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CHAPTER 2 SYSTEMS DESIGN: JOB ORDER

COSTING

Key Terms and Concepts to Know Job-Order Costing vs. Process Costing

Job-order costing is used for companies that produce different products each period. Costs are accumulated for each job.

Process costing is used for companies that produce many identical units of a single product for long periods of time. Costs are accumulated by manufacturing department.

Key Job-Order Costing Documents

Material requisitions request materials for production and support direct materials costs charged to each job.

Time cards or time tickets record direct labor hours used in production and support direct labor costs charged to each job.

Job cost sheets are the most important job costing document. They summarize all of the key information about the job and accumulate total direct materials costs, total direct labor costs and overhead costs applied to the job to determine the total costs for the job.

Actual Manufacturing Overhead vs. Manufacturing Overhead Applied

Actual manufacturing overhead costs are the indirect manufacturing costs incurred in the production process.

Manufacturing overhead applied are the overhead costs added or applied to each job during the production process. These costs are added to work-in-process to become part of total manufacturing costs along with direct materials and direct labor.

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Key Topics to Know

Choosing a Cost System

Job-order costing is used by companies with multiple unique products which generally have a low to moderate annual production volume.

Example #1 Which method for assigning costs to products would be more appropriate in each of the following cases?

a) Cruise ship builder b) Cornflakes factory c) Law firm d) Dentists office e) Beverage bottling company

Solution #1

a) Job-order costing (every ship is a separate job) b) Process costing c) Job-order costing (every case is a separate job) d) Job-order costing (every patient visit is a separate job) e) Process costing

Applying Manufacturing Overhead

Manufacturing overhead is applied or added to each job while it is in process. There are three kinds of overhead costs consider:

o Estimated overhead cost which is determined from the annual budget prepared before the year begins and is used only in the pre-determined overhead rate calculation

o Actual overhead cost which is incurred periodically throughout the year and debited to the manufacturing overhead account

o Applied overhead cost which is added to jobs in the work-in-process inventory account throughout the year and credited to the manufacturing overhead account

The manufacturing overhead account is a holding account for the actual overhead costs (debits) and applied over costs (credits).

o Actual overhead costs flow into the account as they are incurred

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o Applied overhead costs flow out of the account as the jobs flow through the production process.

o The account balance may be either debit (underapplied) or credit (overapplied).

o Underapplied overhead represents an expense which must be transferred to cost of goods sold.

o Overapplied overhead represents a reduction of expense charged to jobs which must be transferred to cost of goods sold.

Manufacturing overhead is applied to jobs in work-in-process using the following formula:

Overhead applied = Pre-determined overhead rate X amount of allocation base incurred by the job

The predetermined overhead rate is computed before the period begins:

Pre-determined overhead rate = Estimated annual overhead costEstimated amount of the allocation base (denominator activity)

Example #2 ABC Company uses job-order costing. It incurred the following costs for job M301: 20 pounds of raw materials (all direct) were issued to be used for job M301 at a cost of $7 per pound. Three people were assigned to work on Job M301 at a rate of $12 per hour. Records show that a total of 25 direct labor-hours were worked on Job M301. Manufacturing overhead is applied based on direct labor-hours. At the beginning of the year, estimated total manufacturing overhead was $450,000 and the total direct labor-hours incurred would be 50,000. Required: Determine the cost assigned to Job M301. Solution #2

Pre-determined overhead rate = $9.00 = $450,000 50,000 direct labor hours Direct materials 20 pounds X $7.00 = $140 Direct labor 25 hours X $12.00 = $300 Manufacturing overhead 25 hours X $9.00 = $225 $665

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Flow of Costs Through Inventory Accounts

Raw Materials Work in Process Finished Goods Cost of Goods Sold Beginning Balance

Beginning Balance

Beginning Balance

Beginning Balance

-DM

Usage +DM

Usage

+Purchases +DL

Usage

-COGM +COGM -COGS +COGS

+MOH Applied

=Ending Balance

=Ending Balance

=Ending Balance

=Ending Balance

Manufacturing

Overhead

Beginning Balance

+Actual

overhead costs incurred

-MOH applied

=Under-

applied = Over-applied

With the exception of overhead, this is the same process described in Chapter 1. Actual overhead costs incurred are now flow through the Manufacturing Overhead

account instead of directly into the work-in-process inventory. The balance in the manufacturing overhead account may be a debit or credit,

depending on whether: o Debit if the overhead applied is less than the actual overhead costs incurred

(underapplied) o Credit if overhead applied is more than the actual overhead costs incurred

(overapplied). Some companies may use departmental predetermined overhead rates rather

than the single plant-wide predetermined overhead rate shown here in an effort to make the overhead application process more accurate.

