102B

Section 2 Handout
September 13, 2019
GSI: Kimmie George
[email protected]

Lecture Notes

• Absorption costing – all manufacturing costs, both fixed and variable, are assigned to units
of product
• Job order costing
o Used when many different products are produced each period
o Each order of a specific product is called a job
o Costs are traced and allocated to jobs
o Costs of the job are divided by number of units to get average cost per unit
• Job Cost Sheet
o Records the materials, labor and manufacturing overhead costs charged to a job
• Measuring Direct Labor cost
o Direct labor – labor charges easily traced to a particular job
o *note* labor costs that cannot be easily traced to specific jobs are treated as
manufacturing overhead (example – maintenance, supervision, cleanup)
• Computing Predetermined Overhead Rates
o Allocation base- a measure such as direct labor hours or machine hours that is used
to assign overhead costs to products and services
§ Most commonly used include direct labor-hours, direct labor cost, machine-
hours, units of product
o Predetermined overhead rate – computed by dividing total estimated
manufacturing overhead cost for the period by the estimated total amount of the
allocation base

o Four steps to compute predetermined overhead rate
o 1. Estimate total amount of the allocation base that will be required for next
period’s estimated level of production (example – total labor-hours required
to produce 100 units)
o 2. Estimate total fixed manufacturing overhead cost for the coming period
and the variable manufacturing overhead cost per unit of the allocation base
o 3. Use the cost formula to estimate the total manufacturing overhead cost
§ Total Cost = Fixed Cost + Variable Cost*Allocation Base
o 4. Compute predetermined overhead rate for the year using the above
formula
• Total job costs and unit product costs
o Total job cost = direct materials + direct labor + manufacturing overhead
o Unit product cost = total job cost / number of units
 o *note* The unit product cost is an average cost and cannot be interpreted as the cost
that would be incurred to produce another unit
• Why is job-order costing useful?
o Sales and production plans
o Pricing decisions
• Choosing an allocation base
o Oftentimes allocation bases do not reflect how jobs actually use overhead resources
§ Splitting the check example
§ Allocation base should drive the overhead cost
o Cost driver- factor such as machine-hours, computer time, or flight-hours that
causes overhead costs
§ Many companies assume direct labor-hours is only overhead cost driver and
use a single predetermined overhead rate
• Companies can improve job cost accuracy by using multiple predetermined overhead rates
o Department-specific OH rates
§ In labor-intensive departments, apply OH using direct labor-hours
§ In machine-intensive departments, apply OH using machine-hours
o Activity-based costing- create overhead rates based on activities performed by the
company
• Fun with journal entries!
o Recall the inventory accounts –

o And our new Manufacturing Overhead clearing account!

Quick Check – what are the journal entries made for the following transactions?


1. On April 1, Ruger Corp had $7,000 in raw materials on hand. During the month the company
purchased on account an additional $60,000 of raw materials.

Raw Materials 60,000
Accounts Payable 60,000


2. During April, $52,000 in (direct) raw materials were requisitioned from the storeroom for
use in production.

Work in Process 52,000
Raw Materials 52,000


3. In April, there was $60,000 of direct labor and $15,000 of indirect labor.

Work in Process 60,000
Manufacturing Overhead 15,000
Wages Payable 75,000


4. In April, there were general factory costs which include $21,000 for utilities, $16,000 for
rent on equipment, and $3,000 for miscellaneous overhead (all paid for on account).

Manufacturing Overhead 40,000
Accounts Payable 40,000


5. In April, there was $18,000 depreciation on factory equipment.

Manufacturing Overhead 18,000
Accumulated Depreciation 18,000


6. During April, the company applied manufacturing overhead to Work-in-Process using a $6
per machine-hour predetermined overhead rate. Assume that a total of $15,000 machine
hours were used.

Work in Process 90,000
Manufacturing Overhead 90,000



7. The company incurred $7,000 in depreciation on office equipment.

Depreciation Expense 7,000
Accumulated Depreciation 7,000


8. The company completes Job A in work-in-process to finished goods, with total costs of
$158,000.

Finished Goods 158,000
Work in Process 158,000


9. The company sells 750 of the 1,000 units produced in Job A for $225,000.

Accounts Receivable 225,000
Revenue 225,000

Cost of Goods Sold 118,500
Finished Goods 118,500


• Overhead and the Income Statement
o Overhead application will never be perfect
§ Underapplied overhead – company applies less overhead to production than
actually incurs
§ Overapplied overhead – company applies more overhead to production than
actually incurs
o Manufacturing Overhead clearing account
§ Debit actual incurred overhead costs and credit applied overhead costs
§ Balance must be 0 at the end of the period
• We must make adjustments such that manufacturing overhead
applied = manufacturing overhead incurred
o Year-end adjustments
§ We can take all of the under or over-applied overhead to cost of goods sold
§ OR we can allocate the under or over-applied overhead to finished goods,
work in process, and COGS based on the weights of their ending balance
• Example – underapplied overhead=$100, FG ending balance = $600,
WIP ending balance = $200 and COGS = $200
o Allocate 60% to Finished Goods - $60
o Allocate 20% to Work in Process - $20
o Allocate 20% to COGS – $20

