Chapter 3: Job Order Costing Systems

A job-order costing is used in situations where many different products are produced
each period. Job order costing is a costing method which is used to determine the cost
of manufacturing each product. This costing method is usually adopted when the
manufacturer produces a variety of products which are different from one another and
needs to calculate the cost for doing an individual job.
Cost Accounting System
▪ The cost accounting system uses the perpetual inventory system, and achieves
greater accuracy in the determination of product costs than is possible with the
general accounting system.
▪ A job order cost system provides a separate record of the cost of each particular
quantity of product that passes through the factory. The system accumulates costs
for a particular batch of production, commonly referred as a Job. A job has a
definite starting and completion time as would, for example, the production of 10
pieces of windows, or 50 coffee tables.
▪ In job order costing system, costs are accumulated by job. For each job, the firm
maintains a separate job cost sheet, which is a record on which manufacturing
costs of the job are accumulated.
Job order costing for manufacturing firms:
An interrelationship exists between the physical flow of production, and the cost
accounting cycle. The flow of costs parallels the flow of work in the production settings.
Work and cost flow in job order costing cycle
The physical flow of production is the sequence of operating activity that begins with the
decision to order direct materials and ends with finished product being sold to customers.
The intervening steps may vary from firm to firm, but they share a common thread. The
following may show the steps of the physical flow of production.
1. Purchase requisition – For commonly used direct materials, organizations have a
reorder level, which is the minimum amount of stock that can be on hand at any
given time before another purchase is made to meet the lead time demand. The
reason for maintaining such a minimum stock level is to hedge against the risk of
stock shortages due to reasons like unexpected heavy usage, delays and other
reason that results in stock out situations. When the stock level reaches such a
point, the storeroom clerk fills a purchase requisition, a form requesting the
purchase of the needed material. After the form is duly filled, it will be sent to the
purchasing department.
A sample of purchase requisition form looks like the one as follows:
ALDER Furniture Factory
Date January 5, 2004 Requisition no. 121
Purchase requisition form
Prepared by:
Quantity Description Date needed
1,000.00 board ft Lumber (eucalyptus) January 15, 2004

5 gallons Glue January 15, 2004

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 50 boxes Nails January 15, 2004

 No journal entry is required when a purchase requisition is

prepared.
2. Purchase order – the purchasing department following purchase requisitions from
the storeroom clerk will prepare a purchase order. A purchase order is a document
that authorizes the supplier to ship the specified merchandise ordered. A typical
purchase order may contain the following:
A sample purchase order looks the following:
ALDER Furniture Factory
Purchase order form
Date January 6, 2004 Purchase No. 496
Vendor
Gentle lumber processing
Arat Kilo, Close to AAU, Science faculty
F.O.B point Ship Via Terms Delivery Requisition
date no.
Factory site Tana 2/10, n/30 Jan. 15, 121
Transport PLC 2003
Item no. Quantity Description Unit price Total
1. 1,000 board ft. Lumber 20 20,000.00
(eucalyptus)
 No journal entry is required when a purchase order is
filled.
3. Receiving report – when the ordered materials are received, the receiving
department prepares a receiving report, which lists the description, and quantities
of goods received. A copy of the document will be sent to the storeroom clerk
along with the materials. The receiving report, together with the invoice of the
supplier forms the basis for recording the purchase of the materials. The purchase
of the lumber in the above example, for instance, would be as follows:

Dr. Cr.
January 15, 2003 Direct material 20,000.00
Account payable 20,000.00

A sample receiving report is shown below.

ALDER Furniture Factory
Receiving report form
Received from: Receiving report No. R
Gentle lumber processing Arat Kilo 1345
Close to AAU, Science faculty
Freight: Purchase order No. 496
Pd Collect
X

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 Date received: February 15, 2003 Received by: Abera G.

