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Copyright © 2008, The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin

Chapter Three

Systems Design:Job-Order Costing

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3-2

Learning Objective 1

Distinguish between

process costing and job-order costing and identifycompanies that would use

each costing method.

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3-3

Types of Product Costing Systems

ProcessCosting

Job-order Costing

A company produces many units of a singleproduct.

One unit of product is indistinguishable fromother units of product.

The identical nature of each unit of product enablesassigning the same average cost per unit.

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3-4


ProcessCosting

Job-order Costing

A company produces many units of a singleproduct.

One unit of product is indistinguishable fromother units of product.

The identical nature of each unit of product enablesassigning the same average cost per unit.

Example companies:

1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)

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3-5


ProcessCosting

Job-order Costing

Many different products are produced each period.

Products are manufactured to order.

The unique nature of each order requires tracing or allocating costs to each job, and maintaining costrecords for each job.

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3-6


ProcessCosting

Job-order Costing

Many different products are produced each period.

Products are manufactured to order.

The unique nature of each order requires tracing or allocating costs to each job, and maintaining costrecords for each job.

Example companies:1. Boeing (aircraft manufacturing)

2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)

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3-7

Comparing Process and Job-Order Costing

Job-Order Process

Number of jobs worked Many Single Product

Cost accumulated by

Job Department

Average cost computed by Job Department

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3-8

Quick Check

Which of the following companies wouldbe likely to use job-order costing rather than process costing?

a. Scott Paper Company for Kleenex.

b. Architects.

c. Heinz for ketchup.

d. Caterer for a wedding reception.

e. Builder of commercial fishing vessels.

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3-9

Quick Check

Which of the following companies wouldbe likely to use job-order costing rather than process costing?

a. Scott Paper Company for Kleenex.

b. Architects.

c. Heinz for ketchup.

d. Caterer for a wedding reception.

e. Builder of commercial fishing vessels.

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3-10


Identify the documentsused in a job-order

costing system.

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3-11

ManufacturingOverhead

Job No. 1

Job No. 2

Job No. 3

Chargedirect

material anddirect labor

costs to

each job aswork isperformed.

Job-Order Costing – An Overview

Direct Materials

Direct Labor

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3-12

ManufacturingOverhead,includingindirect

materials andindirect labor ,are allocated

to all jobsrather thandirectly tracedto each job.

Direct Materials

Direct Labor

Job No. 1

Job No. 2

Job No. 3ManufacturingOverhead

Job-Order Costing – An Overview

3 13

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3-13

PearCo Job Cost Sheet Job Number A - 143 Date Initiated 3-4-08

Date Completed Department B3 Units Completed Item Wooden cargo crate Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped Direct Materials Date Number Balance Direct Labor Manufacturing Overhead Total Cost Unit Product Cost

The Job Cost Sheet

3 14

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3-14

Measuring Direct Materials Cost

Will E. Delite

3 15

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3-15

PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-08

Date Completed

Department B3 Units Completed

Item Wooden cargo crate

Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Amount Hours Rate Amount

X7-6890 116 $

Cost Summary Units Shipped

Direct Materials 116 $ Date Number Balance

Direct Labor

Manufacturing Overhead

Total Cost

Unit Product Cost

Measuring Direct Materials Cost

3 16

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3-16

Measuring Direct Labor Costs

PearCo Employee Time Ticket

Time Ticket No. 36 Date 3/5/2008

Employee I. M. Skilled Station 42

Starting Ending Hours Hourly Time Time Completed Rate Amount Job No.

0800 1600 8.00 11.00 $ 88.00 $ A-143

Totals 8.00 11.00 $ 88.00 $ A-143

Supervisor C. M. Workman

3 17

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3-17

Job-Order Cost Accounting

PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-08

Date Completed

Department B3 Units Completed

Item Wooden cargo crate

Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Amount Hours Rate Amount

X7-6890 116 $ 36 8 88 $

Cost Summary Units Shipped

Direct Materials 116 $ Date Number Balance

Direct Labor 88 $

Manufacturing Overhead

Total Cost

Unit Product Cost

3 18

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3-18


Compute predeterminedoverhead rates and

explain why estimatedoverhead costs (rather than actual overhead

costs) are used in thecosting process.

3 19

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3-19

Why Use an Allocation Base?

