Chapter 4

JOB ORDER COSTING SYSTEM

OVERHEAD COST CONCEPTS

References:
CMA Excel Learning System – Exam Review Part 1 and Part 2 (2019) Publisher: Wiley.
Weygandt, J., Kimmel, P., and Kieso, D. (2015). Accounting Principles 12 th edition, John Wiley and Sons, Singapore.
Intended learning outcomes
After studying this topic, you should be able to:
1. DESCRIBE COST SYSTEMS AND THE FLOW OF COSTS IN A JOB ORDER SYSTEM.
2. USE A JOB COST SHEET TO ASSIGN COSTS TO WORK IN PROCESS.
3. DEMONSTRATE HOW TO DETERMINE AND USE THE PREDETERMINED OVERHEAD RATE.
4. PREPARE ENTRIES FOR MANUFACTURING AND SERVICE JOBS COMPLETED AND SOLD.
5. DISTINGUISH BETWEEN UNDER- and OVERAPPLIED MANUFACTURING OVERHEAD
 Cost Accounting
Cost Accounting involves:
Measuring, Recording, and Reporting product costs.

Objective of costing systems to provide cost information for :

* Pricing *cost control *inventory valuation *F.S Presentation

- There are a number of cost models used to track costs through the organization's cost accounting system.
- Two of the most common cost models are:
• Job order costing
• Process costing.
- The nature of the organization's work determines which costing system to use.
 Cost Accounting
- Tracking costs within the organization is challenging.
- That challenge becomes more difficult and more crucial to manage successfully as
organizations become larger and more complex, and as competition becomes faster and more
aggressive.

- Tracking costs is often about much more than knowing how to properly set prices.
- The nature of competition puts most organizations in a “price taker” rather than a “price maker”
position in the economy.
 Cost Accounting
To compete effectively, the organization's ability to accurately track costs is critical in two ways:

• Without a clear and confident view of costs,

• organizations will struggle to efficiently manage costs and incentivize employees in order to
reduce costs and improve quality.

• With a clear and confident view of costs

• Organizations can then use that information to effectively manage their market positions by
emphasizing and deemphasizing (or even exiting) certain products or customers available in the
organizations’ portfolio in order to establish the most strategically successful market position.
 Job Order Cost System
- Job order costing is used by organizations that can identify (and even customize) the product or
cost in advance for a specific customer or client.
 Costs are assigned to each job or batch of goods.
 Key feature: Each job or batch has its own distinguishing characteristics.
 Objective: Compute the cost per job.
 Measures costs for each completed job rather than for set time periods.

◦ The three product costs (direct materials, direct labor, and overhead) are accumlated then tracked to a
job cost invoice that is used to flow the costs through the accounting system until they are expensed to
the income statement as cost of goods sold.
 Cost Accounting Systems
• If the customer or client receiving the product can be identified before the process begins (a manufacturing
process or a service process) and the job and its costs are tracked together throughout the process ->
• then a job order costing model is used.

• If the organization is building similar products without separately identifying each product during the process and
can only identify the buyer during the selling process ->
• then a process costing model is used.

• For example, a clothing company produces men's professional suits.

• If these suits are custom ordered and fitted to clients before assembly, then the company will use a job order
costing model.
• If similar suits are produced in various sizes and subsequently sold “off the rack” as customers come to a
digital or physical storefront, then the company will use a process costing model.
• Notice that the product is the same in either system—professional suits—and notice that the nature of costs is the
same as well—materials, labor, and overhead.
• The difference is the existence of an identified customer that provides the means to track production costs to a
specific job as the costs flow through the accounting system.
Can a Company Use Both Types of
Cost Systems?
Car Manufacturing
Company

Can Use

Job order Process cost

cost system
Producing a custom-made
system
Producing standard model
limousine for the King cars
Cost flows in the three basic types of organizations
Cost flows in manufacturing organizations
 Cost flows in the manufacturing companies
Job order cost accounting parallels the physical flow of the
materials as they are converted into finished goods

 DM, DL & OH are accumulated “Manufacturing

Cost”.

 Manufacturing costs are assigned to Work in

Process (WIP) Inventory account.

 Cost of completed jobs is transferred to Finished

Goods Inventory.

 When units are sold, the cost is transferred to Cost

of Goods Sold.
 A) Accumulating Manufacturing Costs
1) Raw Material Costs

The entry to record purchases of raw material on account / Cash:

Dr. Raw Materials Inventory

Cr. Accounts Payable / Cash

(Raw Material Payable / Cash)

 A) Accumulating Manufacturing Costs
2) Factory Labor Costs
Consists of three costs:
1.Gross earnings of factory workers,
2.Employer payroll taxes on these earnings, and
3.Fringe benefits incurred by the employer (sick pay, pensions, vacation pay).