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In Chapter 8 terms, the balance in the overhead account is:

o A favorable variance if it is overapplied o An unfavorable variance if it is underapplied

The basic journal entries to record the flow of costs through the inventory accounts are:

Purchase of raw materials Raw material inventory xxx

Accounts payable xxx Issue raw materials Work-in-process inventory (direct) xxx Manufacturing overhead (indirect) xxx Raw materials inventory xxx Labor costs incurred Work-in-process inventory (direct) xxx Manufacturing overhead (indirect) xxx Wages and salaries payable xxx Manufacturing overhead costs incurred Manufacturing overhead xxx Accounts payable or cash xxx Manufacturing overhead xxx Accumulated depreciation xxx Manufacturing overhead xxx Prepaid expenses xxx Manufacturing overhead xxx Accrued expenses xxx Manufacturing overhead applied Work-in-process inventory xxx Manufacturing overhead xxx Goods are completed Finished goods inventory xxx Work-in-process inventory xxx

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Finished goods are sold Cash or accounts receivable xxx Sales xxx Cost of goods sold Xxx Finished goods inventory xxx Close balance in overhead account

Underapplied Cost of goods sold xxx Manufacturing overhead xxx

Overapplied Manufacturing overhead xxx Cost of goods sold xxx

Summary of Manufacturing Overhead Accounting

At the beginning of the period Estimated amount of MOH / Estimated amount of allocation base = Predetermined overhead rate

During the period

Predetermined overhead rate x Actual amount of allocation base incurred = Total manufacturing overhead applied

At the end of the period Actual manufacturing overhead cost Total manufacturing overhead applied = Underapplied (overapplied) overhead Underapplied (overapplied) overhead is closed to Cost of Goods Sold.

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Example #3 ABC uses job-order costing. It applies overhead cost to jobs on the basis of direct labor-hours. For the current year the company estimates that it will work 20,000 direct labor-hours and will incur $650,000 of manufacturing overhead. The following transactions took place during the year:

a) $300,000 of raw materials were purchased on account b) Raw materials were issued into production, $90,000 direct materials and

$40,000 indirect materials c) Labor costs incurred: $40,000 direct, $130,000 indirect, sales commissions

$50,000, administrative salaries $100,000 d) Utility costs for the factory were $60,000 e) Depreciation recorded was $300,000 (70% related to factory; 30% related

to administrative offices) f) Manufacturing overhead was applied to production. Actual direct labor-

hours incurred were 22,000. g) Units costing $300,000 were completed and transferred into the finished

goods inventory. h) Goods with a cost of $150,000 were sold on account for $200,000. i) Closed the under/overapplied overhead for the year.

Solution #3

a) Raw materials 300,000 Accounts payable 300,000

b) Work in process 90,000 Manufacturing overhead 40,000 Raw materials 130,000

c) Work in process 40,000 Manufacturing overhead 130,000 Sales commission expense 50,000 Administrative salaries expense 100,000 Salaries and wage payable 320,000

d) Manufacturing overhead 60,000 Accounts payable 60,000

e) Manufacturing overhead 210,000 Depreciation expense 90,000 Accumulated depreciation 300,000

