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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: Pre-determined amount of allocation Overhead applied = X overhead rate base incurred by the job The predetermined overhead rate is computed before the period begins: Pre-determined overhead rate = Estimated annual overhead cost Estimated 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 laborhours incurred would be 50,000. Required: Determine the cost assigned to Job M301. Solution #2 Pre-determined overhead rate = $9.00 = Direct materials Direct labor Manufacturing overhead 20 pounds X 25 hours X 25 hours X $450,000 50,000 direct labor hours $7.00 = $12.00 = $9.00 = $140 $300 $225 $665

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Flow of Costs Through Inventory Accounts

Raw Materials Beginning Balance -DM Usage +Purchases Work in Process Beginning Balance +DM Usage +DL Usage +MOH Applied =Ending Balance Manufacturing Overhead Beginning Balance +Actual overhead costs incurred =Underapplied -MOH applied -COGM +COGM -COGS +COGS Finished Goods Beginning Balance Cost of Goods Sold Beginning Balance

=Ending Balance

=Ending Balance

=Ending Balance

= Overapplied

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

xxx

xxx xxx

xxx

xxx xxx

xxx xxx

xxx xxx

xxx xxx

xxx xxx xxx

xxx

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Finished goods are sold Cash or accounts receivable Sales Cost of goods sold Finished goods inventory Close balance in overhead account Underapplied Cost of goods sold Manufacturing overhead Overapplied Manufacturing overhead Cost of goods sold

xxx Xxx

xxx xxx

xxx xxx xxx 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 laborhours 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 Accounts payable b) Work in process Manufacturing overhead Raw materials c) Work in process Manufacturing overhead Sales commission expense Administrative salaries expense Salaries and wage payable d) Manufacturing overhead Accounts payable e) Manufacturing overhead Depreciation expense Accumulated depreciation 300,000 90,000 40,000 40,000 130,000 50,000 100,000 60,000 60,000 210,000 90,000 300,000

300,000

130,000

320,000

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f)

Work in process Manufacturing overhead (1)

715,000 715,000 300,000 200,000 200,000 150,000 275,000 275,000 150,000 300,000

g) Finished goods Work in process h) Accounts receivable Sales Cost of goods sold Finished goods i) Manufacturing overhead Cost of goods sold

Predetermined overhead rate = Overhead applied =

$650,000 20,000 DLH

= $32.50 per DLH

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

Manufacturing Overhead actual applied 40,000 130,000 715,000 60,000 210,000 275,000 overapplied

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Practice Problems
Practice Problem #1 Company XYZ makes custom motor boats. It incurred the following costs for the justcompleted 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 $100,000 Insurance expense 10,000 Depreciation expense 75,000 Indirect labor expense 150,000 Utilities expense 25,000 Rent 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 Actual manufacturing overhead Estimated direct labor cost Actual direct labor cost Total debits in the Work-In-Process account Total credits in the Work-In-Process account $600,000 639,000 480,000 500,000 1,880,000 920,000

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 workin-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: Direct Materials Direct Labor Job # 1 $145,000 $35,000 2 320,000 65,000 3 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) b) c) d) e) f) Compute the company's predetermined overhead application rate. Compute Rock Star's ending work-in-process inventory. Determine Rock Star's sales revenue. Was manufacturing overhead under- or overapplied during 20x3? By how much? Present the necessary journal entry to handle under- or overapplied manufacturing overhead at year-end. 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 Manufacturing overhead account is debited for the actual overhead costs incurred. True False Job cost sheets are used in a process costing system. True False Process costing is appropriate when a large number of identical products are produced. True False In a normal costing system manufacturing overhead is applied by multiplying the predetermined overhead rate by actual amount of the allocation base. True False The predetermined overhead rate is computed using actual amount of overhead. True False Underapplied overhead means that the actual overhead was less than the applied overhead. True False In the journal entry to close overapplied overhead Cost of Goods Sold is credited. True False Finished Goods inventory account is credited for the amount of cost of goods manufactured during a period. True False

2.