Manufacturing overhead is applied to jobs thatare in process. An allocation base, such asdirect labor hours, direct labor dollars, or

machine hours, is used to assignmanufacturing overhead to individual jobs.

We use an allocation base because:

1. It is impossible or difficult to trace overhead costs to particular jobs.

2. Manufacturing overhead consists of many different items rangingfrom the grease used in machines to production manager’s salary.

3. Many types of manufacturing overhead costs are fixed even thoughoutput fluctuates during the period.

3-20

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3-20

The predetermined overhead rate (POHR ) used to apply overhead to jobs is

determined before the period begins.

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

Ideally, the allocation baseis a cost driver that causes

overhead.

Application of Manufacturing Overhead

3-21

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3-21

Using a predetermined rate makes itpossible to estimate total job costs sooner.

Actual overhead for the period is notknown until the end of the period.

$


3-22

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3 22


Estimate the level of

production for the period.

Estimate the total amount of theallocation base in the denominator that

would be required for that level of production. Estimate the total manufacturing overhead

cost in the numerator that would be incurred

for the estimated amount of the allocation base.

Predetermined overhead rates arecalculated using a three-step process.

3-23

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3 23


Overhead applied = POHR × Actual activity

The predeterminedoverhead rate(POHR) isbased on estimates anddetermined before the

period begins.

Actual amount of the allocation isbased upon the actual level of activity.

3-24

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3 24

For each direct labor hour worked on aparticular job, $4.00 of factory overhead

will be applied to that job.

POHR = $4.00 per DLH

$640,000

160,000 direct labor hours (DLH)POHR =

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =


3-25

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3 25


3-26

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3-27

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Interpreting the Average Unit Cost

The average unit cost should not be interpretedas the cost that would actually be incurred if an

additional unit were produced.

Fixed overhead would not change if another unitwere produced, so the incremental cost of another unit is something less than $118.

3-28

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Quick Check

Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at$15 per hour. Estimated total overhead for the year was $760,000 and estimated direct

labor hours were 20,000. What would berecorded as the cost of job WR53?

a. $200.

b. $350.c. $380.

d. $730.

3-29

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Quick Check

Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at$15 per hour. Estimated total overhead for the year was $760,000 and estimated direct

labor hours were 20,000. What would berecorded as the cost of job WR53?

a. $200.

b. $350.c. $380.

d. $730.

POHR = $760,000/20,000hours $38

Direct materials $200Direct labor $15 x 10 hours $150

Manufacturing overhead $38 x 10 hours $380

Total cost $730

3-30 Job Order Costing

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Job-Order CostingDocument Flow Summary

A sales order is thebasis of issuing aproduction order.

A productionorder initiateswork on a job.

3-31 Job-Order Costing

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Job CostSheets

MaterialsRequisition

ManufacturingOverheadAccount

Directmaterials

Indirectmaterials

Materials usedmay be either

direct or indirect.


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Job CostSheets

Employee TimeTicket


An employee’s time may be either direct or indirect. Direct

Labor

IndirectLabor


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Other Actual

OverheadCharges

Job CostSheets

Applied

Overhead

MaterialsRequisition

EmployeeTime Ticket

Indirect

Material

Indirect

Labor


3-34 An Extended Example

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An Extended Exampleof Job-Order Costing

Rand Company produces gold and silver commemorative medallions. At the beginning of April,Rand company had no finished goods inventory and

one job (Job A) in process, a special mintingof 1,000 gold medallions commemorating the

invention of motion pictures. Manufacturing costsincurred to date on Job A total $30,000. Job A will be

completed in April and Job B, an order for 10,000 sliver medallions commemorating the fall of the Berlin Wall,

will be started in April and finished in a subsequent month.


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Given this information, we will now

track the flow of Rand Company’s raw materials, direct labor andoverhead costs for April and preparean income statement for the month.