Quick Check: Write the journal entries for the end of year adjustment in the above example.
 Finished Goods 60
Manufacturing Overhead 60

Work in Process 20
Manufacturing Overhead 20

COGS 20
Manufacturing Overhead 20



Practice Problems

23) In a job-order costing system that is based on machine-hours, which of the following formulas
is correct?
A) Predetermined overhead rate = Actual manufacturing overhead ÷ Actual machine-hours
B) Predetermined overhead rate = Actual manufacturing overhead ÷ Estimated machine-hours
C) Predetermined overhead rate = Estimated manufacturing overhead ÷ Estimated machine-hours
D) Predetermined overhead rate = Estimated manufacturing overhead ÷ Actual machine-hours



29) Johansen Corporation uses a predetermined overhead rate based on direct labor-hours to apply
manufacturing overhead to jobs. The Corporation has provided the following estimated costs for
the next year:


Direct materials $ 6,000
Direct labor $ 20,000
Rent on factory building $ 15,000
Sales salaries $ 25,000
Depreciation on factory equipment $ 8,000
Indirect labor $ 12,000
Production supervisor's salary $ 15,000


Jameson estimates that 20,000 direct labor-hours will be worked during the year. The
predetermined overhead rate per hour will be:
A) $2.50 per direct labor-hour
B) $2.79 per direct labor-hour
C) $3.00 per direct labor-hour
D) $4.00 per direct labor-hour

Solution:
Rent on factory building $ 15,000

Depreciation on factory equipment 8,000

Indirect labor 12,000

Production supervisor's salary 15,000

Manufacturing overhead $ 50,000

Predetermined overhead rate = Estimated total manufacturing overhead cost ÷ Estimated total
amount of the allocation base

Predetermined overhead rate = $50,000 ÷ 20,000 direct labor-hours = $2.50 per direct labor-hour

31) Purves Corporation is using a predetermined overhead rate that was based on estimated total
fixed manufacturing overhead of $121,000 and 10,000 direct labor-hours for the period. The
company incurred actual total fixed manufacturing overhead of $113,000 and 10,900 total direct
labor-hours during the period. The predetermined overhead rate is closest to:
A) $10.37
B) $12.10
C) $11.10
D) $11.30

Solution:

Estimated total fixed manufacturing overhead (a) $ 121,000

Estimated activity level (b) 10,000

Predetermined overhead rate (a) ÷ (b) $ 12.10

34) Giannitti Corporation bases its predetermined overhead rate on the estimated machine-hours
for the upcoming year. Data for the upcoming year appear below:


Estimated machine-hours 36,000
Estimated variable manufacturing overhead $ 3.01 per machine-hour
Estimated total fixed manufacturing overhead $ 1,058,040


The predetermined overhead rate for the recently completed year was closest to:
A) $29.39 per machine-hour
B) $32.40 per machine-hour
C) $32.81 per machine-hour
D) $3.01 per machine-hour

Solution:

Estimated total manufacturing overhead = $1,058,040 + ($3.01 per machine-hour × 36,000

Predetermined overhead rate = Estimated total manufacturing overhead ÷ Estimated total amount
of the allocation base = $1,166,400 ÷ 36,000 machine-hours = $32.40 per machine-hour

49) Carradine Corporation uses a job-order costing system with a single plantwide predetermined
overhead rate based on machine-hours. The company based its predetermined overhead rate for
the current year on total fixed manufacturing overhead cost of $105,000, variable manufacturing
overhead of $3.00 per machine-hour, and 70,000 machine-hours. The company recently completed
Job P233 which required 60 machine-hours. The amount of overhead applied to Job P233 is closest
to:
A) $90
B) $270
C) $450
D) $180

Solution:

Estimated total manufacturing overhead cost = Estimated total fixed manufacturing overhead cost
+ (Estimated variable overhead cost per unit of the allocation base × Estimated total amount of the
allocation base) = $105,000 + ($3.00 per machine-hour × 70,000 machine-hours) = $105,000 +
$210,000 = $315,000

Predetermined overhead rate = Estimated total manufacturing overhead cost ÷ Estimated total
amount of the allocation base = $315,000 ÷ 70,000 machine-hours = $4.50 per machine-hour
Overhead applied to a particular job = Predetermined overhead rate x Amount of the allocation
base incurred by the job = $4.50 per machine-hour × 60 machine-hours = $270

Homework Review

2-1 Job-order costing is used in situations where many different products, each with individual and
unique features, are produced each period.