Quantity Description Weight

Gross Net
1,000 board ft. Lumber (eucalyptus)

4. Production order – a manufacturer can produce in response to a customer order

or just for stock. Whatsoever, when the decision to produce is made, productions
order will be prepared and approved by the manager in charge.
A sample production order is presented here below.
ALDER Furniture Factory
Production Order
Date: January 19, 2003 Job No. 365
Manufactured for: Stock
Date needed: March 20, 2003
Quantity Model number Description
150 F. 4152 Coffee table

Authorized by: Dereje Demissie

 No journal entries are required on the company’s books
when the production order is issued.
5. Material requisition – to commence production, evidently the production
department needs direct materials. The materials required for production are
requested through a document called material requisition form. The material
requisition form should contain specific description of the direct and indirect
materials required for production.
A sample material requisition form is shown below:
Material requisition No. 906 Date: January 28, 2003
Job No. to be charged: 365
Quantity Description Unit cost Total cost Classification
500 board ft. Lumber 20 10,000.00 Direct
1 box Nail 22 22 Indirect
1 Gallon Glue 30 30 Indirect
10,052.00
Direct materials -------10,000.00
Authorized signature Indirect materials ----------52.00

At the time the materials are issued from the storeroom, the following entry is made:
Jan. 28, 2003 Work in process 10,000.00
Manufacturing overhead 52.00
Raw materials 10,052.00

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 o Direct materials that are sent for manufacturing process are no more direct
materials since they are soon to be processed to become finished goods Thus, the
cost is charged to work in process account.
Job Cost Sheet
➢ Right after the materials are received from store, a job cost sheet will be prepared.
The job cost sheet is used to accumulate the manufacturing costs incurred in
producing that particular job.
➢ The key source document in a job costing system is a job cost record, also called
a job cost sheet, a document that records and accumulates all the costs assigned to
a specific job. The job cost record is started as soon as work begins in a particular
job.
➢ After being notified that the production order had been issued, the Accounting
Department prepares a job cost sheet. A job cost sheet is a form prepared for each
separate job that records the materials, labor, and overhead costs charged to the
job.
➢ In addition to serving as a means for chagrining costs to jobs, the job cost sheet
also serves as a key part of a firm’s accounting records. The job cost sheet form a
subsidiary ledger to the Work in Process account. A separate cost sheet is
maintained for each job. Thus, the value of work in process at any time can be
found by adding the different job cost sheet.
The following is a sample job cost sheet:
Job Cost sheet
Job No. 365 Date started: Jan. 29, 2003
Date completed: March 20, 2003
Item 4152 – coffee tables
For stock
Direct material Direct labor Manufacturing overhead
Date Req. Amount Date Hours Amount Date DLH Rate Amount
No.
Jan. 28 906 10,000
2003
Cost summary
Cost item Amount
Total direct material
Total direct labor
Total manufacturing overhead applied
Shipping summary
Date Number of units shipped Cost balance

6. Job time ticket – the second cost category of manufacturing firms is the direct
labor employed. A job time ticket is used to record how much time is spent on a
particular job. When a particular job is started, the employee fills the time the job
is started on the job time ticket, and he punch out the card and fills the time he
stopped when he left the job. Suppose analysis of the job time ticket showed

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 direct labor of 9,600.00 and indirect labor of 4,800.00, the journal entry to record
the cost of direct and indirect labor looks like the following:

Jan. 28, 2003 Work in process 9,600.00

Manufacturing overhead 4,800.00
Wages payable 14,400.00

A sample of job time ticket is shown below

Job time ticket
Employee’s Name: Date: March 5
Department: Sanding Time started: 8:30 am
Time completed: 11:30
Operation: Sanding Job no. 365
Hours Rate of pay Direct labor Comment
3 hrs. 8 24