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Beginning balance 30,000$

Direct materials 28,000

Direct labor 40,000

Job Cost SheetJob A

Beginning balance -$


Direct labor 20,000

Job Cost SheetJob B

Indirect materials 2,000$

Indirect labor 15,000

Manufacturing OverheadIncurred

Job A direct labor 40,000$

Job B direct labor 20,000


Total 75,000$

Various Time Tickets


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Direct labor 40,000

Job Cost SheetJob A



Direct labor 20,000

Job Cost SheetJob B



General factory

overhead 78,000


Factory utilities 21,000$

Rent on factory equipment 16,000 Factory property taxes 13,000

Factory insurance 7,000

Manufacturing depreciation 18,000

Miscellaneous factory overhead costs 3,000

Total general factory overhead 78,000$

Manufacturing Overhead Accounts

3-39

L i Obj ti 4

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Apply overhead

costs to jobs usinga predeterminedoverhead rate.


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Let’s assume the following:

• Rand’s predetermined overhead rate is $6 per machine hour.

• During April, 10,000 machine hours were worked on Job A.

• During April, 5,000 machine hours were worked on Job B.

Job A: $6 per machine hour × 10,000 machine hours = 60,000$

Job B: $6 per machine hour × 5,000 machine hours = 30,000

Total overhead applied to jobs 90,000$

Overhead Applied to Jobs


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Job A: $6 per machine hour × 10,000 machine hours = 60,000$

Job B: $6 per machine hour × 5,000 machine hours = 30,000

Total overhead applied to jobs 90,000$

Overhead Applied to Jobs



Direct labor 40,000

Manufacturing overhead

applied 60,000

Total 158,000$

Job Cost SheetJob A



Direct labor 20,000

Manufacturing overhead

applied 30,000

Total 72,000

Job Cost SheetJob B



General factory

overhead 78,000

Total 95,000$


3-42

L i Obj ti 5

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Determine underappliedor overapplied overhead.

3-43

U d li d O li d O h d

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Underapplied or Overapplied Overhead

The difference between the overhead cost applied toWork in Process and the actual overhead costs of aperiod is referred to as either underapplied or

overapplied overhead.

Underapplied overhead exists when the amount of overhead applied to jobs

during the period using the

predetermined overheadrate is less than the total

amount of overhead actuallyincurred during the period.

Overapplied overhead exists when the amount of overhead applied to jobs

during the period using the

predetermined overheadrate is greater than the totalamount of overhead actuallyincurred during the period.

3-44

U d li d O li d O h d

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Actual manufacturing overhead 95,000$

Manufacturing overhead applied 90,000

Underapplied manufacturing overhead 5,000$

Recall the following facts for Rand Company:

Underapplied or Overapplied Overhead

3-45

Q i k Ch k

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Tiger, Inc. had actual manufacturing overheadcosts of $1,210,000 and a predeterminedoverhead rate of $4.00 per machine hour. Tiger,Inc. worked 290,000 machine hours during theperiod. Tiger’s manufacturing overhead is

a. $50,000 overapplied.

b. $50,000 underapplied.

c. $60,000 overapplied.

d. $60,000 underapplied.

Quick Check

3-46

Q i k Ch k

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Tiger, Inc. had actual manufacturing overheadcosts of $1,210,000 and a predeterminedoverhead rate of $4.00 per machine hour. Tiger,Inc. worked 290,000 machine hours during theperiod. Tiger’s manufacturing overhead is

a. $50,000 overapplied.

b. $50,000 underapplied.

c. $60,000 overapplied.

d. $60,000 underapplied.

Quick Check

Overhead Applied$4.00 per hour × 290,000 hours= $1,160,000

Underapplied Overhead$1,210,000 - $1,160,000= $50,000

3-47

Di iti f U d O li d O h d

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Disposition of Under- or Overapplied Overhead

$5,000 can beclosed directly to

cost of goods sold.

Cost of Goods Sold

Rand’s Method

Work inProcess

FinishedGoods

Cost of Goods Sold

$5,000can be allocated

to these accounts.

OR

3-48

Di iti f U d O li d O h d

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Disposition of Under- or Overapplied Overhead

We will alwaysassume that underapplied or

overapplied overhead is closed outto Cost of Goods Sold.

Overapplied overhead isdeducted from

Cost of Goods Sold.

Underapplied overhead isadded to

Cost of Goods Sold.

3-49

Quick Check

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Quick Check

What effect will the underapplied overheadhave on Rand’s net operating income?

a. Net operating income will increase.

b. Net operating income will be unaffected.

c. Net operating income will decrease.