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f) Work in process 715,000

Manufacturing overhead (1) 715,000

g) Finished goods 300,000 Work in process 300,000

h) Accounts receivable 200,000 Sales 200,000 Cost of goods sold 150,000 Finished goods 150,000

i) Manufacturing overhead 275,000 Cost of goods sold 275,000

Predetermined overhead rate =

$650,000 = $32.50 per DLH 20,000 DLH

Overhead applied = $32.50 X 22,000 DLH = $715,000

Manufacturing Overheadactual applied

40,000 130,000 715,00060,000

210,000 275,000 overapplied

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Practice Problems Practice Problem #1 Company XYZ makes custom motor boats. It incurred the following costs for the just-completed job B011. 500 pounds of direct materials were used at a cost per pound of $25. The job cost sheet indicates that a total of 90 direct labor-hours incurred on job B011. The workers were paid at a rate of $18 per hour. The company applies overhead based on machine hours. At the beginning of the year, it was estimated that the total amount of overhead would be $180,000 and a total of 30,000 machine hours would be incurred. Job B011 required 150 machine hours. Required: Determine the total cost assigned to Job B011. Practice Problem #2 X company uses job-order costing. It applies overhead cost to jobs on the basis of direct labor cost. For the current year, the company estimates that it will incur $25,000 in direct labor cost and $550,000 of manufacturing overhead. During the year, $30,000 of direct labor costs were incurred. Actual overhead costs incurred were:

Indirect materials expense $100,000Insurance expense 10,000Depreciation expense 75,000Indirect labor expense 150,000Utilities expense 25,000Rent expense 200,000

Required:

a) Compute the companys predetermined overhead rate. b) Compute the amount of over or underapplied overhead. c) Prepare the necessary journal entry to close the over or underapplied

overhead.

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Practice Problem #3 Theodores Cookies had 3 cookie orders in production at June 30: chocolate chip, oatmeal raisin and peanut butter. Material costs for chocolate chip and peanut butter were $500 and $350. Direct labor costs per batch were $200 and $250 for chocolate chip and oatmeal raisin, respectively and $600 in total. Overhead is applied at the rate of 50% of direct materials costs. Total costs for the oatmeal raisin batch were $1,150. Required: What was the balance in work-in-process at June 30? Practice Problem #4 Buckman Corporation, which began operations on January 1 of the current year, reported the following information:

Estimated manufacturing overhead $600,000 Actual manufacturing overhead 639,000 Estimated direct labor cost 480,000 Actual direct labor cost 500,000 Total debits in the Work-In-Process account 1,880,000 Total credits in the Work-In-Process account 920,000

Buckman uses a normal cost system and applies manufacturing overhead to jobs on the basis of direct labor cost. A 60% markup is added to the cost of completed production when finished goods are sold. On December 31, job no. 18 was the only job that remained in production. That job had direct-material and direct-labor charges of $16,500 and $36,000, respectively. Required:

a) Determine the company's predetermined overhead rate. b) Determine the amount of under- or overapplied overhead. Be sure

to label your answer. c) Compute the amount of direct materials used in production. d) Calculate the balance the company would report as ending work-

in-process inventory. e) Prepare the journal entry(ies) needed to record Buckman's sales,

which are all made on account.

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Practice Problem #5 Kei Products uses a predetermined overhead application rate of $18 per labor hour. A review of the company's accounting records revealed budgeted manufacturing overhead for the period of $621,000, applied manufacturing overhead of $590,400, and overapplied overhead of $11,900. Required:

a) Determine Kei's actual labor hours, budgeted labor hours, and actual manufacturing overhead.

b) Prepare the year-end journal entry to adjust the overapplied overhead.

Practice Problem #6 Rock Star, Inc., which uses a job-costing system, began business on January 1, 20x3 and applies manufacturing overhead on the basis of direct-labor cost. The following information relates to 20x3:

Budgeted direct labor and manufacturing overhead were anticipated to be $200,000 and $250,000, respectively.

Job nos. 1, 2, and 3 were begun during the year and had the following charges for direct material and direct labor:

Job # Direct Materials Direct Labor1 $145,000 $35,0002 320,000 65,0003 55,000 80,000

Job nos. 1 and 2 were completed and sold on account to customers at a profit of 60% of cost. Job no. 3 remained in production.

Actual manufacturing overhead by year-end totaled $233,000. Rock Star adjusts all under- and overapplied overhead to cost of goods sold.

