CHAPTER 2

Job-Order Costing for Manufacturing And

Service Companies

Merchandising and Manufacturing Firms

Balance Sheet Presentation of Product Costs

Raw Materials Inventory
Cost of materials on hand used to produce a companys products

Work in Process Inventory

Inventory account for the cost of goods that are only partially completed

Finished Goods Inventory

Account for the cost of all the items complete and ready to sell

Cost Classifications for Manufacturing Firms

Manufacturing Costs
Also known as product costs All costs associated with the production of goods

Nonmanufacturing Costs
Also known as period costs All costs not associated with the production of goods

costs expensing
Only manufacturing (product) costs are added to the value of inventory (just like purchases in a merchandising company). These costs become expenses when inventory is sold = cost of goods sold.

Nonmanufacturing (Period) costs are expensed in the period they are incurred.
Example: depreciation of manufacturing equipment is included in manufacturing overhead but depreciation of office furniture is depreciation expense of the period.

Manufacturing Costs
Direct Material Cost
Cost of all materials directly traced to items produced

Direct Labor Cost

Cost of labor directly traced to items produced

Manufacturing Overhead
Cost of manufacturing activities other than direct materials and direct labor (see next slide)

Common Manufacturing Overhead Costs

Nonmanufacturing Costs
Selling Costs
All costs associated with securing and filing customer orders

General and Administrative Costs

All costs associated with the firms general management

Which of the following is a product cost and so would be included in the cost of inventory?
1. Office supplies for the treasurers office. 2. Salaries of the mailroom employees. 3. Insurance premiums for factory building. 4. Sales commissions to the companies sales agents.
50% 50%

0%
1 2 3

0%
4

Flow of Product Costs in Accounts

cost of goods manufactured: the cost of goods that their manufacturing was finished and they were transferred from work-in-progress to finished goods.

Example: Glass factory 2010 results

a) What is the cost of goods manufactured?

b) What is net income for 2010?

Cost of Goods Manufactured

Cost of Goods Manufactured includes all costs of goods completed during the period.

Cost of Goods Sold

Cost of Goods Sold:

Cost of goods sold is always lower than cost of goods manufactured?

1. True 2. False

100%

0%
1 2

Job Costs Direct Materials

Requisition of raw materials for use on a specific job

Job Costs Direct Labor

Cost of direct labor related to a particular job

Example: Glass factory T accounts

Show the flow of resources through the T accounts: Raw Material Inventory (assume beginning balance was $500,000, purchases were $1,800,000, and ending balance was $300,000) Manufacturing overhead Work-in-progress inventory Finished goods inventory Cost of goods sold

Costing

What is the cost per unit produced? Why is it important?

Types of Costing Systems

Job-order Costing System
For Companies who produce individual products or batches of unique products Construction Company. Cost is allocated to each individual jobs according to the resources that were specifically used by it.

Process Costing System

Companies produce large quantities of identical items

Job-Order and Process Costing Examples

Companies who use job order: Cray Computer Corporation, Boeing Company, Chris Craft Boat Company, construction, Legal Services, or Repair Services tailored to client.

Companies who use process costing: Pepsico Incorporated, Starbucks Corporation, Revlon Consumer Products Corporation, Goodyear Tire and Rubber Company

Consider an aluminum company (e.g. ALCOA) and a company that builds space satellites (e.g. ASTRA). Which costing systems are they likely to use?
50% 50%

1. ALCOA: job costing; ASTRA: job costing 2. ALCOA: job costing; ASTRA: process costing 3. ALCOA: process costing; ASTRA: job costing 4. ALCOA: process costing; ASTRA: process costing

0%
1

0%
2 3 4

Relation Between the Costs of Jobs and the Flow of Costs

Relating Product Costs to Jobs

In a Job-Order Costing System, product costs (materials, labor and overhead) are related to specific jobs.

Job Cost Sheet

In Job-Order Costing Systems the primary document is called a Job-Cost Sheet. It is used to accumulate product costs. Direct Material Cost Material requisition form

Direct Labor Cost Time Tickets

Manufacturing Overhead ???

Overhead allocation
While direct materials and direct labor can be easily traced to jobs, overhead costs are indirect and need to be somehow allocated to jobs.

Job Costs Manufacturing Overhead

Apply manufacturing overhead to jobs
Choose an allocation base e.g. direct labor hours or direct labor cost Calculate overhead allocation rate
Estimated overhead /Estimated quantity of the allocation base

Use rate to apply overhead to jobs based on actual quantity of base used

Manufacturing Overhead

Job costing example

A boat factory makes custom boats. Factory workers consist of skilled supervisors (level 1 workers) and regular workers (level 2 workers). Three jobs were worked on this month: Job 1: 15 hours of labor (4 level 1, 11 level 2), $500 materials. Job 2: 20 hours of labor (4 level 1, 16 level 2), $2,000 materials. Job 3: 7 hours of labor (2 level 1, 5 level 2), $1,000 materials. Hourly wage: level 1 - $41, level 2 - $20. Manufacturing overhead for the month: $2,100.