The entry to record factory labor:

Dr. Factory Labor
Cr. Factory Wages Payable
Employer Payroll Taxes Payable
(To record factory labor costs)
 A) Accumulating Manufacturing Costs
3) Manufacturing Overhead Costs
- Costs unrelated to manufacturing process (period costs) are expensed.
- Costs related to manufacturing process are accumulated in Manufacturing Overhead.

The entry to record manufacturing overhead:

Dr. Manufacturing Overhead

Cr. Utilities Payable

Accounts Payable (for repairs)

Accumulated Depreciation

Property Taxes Payable

(To record Overhead Costs)

 B) Assigning Manufacturing Costs to Work in Process

Manufacturing costs are assigned to Work in Process with:

Dr. Work in Process Inventory

Cr. Raw Materials Inventory

Factory Labor
Manufacturing Overhead
 B) Assigning Manufacturing Costs to Work in Process
Job Cost Sheet
 Used to record
 the costs chargeable to a specific job and
 to determine the total and unit costs of the completed job.

 Constitutes the subsidiary ledger for the Work in Process

Inventory account.
 Each entry to a Work in Process Inventory must be
accompanied by a corresponding posting to one or more
job cost sheets.
 B) Assigning Manufacturing Costs to Work in Process
1) Raw Material Costs

are assigned to a job when materials are issued.

 Source Document: Materials requisition slip

 Written authorization for issuing raw materials.

 Quantity and type of materials.

Company will charge direct materials to Work in Process Inventory,

and indirect materials to Manufacturing Overhead.
Dr. Work in Process Inventory “DM”
Manufacturing Overhead “IDM”
Cr. Raw Materials Inventory “DM+IDM”
Assigning Materials to WIP and Overhead
Example: Wallace uses $24,000 of direct materials and $6,000 of
indirect materials in January, the entry is:

Jan. 31 Work in Process Inventory 24,000

Manufacturing Overhead 6,000
Raw Materials Inventory 30,000
 Assigning Raw Materials to Work in Process

The sum of the direct

materials columns of
the job cost sheets
should equal the
direct materials
debited to Work in
Process Inventory.
 B) Assigning Manufacturing Costs to Work in Process
2) Factory Labor Costs
Assigned to jobs on the basis of time tickets prepared when the
work is performed.
 Time tickets indicate; employee, hours worked, account and job
charged, and total labor cost

Company will charge direct labor to Work in Process Inventory, and

indirect labor to Manufacturing Overhead.

Dr. Work in Process Inventory “DL”

Manufacturing Overhead “IDL”
Cr. Factory Labor “DL+IDL”
 Assigning Factory Labor to WIP and Overhead
Example: Time tickets are sent to the payroll department, which applies the
employee’s hourly wage rate and computes the total labor cost. If the $32,000 total
factory labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the
entry is:
Jan. 31 Work in Process Inventory 28,000
Manufacturing Overhead 4,000
Factory Labor 32,000
 Assigning Direct Labor to Work in Process

The sum of the

direct labor columns
of the job cost
sheets should equal
the direct labor
debited to Work in
Process Inventory.
 B) Assigning Manufacturing Costs to Work in Process
3) Manufacturing Overhead Costs

 Relates to production operations as a whole.

 Cannot be assigned to specific jobs based on actual costs

incurred.

 Companies assign manufacturing overhead to work in process

and to specific jobs on an estimated basis through the use of a

Predetermined Overhead Rate

 B) Assigning Manufacturing Costs to Work in Process
3) Manufacturing Overhead Costs Step 1

Predetermined Overhead Rate

 Established at the beginning of the year.

 Base on the relation between estimated annual overhead costs and expected
annual operating activity, expressed in terms of a common activity base.
 Examples of activity base; direct labor costs, direct labor hours, machine hours
or any other activity that is an equitable base for applying overhead costs to
jobs
Choosing the Activity Level
The predicted level of the activity usage includes:
1. Expected activity level—the level of production level the firm expects to attain for the coming
year.
2. Normal activity level—the long-run average activity level (normal value is computed over more
than one year).
Advantages: Cost assignment using normal activity produces less fluctuation in the period-to-period
overhead assignment. It also avoids assigning the costs of idle capacity to products when production
is down.
3. Theoretical activity level—the level of activity achieved under ideal operating conditions
(absolute maximum production activity).
4. Practical activity level—the level of activity achieved under efficient operating conditions (it
allows for some imperfections).
Comparisons between different predicted activity levels:
Expected and normal activities tend to reflect consumer demand.
Theoretical and practical activities tend to reflect production capabilities.
 B) Assigning Manufacturing Costs to Work in Process
3) Manufacturing Overhead Costs Step 2

Dr. Work in Process Inventory “Applied”

Cr. Manufacturing Overhead “Applied”
Assigning Manufacturing Overhead to WIP
Example: Wallace uses direct labor cost as the activity base.
Assuming that the company expects annual overhead costs to be
$280,000 and direct labor costs for the year to be $350,000, compute
the overhead rate.