Idle time may exist because of machine breakdown, or when there is material shortage or
time lost while the employee shifts from one job to another. The cost of idle time should
be absorbed by all units produced in the year instead of cost of a specified product. Thus,
cost of idle time is debited to overhead.
7. Manufacturing overhead – costs other than direct material and direct labor that
are necessary to transform the raw materials into finished goods are called
manufacturing overhead.
▪ Such Manufacturing costs are common costs – costs shared by more than one cost
object- that should be apportioned among the cost objects sharing the cost.
▪ However, the total overhead costs cannot be known exactly until the end of the
year. Thus, organizations should wait up to the end of the year if they are to
charge the actual amount.
▪ Yet, many jobs are completed but the job cost sheet remains open waiting for the
actual overhead cost. Thus, interim financial statements are impossible which in
turn affect managerial decision purposes.
▪ A predetermined overhead rate is determined to allocate such costs to individual
jobs, which is found by dividing estimated overhead cost to the estimated amount
of allocation base.
▪ The allocation base is assumed to be a cost driver of manufacturing overhead
costs.
▪ In other words, there has to be a cause and effect relationship between the
allocation base and manufacturing overhead costs. For instance, a labor intensive
firm should use a labor oriented base, and a machine base should use a machine
oriented base since most these overhead costs may respond to a change to the
allocation base.
o Costs include factory rent, electricity, and depreciation on machinery. Most of
these costs are common to more than one batch of job and hence cannot be
directly traced to a specific job.

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 o Thus, such costs must be assigned to the different cost objects in some way.
However, assigning MO to units of product is a difficult task; because of three
reasons:
1. MO is an indirect cost, it is difficult to trace to a particular job.
2. MO consists of many different items ranging from the grease used in machines to
the annual salary of production manager.
3. MO costs tend to remain relatively constant due to the presence of fixed costs.

❖ Therefore, the only way to assign overhead costs to products is to use an

allocation process. This allocation overhead cost is accomplished by selecting an
allocation base that is common to all of the company’s products and services.
❖ An allocation base is a measure such as direct labor hours (DLH) or machine
hours (MH) that is used to assign overhead costs to products and services. The
allocation base is used to compute the predetermined overhead rate:

Predetermined overhead rate = Estimated total manufacturing overhead cost

Estimated total units in the allocation base
➢ The predetermined overhead rate is based on estimated rather than an actual
figure. This is because the predetermined overhead rate is computed before the
period begins and is used to apply overhead cost to jobs throughout the period.
The process of assigning overhead cost to jobs is called overhead application.

Overhead applied to a particular job = Predetermined * Amount of the allocation

overhead rate base incurred by the job
o A predetermined overhead rate is calculated using the projected overhead cost and
some activity base that has a cause and effect relationship with manufacturing
overhead costs. For instance, assume that the projected overhead cost for the
upcoming year is Birr 80,000.00, and the direct labor hour is estimated to be
4,000 hrs, the predetermined overhead rate can thus be calculated as follows:
Predetermined overhead cost = Estimated overhead cost
Estimated activity base (direct labor hr.)
POR = 80,000 = 20 per direct labor hour.
4,000
If we assume that the direct labor hours spent on the job are 90, the manufacturing over
head applied will therefore be 90 X 20 =1800. The entry to record the manufacturing
overhead applied is as follows:

March 18, 2003 Work in process 1,800.00

Manufacturing overhead applied 1,800.00

▪ The manufacturing overhead applied is a contra account to the actual

manufacturing cost.
▪ Although actual costs are not assigned, they should be recorded as incurred.
Suppose that factory rent, utilities, and other manufacturing costs totaled Birr
22,000.00. The following entry is required to record the actual manufacturing
cost.

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March 20, 2003 Manufacturing over head 22,000.00
Various accounts 22,000.00

8. Finished good inventory ledger card – when work in process is completed and
transferred to the finished good inventory warehouse, the following journal entry
is required:
March 20, 2003 Finished goods 21,400.00
Work in process 21,400.00

9. Cost of goods sold – two records are maintained when sale is made under the
perpetual inventory system: one for sales and the other for cost of goods sold.
Assume that half of the coffee tables produced are sold for birr 180 each on with a
40% down payment. The entry to record the sales looks the following:
April 10, Cash 5,400.00
2003 Account receivable 8,100.00
Sales 13,500.00

▪ The total units produced are 150 as shown in the production order. Half of that
amount is 75, and 75 units at 180 is equal to 13,500.00. When we come to the cost
of goods sold, the total cost of goods produced is Birr 21,400.00. Thus, the unit
cost of each coffee table is Birr 142.67. The cost of the 75 units that are sold is
Birr 10,700.00.
▪ The following entry is necessary to record the cost of goods sold.