Required: a) Compute the company's predetermined overhead application rate.b) Compute Rock Star's ending work-in-process inventory. c) Determine Rock Star's sales revenue.d) Was manufacturing overhead under- or overapplied during 20x3?

By how much? e) Present the necessary journal entry to handle under- or

overapplied manufacturing overhead at year-end. f) Does the presence of under- or overapplied overhead at year-end

indicate that Rock Star's accountants made a serious error? Briefly explain.

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Sample True / False Questions 1. When raw materials are issued into production the Raw Materials account is

debited. True False

2. Manufacturing overhead account is debited for the actual overhead costs incurred.

True False

3. Job cost sheets are used in a process costing system. True False

4. Process costing is appropriate when a large number of identical products are produced.

True False

5. In a normal costing system manufacturing overhead is applied by multiplying the predetermined overhead rate by actual amount of the allocation base.

True False

6. The predetermined overhead rate is computed using actual amount of overhead.

True False

7. Underapplied overhead means that the actual overhead was less than the applied overhead.

True False

8. In the journal entry to close overapplied overhead Cost of Goods Sold is credited.

True False

9. Finished Goods inventory account is credited for the amount of cost of goods manufactured during a period.

True False

10. When direct labor costs are incurred, Work in Process is debited. True False

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11. Factory rent should be assigned equally between manufacturing overhead and selling and administrative expenses.

True False

12. Selling expenses are applied to production using a predetermined overhead rate.

True False

13. The predetermined overhead rate is computed based on estimates. True False

14. Indirect materials are part of manufacturing overhead. True False

15. Work in Process is a control account that contains a summary of all individual job cost sheets for all jobs in process at a point of time.

True False

16. When goods are sold, the Work in Process account is credited. True False

17. Manufacturing overhead account is debited for the amount of overhead applied to Work in Process.

True False

18. The predetermined overhead rate for the year is computed at the end of the year.

True False

19. A company that produces cornflakes will most likely use a job-order cost system.

True False

20. Indirect materials issued into production should be debited to Work in Process. True False

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Sample Multiple Choice Questions

1. A cost driver is: a) Factor that causes overhead costs b) Part of direct materials c) Cost of goods sold d) Expected to be offset in future months

2. Which of the following statements is false? a) The manufacturing overhead account is credited when manufacturing

overhead is applied to Work in Process b) Cost of Goods Sold is debited for the amount of overapplied overhead c) Work in Process inventory account is credited when products are transferred

to Finished Goods d) Manufacturing overhead is applied to Work in Process using a

predetermined overhead rate

3. XYZ Company applies overhead on the basis of direct labor-hours. The following data are available:

Estimated annual overhead cost $450,000 Actual annual overhead cost 580,000 Estimated direct labor-hours 25,000 Actual direct labor-hours 20,000

Compute the amount of overhead applied during the period and the amount of under or overapplied overhead (if any).

a) $450,000 applied and $130,000 underapplied b) $360,000 applied and $220,000 underapplied c) $580,000 applied and no under or overapplied overhead d) $360,000 applied and $220,000 overapplied

4. Overapplied overhead means that:

a) Actual overhead is more than overhead applied b) Actual overhead is equal to overhead applied c) Overhead applied is less than actual overhead d) Actual overhead is less than overhead applied

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5. ABC Company applies overhead on the basis of direct labor costs. The estimated amount of direct labor costs for the year was $35,000. The predetermined overhead rate for the year is 150% and manufacturing overhead applied was $45,000. What is the amount of actual direct labor costs incurred during the year?

a) $67,500 b) $52,500 c) $30,000 d) $53,000

6. During the year X Company estimated that it will incur the following costs for

Job 090: $400,000 direct materials; $40,000 direct labor; $120,000 manufacturing overhead. Overhead is applied based on direct labor costs. Job 090 was completed during the period and it incurred the following actual costs: $350,000 direct materials; $43,000 direct labor; manufacturing overhead $135,000. The amount of under or overapplied overhead was:

a) $6,000 overapplied b) $15,000 underapplied c) $15,000 overapplied d) $6,000 underapplied