3. 4.

5.

6.

7.

8.

9.

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) b) c) d) Factor that causes overhead costs Part of direct materials Cost of goods sold 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) b) c) d)

Actual overhead is more than overhead applied Actual overhead is equal to overhead applied Overhead applied is less than actual overhead 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 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 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 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

6.

7.

8.

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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: Ending Beginning 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) Direct Labor Actual overhead $90,000 $40,000 $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: Direct labor cost: Predetermined overhead rate: Overhead applied to job B011: Total job cost: Practice Problem #2 Predetermined overhead rate: Overhead applied: $550,000 $25,000 $22.00 X $30,000 = $22.00 per DL$ = $660,000 500 pounds X $25.00 90 DLH X $18.00 $180,000 30,000 MH $6.00 X 150 MH $12,500 + $1,620 + $900 = $12,500 = $1,620 = $6.00 per MH = $900 = $15,020

Manufacturing Overhead actual applied 100,000 10,000 660,000 75,000 150,000 25,000 200,000 100,000 overapplied To close the balance in the manufacturing overhead account: Manufacturing overhead Cost of goods sold 100,000 100,000

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Practice Problem #3 Chocolate Chip $500 $200 (1) $250 (2) $950 Oatmeal Raisin (3) $600 $250 (4) $300 $1,150 Peanut Butter $350 (7) $150 (5) $175 (8) $675 Work in Process (6) $1,450 $600 (9) $725 (10) $2,775

Direct Materials Direct Labor Overhead Total Job Costs

(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 = b) Actual manufacturing overhead Applied manufacturing overhead Under-applied overhead c) $639,000 625,000 $14,000

Estimated overhead costs $600,000 Estimated direct labor cost $480,000

= 125% of direct labor cost

Debits to Work-In-Process Direct labor Applied manufacturing overhead Direct materials used

$1,880,000 500,000 625,000 $755,000

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d) Direct materials used Direct labor Applied overhead at 125% of direct labor Total cost e) Accounts receivable Sales Cost of goods sold Finished goods Practice Problem #5 Actual labor hours: Budgeted labor hours Actual overhead: Manufacturing overhead Cost of goods sold $590,000 $18.00 per hour $621,000 $18.00 per hour $590,000 - $11,900

Job #18 $16,500 36,000 45,000 $97,000 1,472,000 920,000 920,000

1,472,000

= 32,800 hours = 34,500 hours = $578,500 920,000

920,000

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Practice Problem #6 a) Estimated Overhead cost Estimated direct labor cost b) Job #3: Direct materials Direct labor Overhead applied c) Jobs #1 and #2: Direct materials Direct labor Overhead applied Revenue d) Actual manufacturing overhead Applied manufacturing overhead Under-applied overhead e) f) Cost of goods sold Manufacturing overhead

$250,000 $200,000

= 125% of direct labor $55,000 80,000 100,000 $235,000 $465,000 100,000 125,000 $690,000

$690,000 x 160% =

$1,104,000 $233,000 225,000 8,000

8,000

8,000

No. Companies use a predetermined application rate for several reasons including 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. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. False because the raw materials account is credited when raw materials are issued. True False because cost sheets are used in a job-order system. True True False because the pre-determined rate is computed using estimated overhead. False because underapplied means that the applied overhead is less than the actual overhead incurred. True False because finished goods is debited for the cost of goods manufactured. True False because factory rent is part of manufacturing overhead. False because selling expenses are expensed as incurred as a period cost. True True True 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. False because overhead is credited when overhead is applied. False because the pre-determined overhead rate is computed at the beginning of the year (hence the prefix pre). False because process costing is appropriate when all the products (the cornflakes) are essentially the same. False because indirect materials issued should be debited to Manufacturing Overhead.

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Solutions to Multiple Choice Questions

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

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