April 10, Cost of goods sold 10,700.00

2003 Finished goods 10,700.00

➢ In general, a firm’s cost accounting system parallels its flow of operation. The
nine steps followed in the previous illustration are summarized below in a concise
manner.
1. Procurement – raw materials and supplies needed for manufacturing are
ordered, received, and stored.
2. Production – raw materials are transferred from storeroom to factory. Labor,
tools, machines, power, and other costs are applied to transform the raw material
into finished product.
3. Warehousing – finished goods are moved from the factory to the ware house to
be held until they are sold.
4. Selling – customers are found. Merchandises are shipped from the warehouse,
and customer accounts are charged.

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The following diagram shows the above points:

Procurement Production Warehousing Selling

Raw materials Work in process Finished good CGS

In Out In Out In Out In

Direct labor

Out

MOH

Out

As shown in the table cost flow parallels with the physical flow of production.

Actual Costing versus Normal costing

The use of an applied overhead instead of an actual overhead has the advantage of
timeliness, and hence relevance for timely decision making. However, the amount may
not be as accurate as the actual overhead cost. But the actual cost is known only at the
end of the period, and thus product costing is impossible before the year ends. Actual
costing thus makes product costing untimely, and this in turn affect decisions like product
pricing, and controlling operations. Therefore, most firms use an applied overhead cost
than actual cost for indirect manufacturing costs.
▪ Normal costing is a costing system where the actual direct material and direct
labor are added to the work in process inventory at the actual amount, and
overhead costs are applied to the work in process inventory using a predetermined
overhead rate. The term normal comes from the idea that the rate is normalized
over a long period of time.
▪ Actual costing is a costing system where direct material and direct labor costs
are traced to the job at their actual amounts, and overhead costs are allocated
using actual overhead. Since manufacturing overhead costs cannot be directly
traced to each job in an economically feasible way, still the amount charged to
each job is simply an allocated amount. The difference is simply the use of an
actual overhead than an estimated overhead.

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The table below shows summary of actual and normal costing

Cost Assignment Actual costing Normal costing

Direct material Tracing Actual Actual
Direct labor Tracing Actual Actual
Manufacturing overhead Allocation Actual over head Estimated
rate X actual cost overhead rate X
driver used actual amount
of cost driver

Disposition of over and under applied overhead

Under normal costing, the actual amount of manufacturing overhead costs at the end of
the period rarely matches with the applied manufacturing overhead costs during that same
period. Often the applied amount may either be less or more than the actual amount.
▪ If the amount of manufacturing overhead is less than the actual amount, the
difference is said underapplied overhead or under absorbed overhead. When the
reverse is true, the difference is said overapplied overhead or over absorbed
overhead.
▪ Under and overapplied overhead at the end of one fiscal year should not be
carried to the upcoming periods; rather they should be disposed off in the year
the difference occurs. The disposition of under and over applied overhead costs
can take one of the following two ways.
➢ Closed out to Cost of Goods Sold.
➢ Allocated between Work in Process, Finished Goods, and Cost of Goods
Sold in proportion to the overhead applied during the current period in the
ending balances of these accounts.
Closed out to Cost of Goods Sold
Cost of Goods Sold xxx
Manufacturing Overhead xxx
(If the actual cost  overhead applied = Underapplied)