What is the cost of each job?

Overhead Allocation Base

The overhead allocation base should be something common to all jobs which is also related to overhead costs

Alternative bases include: 1. Direct labor hours 2. Direct labor cost 3. Direct material cost.
Work out the previous example with different bases.

Assume a company allocates overhead with labor hours as the allocation base. A labor hour costs $10. The overhead allocation rate is $5 per labor hour. Assume that a certain job already required 2 labor hours and $30 of materials but now it seems it would need an additional labor hour to be finished (no additional materials will be needed). By how much would that additional labor hour increase the cost of the job?

1. $10 2. $20 3. $15 4. $40

25%

25%

25%

25%

Assigning Costs to Jobs: A Summary

Pricing and Evaluating with Job Order Costing

The estimated (budgeted) cost for a job can be used to determine a fair price. The actual cost can be compared to the estimated cost for performance evaluation.

Allocating Overhead to Jobs during the year

Should we just wait until the end of the year/period to figure out the overhead rate?

Predetermined Overhead Allocation Rate

At the beginning of the period the company estimates its overhead costs for the period, and estimates its use of the overhead base. This is used to calculate the above pre-detrmined overhead rate. During the year, overhead is applied to jobs according to units of the base used.

Allocating Overhead to Jobs

Actual overhead costs are accumulated in a manufacturing overhead control account by debiting or charging this account for overhead Overhead is applied by crediting manufacturing overhead and debiting work in process inventory

Job costing example

Take again the boat company example we used before, but assume that at the beginning of the month the company estimated overhead at $2,400 and labor hours at 40 hours (the details of the jobs are presented again for convenience): Job 1: 15 hours of labor (4 level 1, 11 level 2), $500 materials. Job 2: 20 hours of labor (4 level 1, 16 level 2), $2,000 materials. Job 3: 7 hours of labor (2 level 1, 5 level 2), $1,000 materials. Hourly wage: level 1 - $41, level 2 - $20. Manufacturing overhead for the month: $2,100. What would be the cost of each job? How much overhead was allocated/applied to jobs?

Job costing example

Show the T-account flow of the previous example assuming all 3 jobs started, ended, and were sold on the same month.

Comparing actual overhead costs to applied overhead

What if Applied overhead Actual overhead?
Under-applied Overhead
Actual overhead cost is greater than applied overhead

Over-applied Overhead
Actual overhead cost is less than applied overhead

Accounting for under or over applied overhead If the amount is relatively small it is treated as an adjustment to cost of goods sold If the amount large then it should be allocated between cost of goods sold, work in process and finished goods inventories If the amount is large then consider revising the rate and/or the base

If the overhead costs account has a debit balance at the end of the period (before closing it to COGS) that means that overhead was:
50% 50%

1. Over-applied 2. Under-applied

Activity-Based Costing (ABC) and Multiple Overhead Rates ABC is a method of assigning overhead based on a number of different allocation bases (rather than just one). ABC groups overhead costs into Cost Pools and selects a base for each pool. We discuss the ABC method later in chapter 6

Job-Order Costing for Service Companies

Job order costing may be ideal for service companies Examples
Hospitals Repair Shops Consulting Firms Accounting and legal services Painters, carpenters etc.

Job-Order Costing for Service Companies: example

LePlatt & Associates is an accounting firm. It employs 50 professionals who work directly with clients. The average expected total compensation per professional for the year is $115,000. Each professional works for clients to their maximum of 1,600 billable hours. All professional salaries are traced to individual client service summaries. All costs other than professional salaries are included in a single indirect cost pool (professional support). The indirect costs are assigned to service summaries using professional hours as the allocation base. The expected amount of indirect costs for the year is $5,000,000. Required a. Compute the budgeted indirect cost rate per hour of professional service. b. LaPlatt & Associates is bidding on tax and audit services for a potential client that are expected to require 100 hours of professional service time. Calculate the estimated cost of the work using average professional wage rates and basing indirect costs on estimated service time.

Modern Manufacturing Practices

Just-in-Time Production (JIT) Supply chain management results in little or no inventory. Inventory accounting becomes less important. Example- Dell Computer Company Computer-Controlled Manufacturing Automation More of the costs are indirect. Direct labor becomes less important. Total Quality Management (TQM) Costs of inspection and other indirect costs of maintaining quality become more important. Trade off costs of controlling quality against costs of defective units.

JIT or Just-in-Case?
Maintaining a large inventory is costly (financing, storage, and insurance costs) JIT avoids this by relying on supply chain to provide parts and materials on short notice. But if the supply chain is disrupted because of natural disasters,political events, or business problems then production may have to shut down causing loss of sales and customers.