$280,000 ÷ $350,000 = 80%

This means that for every dollar of direct labor, Wallace will assign
80 cents of manufacturing overhead to a job.
_______
Assigning Manufacturing Overhead to WIP
Example: Wallace applies manufacturing overhead to work in
process when it assigns direct labor costs. Calculate the amount of
applied overhead assuming direct labor costs were $28,000.

$28,000 x 80% = $22,400

The following entry records this application.

Jan. 31 Work in Process Inventory 22,400

Manufacturing Overhead 22,400
 Assigning Manufacturing Overhead to WIP

The sum of the

manufacturing
overhead
columns of the
job cost sheets
should equal the
manufacturing
overhead debited
(i.e., applied) to
Work in Process
Inventory.
B) Assigning Manufacturing Costs to Work in Process
 Test Your Knowledge (1)
The following information is available for a particular consulting contract performance by Newton
Business Consultants:
Newton applies overhead on the basis of client consulting hours. The estimated total overhead for
the year was $8.25 million and the estimated total consulting hours was 150,000. Newton pays its
consultants $40 per hour.
Consulting labor costs $6,500.00
Supplies 850.50
Overhead ?
Total Cost ?

Compute the predetermined overhead application rate. What is the allocated cost and total cost of
this particular contract?
 Answer
The overhead application rate is $8,250,000 ÷ 150,000 hours = $55.00 per hour. Based on the
$40 pay rate, Newton used 162.5 hours ($6,500.00 ÷ $40) on this client job. The total cost of the
job is presented below.

Consulting labor costs $6,500.00

Supplies 850.50
Overhead $55 × 162.5 8,937.50
Total cost $16,288.00
 C) Assigning Costs to Finished Goods

 When a job is completed, the company summarizes

the costs and completes the job cost sheet.

Dr. Finished Goods Inventory

Cr. Work in Process Inventory
 C) Assigning Costs to Finished Goods

Example: When a job is finished, Wallace makes an entry to transfer

its total cost to finished goods inventory.

Jan. 31 Finished Goods Inventory 39,000

Work in Process Inventory 39,000
 D) Assigning Costs to Cost of Goods Sold

 Companies recognize cost of goods sold when each

sale occurs.
Two Entries:
Dr. Account Receivables/ Cash
Cr. Sales Revenue
( To record sale of the job)
Dr. Cost of Goods Sold
Cr. Finished Goods Inventory
(To record cost of the job)
 D) Assigning Costs to Cost of Goods Sold

Illustration: On January 31 Wallace sells on account Job 101. The

job cost $39,000, and it sold for $50,000. The entries to record the
sale and recognize cost of goods sold are:

Jan. 31 Accounts Receivable 50,000

Sales revenue 50,000
Cost of Goods Sold 39,000
Finished Goods Inventory 39,000
 Reporting Job Cost Data

 Schedule shows manufacturing overhead applied rather than actual overhead costs.
 Applied overhead is added to direct materials and direct labor to determine total manufacturing costs
 Overhead cost - concept
• Overhead includes all production costs other
than direct materials or direct labor.
• Examples of overhead costs include:
• Those supplies that are necessary for
production but that do not become part of the
finished product.
• Materials that are insignificant.
• An overtime premium that is common to all
production runs.
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 Manufacturing Overhead
• Manufacturing overheads include production
costs that:
– are incurred for a variety of products
– could be traced to individual products but
there is little benefit in doing so
– could be traced to individual products but
it is more appropriate to treat this cost as
a cost of all outputs
– include depreciation, factory insurance,
indirect labour, indirect materials

39
 A single charging rate example
• Hamilton & Barry developed an in-house
photocopying department to serve its three
producing departments (audit, tax, and MAS).
• The costs of the photocopying department
include fixed costs of $47,790 per year and
variable costs of $0.023 per page copied.
• Estimated usage in pages by the three producing
departments is as follows:
Audit department 94,500
Tax department 67,500
MAS department 108,000
Total 270,000
=====

40
 A single charging rate

Total costs = $47,790 + (270,000 x

$0.023) = $54,000
Overhead rate = $54,000  270,000
= $0.20 per page
Suppose the actual usage per department is:
Audit department 92,000 Tax
department 65,000 MAS 115,000