Manufacturing Overhead xxx

Cost of Goods Sold xxx
➢ (If the actual cost  overhead applied = Overapplied
▪ Suppose that the manufacturing overhead – control has a debit balance of Birr
607,500, and the manufacturing costs applied is Birr 540,000. The under applied
manufacturing overhead cost can thus be disposed to cost of goods sold in the
following manner:
Debit Credit
Cost of goods sold 67,500.00
Manufacturing overhead applied 540,000.00
Manufacturing overhead -control 607,500.00
OR
Debit Credit
Cost of goods sold 67,500.00

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 Manufacturing overhead 67,500

➢ The applied manufacturing overhead is a contra account to manufacturing

overhead control, and thus, the normal balance for the applied manufacturing
overhead is credit.
➢ At the end of the period both must be closed. The applied manufacturing overhead
is debited and the manufacturing overhead is credited, and any difference is
closed to cost of goods sold.

Allocated Between Accounts (Proration Approach)

Under and over applied overhead costs can also be disposed off by prorating to work in
process, finished good inventory and cost of goods sold. Assume the following
information is pertaining to Awash Manufacturing Company:

End of year balance Manufacturing overhead allocated

before proration component of year-end-balances
(before proration)
Work in process 11,400.00 3,907.00
Finished good 18,600.00 7,814.00
Cost of goods sold 427,500.00 183,629.00
Total 457,500.00 195,350.00

➢ Further, assume that the manufacturing overhead control account shows a

debit balance of Birr 192,650.00, which shows an overapplied balance of
Birr 2,700.00. The over applied amount of manufacturing overhead will
be prorated to work in process, finished good, and cost of goods sold.
o The proration base may be on the basis of the manufacturing overhead applied to
the three accounts, or on the respective balance of the three accounts. Prorating on
the basis of the manufacturing overhead applied is theoretical sound than using
the year-end balance. The table below shows the proration process:

Account Account Manufacturing Proration of the Account

balance overhead applied over allocated balance after
(%) overhead proration
Work in process 11,400.00 3,907.00 = 2% 2% X 2,700.00 11,346.00
54
Finished good 18,600.00 7,814.00 = 4% 4% X 2,700.00 18,492.00
108
Cost of goods sold 427,500.00 183,629.00=94% 94% X 2,700 424,962.00
2,538.00
Total 457,500.00 195,350.00 2,700.00 454,800.00

The following journal entry is required to show the proration of the over allocated
overhead.

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 Debit Credit
Manufacturing overhead applied 195,350.00
Work in process 54.00
Finished good 108.00
Cost of goods sold 2,538.00
Manufacturing overhead -control 192,650.00

Debit Credit
Manufacturing overhead 2700.00
Work in process 54.00
Finished good 108.00
Cost of goods sold 2,538.00

▪ The over allocated amount is prorated and the balance of work in process,
finished good, and cost of goods sold is reduced. The amount is reduced because
the costs of the three accounts initially charged higher than the actual, and thus
the balance must be reduced.
▪ The over allocated amount can be prorated on the basis of the year-end balance of
the respective accounts as well. The following table shows the proration of the
over allocated cost on the basis of the year-end balance of the three accounts.

Account Account Proration of the over allocated Account

balance overhead balance after
proration
Work in process 11,400.00 11,400/457,500.00 = 2.5% 11,332.50
2.5% X 2,700.00 = 67.5
Finished good 18,600.00 18,600.00/457,500.00 = 4% 18,492.00
4% X 2,700.00 = 108
Cost of goods sold 427,500.00 427,500.00/457,500.00 = 93.5% 424,975.50
93.5% X 2,700.00 = 2,524.5
Total 457,500.00 2,700.00 454,800.00

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The journal entry is the same except that the amount is different. The journal entry looks
the following:
Debit Credit
Manufacturing overhead applied 195,350.00
Work in process 67.50
Finished good 108.00
Cost of goods sold 2,524.50
Manufacturing overhead -control 192,650.00

Debit Credit
Manufacturing overhead 2700.00
Work in process 67.50
Finished good 108.00
Cost of goods sold 2,524.50

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