated to the producing departments.
 This method fully accounts for support
department interaction by using a system of
simultaneous linear equations.
 The reciprocal method is not widely used due to
its complexity.
Technology and Support Department
Cost Allocation
 Another factor in allocating support department
cost is the rapid change in technology.
 Many firms currently find that support department
cost allocation is useful for them.
 The move toward activity-based costing and just-
in-time manufacturing can virtually eliminate the
need for support department cost allocation.
LO-6

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CORNERSTONES

Unit costs = Process Costs ÷ Output

 For example, a hospital would accumulate costs

Total costs = Actual direct materials + Actual

 This exhibit illustrates the concepts of over- and

Raw material beginning balance + Purchases -

Purchased raw materials costing $2,500 on

De s c riptio n De bit Cre dit

Accounts Payable 2,500

Requisitioned materials costing $1,500 for

De s c riptio n De bit Cre dit

Raw Materials 1,500

Recognized direct labor costing $1,530.

De s c riptio n De bit Cre dit

Wages Payable 1,530

Applied overhead to production at the rate of

De s c riptio n De bit Cre dit

Overhead Control 340

Incurred actual overhead costs of $415.

De s c riptio n De bit Cre dit

Completed the backpack job and transferred

De s c riptio n De bit Cre dit

Work in Process 2,320

Sold the backpack job at cost plus 50%.

De s c riptio n De bit Cre dit

Finished Goods 2,320

Closed underapplied overhead to Cost of

De s c riptio n De bit Cre dit

 The sequential (or step) method of allocation

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