2-2 In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of
product—units are said to fully absorb manufacturing costs. Conversely, all nonmanufacturing
costs are treated as period costs and they are not assigned to units of product.

2-8 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of
the accounting period to apply overhead and to cost jobs. If the company computes actual overhead
rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal
factors or variations in output. For this reason, most companies use predetermined overhead rates
to apply manufacturing overhead costs to jobs.

E2-9

1. The estimated total overhead cost is computed as follows:

Y = $1,980,000 + ($2.00 per MH)(165,000 MHs)

Estimated fixed overhead $1,980,000

Estimated variable overhead: $2.00 per MH × 165,000 MHs 330,000

Estimated total overhead cost $2,310,000

The plantwide predetermined overhead rate is computed as follows:

Estimated total overhead (a) $2,310,000

Estimated total machine-hours (b) 165,000 MHs

Predetermined overhead rate (a) ÷ (b) $14.00 per MH

 2. Total manufacturing cost assigned to Job P90:

Direct materials $1,150

Direct labor 830

Overhead applied ($14 per MH × 72 MHs) 1,008

Total manufacturing cost $2,988

3a. Given that the company is operating at 50% of its manufacturing capacity, an argument can
made that the company should pursue any business opportunities that generate a positive a
contribution margin. Based on the information provided, it appears that Job P90 does generate a
positive contribution margin as shown below:

Sales $2,500

Direct materials $1,150

Direct labor 830

Variable overhead applied ($2.00 per MH × 72 MHs) 144 2,124

Contribution margin $ 376

3b. The CFO’s argument is based on the assertion that Job P90 does not generate enough revenue to
cover the cost of the manufacturing resources that it consumes. However, given that the company is
operating at 50% of its manufacturing capacity, the overhead costs applied to Job P90 in
requirement 2 do not represent the cost of the overhead resources consumed making Job P90. In
other words, the overhead applied in requirement 2 includes a charge for used and unused
capacity. This reality provides instructors an opportunity to introduce students to the main idea
underlying Appendix 2B.

If we estimate a capacity-based overhead rate for the company and apply overhead costs to Job P90
using this rate, it reveals that the revenue generated by the job ($2,500) is still insufficient to cover
its manufacturing costs of $2,556, as computed below:

The estimated total overhead cost (at capacity) is computed as follows (keep in mind that 165,000
MHs ÷ 50% = 330,000 MHs):
Y = $1,980,000 + ($2.00 per MH)(330,000 MHs)

Estimated fixed overhead $1,980,000

Estimated variable overhead: $2.00 per MH × 330,000 MHs 660,000

Estimated total overhead cost $2,640,000

The predetermined capacity-based overhead rate is computed as follows:

Estimated total overhead (a) $2,640,000

Estimated total machine-hours (b) 330,000 MHs

Predetermined overhead rate (a) ÷ (b) $8.00 per MH

The total manufacturing cost assigned to Job P90 (using a capacity-based overhead rate):

Direct materials $1,150

Direct labor 830

Overhead applied ($8 per MH × 72 MHs) 576

Total manufacturing cost $2,556

E2-14

1. The estimated total overhead cost is computed as follows:

Y = $4,800,000 + ($0.05 per DL$)($8,000,000)

Estimated fixed overhead $4,800,000

Estimated variable overhead: $0.05 per DL$ × $8,000,000 DL$ 400,000

Estimated total overhead cost $5,200,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a) $5,200,000

Estimated total direct labor-dollars (b) 8,000,000 DL$

Predetermined overhead rate (a) ÷ (b) $0.65 per DL$

2. Total cost assigned to You Can Say That Again:

Direct materials $1,259,000

Direct labor 2,400,000

Overhead applied ($0.65 per DL$ × $2,400,000) 1,560,000

Total job cost $5,219,000

5-3 All other things equal, Company B, with its higher fixed costs and lower variable costs, will have
a higher contribution margin ratio than Company A. Therefore, it will tend to realize a larger
increase in contribution margin and in profits when sales increase.