3-50

Quick Check

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What effect will the underapplied overheadhave on Rand’s net operating income?

a. Net operating income will increase.

b. Net operating income will be unaffected.

c. Net operating income will decrease.

Quick Check

3-51


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Use the direct method todetermine cost of goods

sold.

3-52

Prepare an Income Statement

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Let’s recall some key facts from the Rand Company example:

Job A, which consisted of 1,000 goldmedallions, was completed during April,

but Job B was not completed.

The unit product cost for each of the 1,000gold medallions included in Job A was

$158 ($158,000 ÷ 1,000 units).

The overhead for April was underappliedby $5,000.

3-53 The Direct Method of Determining

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gCost of Goods Sold

750 of the 1,000 gold medallionsincluded in Job A were shipped to

customers by the end of April.

Cost of the medallions sold to customers

750 units @ $158 per unit = $118,500

3-54 The Direct Method of Determining

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gCost of Goods Sold

Unadjusted cost of goods sold 118,500$

Add: Underapplied overhead 5,000

Cost of goods sold 123,500$

3-55


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Use the indirect method todetermine cost of goods

sold.

3-56 The Indirect Method of Determining

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gCost of Goods Sold

Let’s recall some key facts from the Rand Company example:

The beginning work in process inventory was $30,000—thebeginning balance on Job A’s cost sheet.

There was no beginning finished goods inventory on April 1.

The total manufacturing costs charged to jobs in April was$200,000 (direct materials of $50,000, direct labor of $60,000

and manufacturing overhead applied of $90,000).

The ending work in process inventory is $72,000—theaccumulated cost of Job B.

Manufacturing overhead was underapplied by $5,000.

3-57 Computing Ending Finished

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p g gGoods Inventory

250 of the 1,000 gold medallionsincluded in Job A were unsold andin ending finished goods inventory.

Cost of the medallions in ending finished

goods inventory250 units @ $158 per unit = $39,500

3-58 Computing Cost of

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p gGoods Manufactured

Total manufacturing cost charged to jobs

+ Beginning work in process inventory

–

Ending work in process inventory= Cost of goods manufactured

3-59 Computing Cost of

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Total manufacturing cost charged to jobs

+ Beginning work in process inventory

–

Ending work in process inventory= Cost of goods manufactured

p gGoods Manufactured

200,000$

+ 30,000

– 72,000

= 158,000$

3-60

Computing Cost of Goods

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Beginning finished goods inventory

+ Cost of goods manufactured

– Ending finished goods inventory

= Cost of goods sold (unadjusted)

3-61


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Beginning finished goods inventory

+ Cost of goods manufactured

– Ending finished goods inventory

= Cost of goods sold (unadjusted)

-$

+ 158,000

– 39,500

= 118,500$


Add $5,000 underapplied overhead toobtain $123,500 cost of goods sold.

3-62


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To complete the income

statement, let’s assume that Rand Company’s total sales revenue and selling and administrative expenses

for April were $225,000 and

$87,000, respectively.

3-63


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Sales 225,000$

Cost of goods sold 123,500

Gross margin 101,500

Selling and administrative expenses 87,000

Net operating income 14,500$

Rand Company

Income Statement

For the Month Ending April 30

3-64

Multiple Predetermined Overhead Rates

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Multiple Predetermined Overhead Rates

To this point, we have assumed that there is asingle predetermined overhead rate called aplantwide overhead rate.

Large companiesoften use multiple

predetermined

overhead rates,

Which is morecomplex but . . .

it is more accuratebecause it reflectsdifferences across

departments.

3-65

Job-Order Costing in Service Companies

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Job Order Costing in Service Companies

Job-order costing is used in manydifferent types of service companies.

3-66

The Use of Information Technology

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The Use of Information Technology

Technology plays an important part in many job-order cost systems. When combined with

Electronic Data Interchange (EDI) or a

web-based programming language calledExtensible Markup Language (XML), bar coding eliminates the inefficiencies and

inaccuracies associated with manual clerical

processes.

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Appendix 3A

The PredeterminedOverhead Rate and Capacity

3-68


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Understand the implications of basing the predetermined

overhead rate on activity atcapacity rather than on

estimated activity for the

period (Appendix 3A).