41
 A single charging rate
The total photocopying department charges
would be as shown: Total #
of Pages OH rate Charges
Audit 92,000 $0.20$18,400
Tax 65,000 $0.2013,000
MAS 115,000 $0.2023,000
Total 272,000 $54,400
===== =====

42
 Multiple charging rates

• Sometimes a single charging rate masks the variety of

causal factors that lead to a support department’s
total costs.
• Calculating separate rates for fixed and variable costs.
• Identify a cost driver to estimate the fixed overhead
rate

43
 Under- or Overapplied Overhead

 A debit balance in manufacturing overhead

means that overhead is underapplied.
 A credit balance in manufacturing overhead
means that overhead is overapplied.
 Under- or Overapplied Overhead

 Any YEAR-END BALANCE in manufacturing overhead is eliminated by

adjusting cost of goods sold.
 Underapplied overhead is debited to COGS
 Overapplied overhead is credited to COGS

Example: Wallace has a $2,500 credit balance in Manufacturing

Overhead in December 31. The adjusting entry for the over-applied
overhead is:

Dec. 31 Manufacturing Overhead 2,500

Cost of Good Sold 2,500
 Test Your Knowledge (2)
Allister Furniture Company manufactures custom furniture and uses job order costing to track cost. Allister
uses a normal cost accounting system. The following information is available in Allister's cost accounting
system.
The accounts below have been set up with accounting balances provided above. Use these accounts to flow
job order costs through the accounting system, and then compute the following:
•Raw materials purchased
•Cost of goods manufactured (COGM) that flow into the finished goods inventory account
•Cost of goods sold (COGS) after adjusting for under-applied manufacturing overhead
 Test Your Knowledge (2)
Beginning raw materials inventory $ 30,000

Raw materials used in production 95,000

Ending raw materials inventory 55,000

Actual manufacturing overhead (MOH) 250,000

Beginning work-in-process inventory 130,000

Ending work-in-process inventory 145,000

Direct labor costs 100,000

Beginning finished goods inventory 65,000

Ending finished goods inventory 80,000

Underapplied MOH 25,000

Answer

 Raw materials purchased = $95,000 + $55,000 –

$30,000 = $120,000
 COGM = $130,000 + $95,000 + $100,000 +
$225,000* – $145,000 = $405,000
 Adjusted COGS = $65,000 + $405,000 – $80,000
+ $25,000 = $415,000
 (*Note: Applied MOH = Actual MOH $250,000 –
Under-applied MOH $25,000)
Recap
1. Explain the characteristics and purposes of cost accounting.
Cost accounting involves the procedures for measuring, recording, and reporting product costs.
From the data accumulated, companies determine the total cost and the unit cost of each
product. The two basic types of cost accounting systems are job order cost and process cost.
2 Describe the flow of costs in a job order costing system.
In job order costing, manufacturing costs are first accumulated in three accounts: Raw Materials
Inventory, Factory Labor, and Manufacturing Overhead. The accumulated costs are then
assigned to Work in Process Inventory and eventually to Finished Goods Inventory and Cost of
Goods Sold.
3 Explain the nature and importance of a job cost sheet.
A job cost sheet is a form used to record the costs chargeable to a specific job and to determine
the total and unit costs of the completed job. Job cost sheets constitute the subsidiary ledger for
the Work in Process Inventory control account.
Recap cont’d
4 Indicate how the predetermined overhead rate is determined and used.
The predetermined overhead rate is based on the relationship between estimated annual overhead
costs and expected annual operating activity. This is expressed in terms of a common activity base,
such as direct labor cost. The rate is used in assigning overhead costs to work in process and to
specific jobs
5 Prepare entries for jobs completed and sold.
When jobs are completed, the cost is debited to Finished Goods Inventory and credited to Work in
Process Inventory. When a job is sold the entries are: (a) Debit Cash or Accounts Receivable and
credit Sales for the selling price. And (b) debit Cost of Goods Sold and credit Finished Goods
Inventory for the cost of the goods.
6 Distinguish between under- and overapplied manufacturing overhead.
Underapplied manufacturing overhead means that the overhead assigned to work in process is less
than the overhead incurred. Overapplied overhead means that the overhead assigned to work in
process is greater than the overhead incurred.
“CAN YOU?” CHECKLIST
Can you describe how a job-order costing system and a process costing system differ?
Can you explain how cost accumulation, cost measurement, and cost assignment differ?
Can you calculate predetermined overhead rates? Do you understand the conditions that must
exist for there to be a need for a predetermined rate? Can you use the rate to assign overhead
to production?
Can you identify over- or underapplied overhead? Can you prorate this to the production
accounts?
Can you prepare the journal entries needed for a job-order costing system?
Can you describe when multiple overhead rates may be preferable to a single rate?