Chapter 17

Job Order Cost Systems and Overhead Allocations

Examples:

Construction companies use job order cost systems because each construction
project is unique.

Job order cost systems are also used by

shipbuilders
motion picture studios
defense contractors
print shops
custom furniture makers.

In addition, these systems are widely used in service organizations, such as

automotive repair shops, accounting firms, law firms, doctors’ offices, and
hospitals.
Overhead isn’t applied to products by simply dividing the company’s annual
actual overhead cost by the actual number of units produced or services
provided during the year.

Why ?

First, total overhead costs and total units produced are not known until the end
of the year. Because the amount of overhead assigned to a unit of service or
product is important information for setting prices to charge customers at the
time of sale, an estimated amount is necessary.

Second, not all products and services consume an equal amount of overhead.

Third, an expected amount of overhead per product or service helps managers

make decisions about whether too much overhead is being used in production.
The overhead application rate is determined at the beginning of the period and
is based on estimated amounts. The rate is typically computed as follows:

The mechanics of computing and using an overhead application rate are quite
simple.

The challenging problems for accountants are

(1) selecting an appropriate activity base and

(2) making reliable estimates at the beginning of the accounting period

regarding the total of the overhead costs to be incurred and the total units in
the activity base that will be required
WHAT “DRIVES” OVERHEAD COSTS?
Historically, direct labor hours (or direct labor costs) were viewed as the
primary driver of overhead costs—and for good reason.

Products that required more direct labor often required

more indirect labor (supervision),

resulted in more wear and tear on machinery (maintenance costs),
and consumed a greater amount of supplies.

Therefore, manufacturing companies often followed the practice of applying all

manufacturing overhead costs in proportion to direct labor hours or direct
labor costs.

Today , as factories have become more highly automated many manufacturing

companies find that activity bases such as machine hours, computer time, or
the time required to set up a production run result in a better matching of
overhead costs and activities.
The Use of Multiple Overhead Application Rates

In an attempt to gain a better understanding of what it costs to manufacture

different types of products, many companies have begun to implement
techniques that rely on the use of multiple allocation bases. One such
approach, activity-based costing, is illustrated later in this chapter.

In essence, activity-based costing uses multiple allocation bases that represent

different types of manufacturing overhead costs. For instance, machine
maintenance costs may be allocated using machine hours as an activity
base, whereas supervision costs may be allocated using direct labor hours.

Different application rates may also be used in each production department

and in applying overhead costs to different types of products.
The Use of Multiple Overhead Application Rates

If the activity base used to apply overhead costs is not a

primary cost driver, the relative production cost of
different products and services may become significantly
distorted.
 In job costing,
Work in Process
Inventory is a
control (or
summary) account,
supported by job
cost sheets for each
job. Collectively,
the job cost sheets
serve as a
subsidiary ledger
showing the details
of costs charged to
each job.