3-69

Predetermined Overhead Rate and Capacity

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Predetermined Overhead Rate and Capacity

Calculating predetermined overhead rates usingan estimated, or budgeted amount of theallocation base has been criticized because:

1. Basing the predetermined overhead rate uponbudgeted activity results in product costs thatfluctuate depending upon the activity level.

2. Calculating predetermined rates based upon

budgeted activity charges products for costs thatthey do not use.

3-70

Capacity-Based Overhead Rates

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Capacity Based Overhead Rates

These criticisms can be overcome by usingestimated total units in the allocation base at

capacity in the denominator of thepredetermined overhead rate calculation.

Let’s look at the difference!

3-71

An Example

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An Example

Equipment is leased for $100,000 per year.Running at full capacity, 50,000 units may beproduced. The company estimates that 40,000 units

will be produced and sold next year. What is the

predetermined overhead rate?

3-72

An Example

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An Example

Equipment is leased for $100,000 per year.Running at full capacity, 50,000 units may beproduced. The company estimates that 40,000 units

will be produced and sold next year. What is the

predetermined overhead rate?

EstimatedMethod

= $2.50 per unit$100,000

40,000=

CapacityMethod

= $2.00 per unit$100,00050,000

=

3-73

Quick Check

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Quick Check

Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. If run atfull capacity, it can cork 50,000 cases of wineper year. The company estimates 40,000 cases

of wine will be produced and sold next year.What is the predetermined overhead rate basedon the estimated number of cases of wine?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

3-74

Quick Check

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Quick Check


of wine will be produced and sold next year.What is the predetermined overhead rate basedon the estimated number of cases of wine?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

3-75

Quick Check

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Quick Check


of wine will be produced and sold next year.What is the predetermined overhead rate basedon the number of cases of wine at capacity?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

3-76

Quick Check

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Q


of wine will be produced and sold next year.What is the predetermined overhead rate basedon the number of cases of wine at capacity?

a. $2.00 per case.

b. $2.50 per case.

c. $4.00 per case.

3-77

Quick Check

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Q

When capacity is used in the denominator of thepredetermined rate, what happens to thepredetermined overhead rate as estimatedactivity decreases?

a. The predetermined overhead rate goes up whenactivity goes down.

b. The predetermined overhead rate stays thesame; it is not affected by changes in activity.

c. The predetermined overhead rate goes downwhen activity goes down.

3-78

Quick Check

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Q

When capacity is used in the denominator of thepredetermined rate, what happens to thepredetermined overhead rate as estimatedactivity decreases?

a. The predetermined overhead rate goes up whenactivity goes down.

b. The predetermined overhead rate stays thesame; it is not affected by changes in activity.

c. The predetermined overhead rate goes downwhen activity goes down.

3-79

Quick Check

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When estimated activity is used in thedenominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?

a.The predetermined overhead rate goes up whenactivity goes down.

b.The predetermined overhead rate stays thesame; it is not affected by changes in activity.

c.The predetermined overhead rate goes downwhen activity goes down.

3-80

Quick Check

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When estimated activity is used in thedenominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?

a.The predetermined overhead rate goes up whenactivity goes down.

b.The predetermined overhead rate stays thesame; it is not affected by changes in activity.

c.The predetermined overhead rate goes downwhen activity goes down.

3-81 Income Statement Preparation(Capacity Method)

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(Capacity Method)

Actual volume 40,000 cases

Selling price $40.00 per caseVariable production cost $24.00 per case

Fixed manufacturing overhead $100,000 per year

Capacity 50,000 cases

Predetermined overhead rate $2.00 per case

Fixed selling and admin. expense $500,000 per year

Revenue 1,600,000$

Cost of goods sold 1,040,000

Gross margin 560,000 Cost of idle capacity 20,000

Selling and admin. expense 500,000


3-82 Income Statement Preparation(Capacity Method)

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Actual volume 40,000 cases

Selling price $40.00 per caseVariable production cost $24.00 per case

Fixed manufacturing overhead $100,000 per year

Capacity 40,000 cases

Predetermined overhead rate $2.50 per case

Fixed selling and admin. expense $500,000 per year

Revenue 1,600,000$

Cost of goods sold 1,060,000

Gross margin 540,000 Cost of idle capacity -

Selling and admin. expense 500,000


(Capacity Method)

3-83

End of Chapter 3

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