7. If the manufacturing overhead account has a credit balance at the end of the year, it means that:

a) Overhead was overapplied b) Overhead was underapplied c) Overhead was not applied d) The amount of actual and applied overhead was the same

8. A company applies overhead based on machine hours. The predetermined overhead rate for the year was $25 per machine hour. Actual machine hours were 8,000. The amount of underapplied overhead was $4,000. What was the amount of actual overhead costs incurred?

a) $200,000 b) $196,000 c) $204,000 d) $150,000

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9. XYZ company had the following data for the current year: Work in Process, beginning balance $420,000

Direct materials used in production 30,000 Direct labor 55,000 Actual overhead 70,000 Overhead applied 65,000 Work in Process, ending balance 40,000

Determine the amount of cost of goods manufactured during the year. a) $155,000 b) $530,000 c) $535,000 d) $520,000

10. ABC company had the following data for the current year: Work in Process, beginning balance $110,000

Direct materials used in production 45,000 Actual overhead 60,000 Overhead applied 70,000 Work in Process, ending balance 30,000 Cost of goods manufactured 235,000

Determine the amount of direct labor cost incurred during the year. a) $50,000 b) $45,000 c) $40,000 d) $35,000

11. The beginning balance of Raw Materials inventory was $10,000. During the year purchases of raw materials for $125,000 were made, but only $75,000 were paid. The balance of Raw Materials at the end of the year was $30,000. What was the amount of raw materials used in production?

a) $55,000 b) $95,000 c) $45,000 d) 105,000

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Questions 12 through 15 refer to the following information.

Z Company uses a job-order costing system and applies overhead based on direct materials used in production. For the recent year it estimated that $150,000 of manufacturing overhead will be incurred and $100,000 of direct materials will be used. The following data were taken from the companys books:

Beginning Ending Raw Materials (all direct) $30,000 $10,000 Work in Process $45,000 $35,000 Finished Goods $20,000 $25,000 Costs incurred during the year: Purchases of raw materials (direct) $90,000Direct Labor $40,000Actual overhead $150,000

12. The amount of manufacturing overhead applied to Work in Process is:

a) $165,000 b) $135,000 c) $180,000 d) $160,000

13. The amount of cost of goods manufactured during the year is: a) $315,000 b) $325,000 c) $360,000 d) $340,000

14. The under or overapplied overhead is: a) $10,000 overapplied b) $15,000 overapplied c) $15,000 underapplied d) $10,000 underapplied

15. The cost of goods sold (including any under or overapplied overhead) is: a) $310,000 b) $320,000 c) $300,000 d) $305,000

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16. Finished Goods inventory account is credited when: a) Goods are purchased on account b) Raw materials are purchased c) Goods are sold d) Underapplied overhead is closed

17. Nonmanufacturing costs are: a) Included in manufacturing overhead b) Not part of the product cost c) Deducted from Work in Process d) Added directly to cost of goods sold

18. The predetermined overhead rate is computed: a) Using a weighted-average method. b) Using actual activity as an allocation base. c) At the beginning of the year, using estimates d) After all actual costs have been incurred

19. Total manufacturing costs for the period consist of: a) Direct materials, direct labor and manufacturing overhead applied b) Manufacturing overhead applied and selling expenses c) All expenses incurred, including selling and administrative d) Cost of goods sold plus ending Finished Goods inventory

20. Cost of Goods Sold is derived from: a) Job-cost sheets b) Raw Materials inventory account c) Finished Goods inventory account d) Estimates for the expected level of sales

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Solutions to Practice Problems Practice Problem #1

Direct materials used: 500 pounds X $25.00 = $12,500Direct labor cost: 90 DLH X $18.00 = $1,620

Predetermined overhead rate: $180,000

= $6.00 per MH 30,000 MHOverhead applied to job B011: $6.00 X 150 MH = $900 Total job cost: $12,500 + $1,620 + $900 = $15,020

Practice Problem #2

Predetermined overhead rate: $550,000

= $22.00 per DL$ $25,000 Overhead applied: $22.00 X $30,000 = $660,000

Manufacturing Overhead

actual applied100,000 10,000 660,00075,000

150,000 25,000

200,000 100,000 overapplied

To close the balance in the manufacturing overhead account:

Manufacturing overhead 100,000 Cost of goods sold 100,000

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Practice Problem #3

Chocolate Chip

Oatmeal Raisin

Peanut Butter

Work in Process

Direct Materials $500 (3) $600 $350 (6) $1,450Direct Labor $200 $250 (7) $150 $600Overhead (1) $250 (4) $300 (5) $175 (9) $725Total Job Costs (2) $950 $1,150 (8) $675 (10) $2,775

(1) $500 X 50% = $250(2) $500 + $200 + $250 = $950(3) $1,150 - $250 = $900 direct materials and overhead

$900 = 150% X direct materials Direct materials = $600

(4) $1,150 $600 - $250 = $300(5) $350 X 50% = $175(6) $500 + $600 + $350 = $1,450(7) $600 - $200 - $250 = $150(8) $350 + $150 + $175 = $675(9) $250 + $300 + $175 = $725(10)$950 + $1,150 + 675 = $2,775 or $1,450 + $600 + $725 = $2,775

Practice Problem #4

a) Predetermined overhead rate =

Estimated overhead costs $600,000 = 125% of direct labor cost Estimated direct labor cost $480,000

b)

Actual manufacturing overhead $639,000Applied manufacturing overhead 625,000Under-applied overhead $14,000

c)

Debits to Work-In-Process $1,880,000Direct labor 500,000Applied manufacturing overhead 625,000Direct materials used $755,000

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d)

Job #18 Direct materials used $16,500 Direct labor 36,000 Applied overhead at 125% of direct labor 45,000 Total cost $97,000

e)

Accounts receivable 1,472,000 Sales 1,472,000

Cost of goods sold 920,000

Finished goods 920,000 Practice Problem #5

Actual labor hours: $590,000 = 32,800 hours $18.00 per hour Budgeted labor hours $621,000 = 34,500 hours $18.00 per hour Actual overhead: $590,000 - $11,900 = $578,500

Manufacturing overhead 920,000 Cost of goods sold 920,000

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Practice Problem #6

a) Estimated Overhead cost $250,000 = 125% of direct labor Estimated direct labor cost $200,000

b) Job #3:

Direct materials $55,000 Direct labor 80,000 Overhead applied 100,000 $235,000

c) Jobs #1 and #2: Direct materials $465,000 Direct labor 100,000 Overhead applied 125,000 $690,000 Revenue $690,000 x 160% = $1,104,000

d) Actual manufacturing overhead $233,000 Applied manufacturing overhead 225,000 Under-applied overhead 8,000

e) Cost of goods sold 8,000 Manufacturing overhead 8,000

f) No. Companies use a predetermined application rate for several reasonsincluding the fact that manufacturing overhead is not easily traced to jobs and products. The predetermined rate is based on estimates of both overhead and an appropriate cost driver, and these estimated rarely equal actual overhead incurred or the actual cost driver activity. Under- or overapplied overhead typically arises at year-end.

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Solutions to True / False Problems

1. False because the raw materials account is credited when raw materials are issued.

2. True 3. False because cost sheets are used in a job-order system. 4. True 5. True 6. False because the pre-determined rate is computed using estimated overhead. 7. False because underapplied means that the applied overhead is less than the

actual overhead incurred. 8. True 9. False because finished goods is debited for the cost of goods manufactured. 10. True 11. False because factory rent is part of manufacturing overhead. 12. False because selling expenses are expensed as incurred as a period cost. 13. True 14. True 15. True 16. False because work-in-process is not part of the journal entries to record a

sale; finished goods is credited for the cost of the goods sold. 17. False because overhead is credited when overhead is applied. 18. False because the pre-determined overhead rate is computed at the beginning

of the year (hence the prefix pre). 19. False because process costing is appropriate when all the products (the

cornflakes) are essentially the same. 20. False because indirect materials issued should be debited to Manufacturing

Overhead.

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Solutions to Multiple Choice Questions 1. A 2. B 3. B 4. D 5. C 6. D 7. A 8. C 9. B 10. C 11. D 12. A 13. B 14. B 15. D 16. C 17. B 18. C 19. A 20. C