Managerial Accounting

Seventh Edition
James Jiambalvo

Chapter 2

Job-Order Costing for Manufacturing &

Service Companies
Copyright ©2020 John Wiley & Sons, Inc.
Chapter Outline Part 1 (1 of 2)

Learning Objectives
LO 1 Distinguish between manufacturing and nonmanufacturing
costs and between product and period costs.
LO 2 Discuss the three inventory accounts of a manufacturing firm
and describe the flow of product costs in a manufacturing
firm’s accounts.
LO 3 Discuss the types of product costing systems and explain the
relation between the cost of jobs and the Work in Process
Inventory, Finished Goods Inventory, and Cost of Goods Sold
accounts.
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 2
Chapter Outline Part 1 (2 of 2)

Learning Objectives
LO 4 Describe how direct material, direct labor, and manufacturing
overhead are assigned to jobs.
LO 5 Explain the role of a predetermined overhead rate in applying
overhead to jobs, and explain the treatment of the difference
between actual overhead and overhead allocated to jobs
using a predetermined rate.
LO 6 Explain how service companies can use job-order costing to
calculate the cost of services provided to customers.
LO 7 Discuss modern manufacturing practices and how they affect
product costing.
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 3
Learning Objective 1

Distinguish between manufacturing and nonmanufacturing

costs and between product and period costs.

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4

Merchandising and Manufacturing Firms

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Manufacturing Costs

• Direct Materials
o Cost of materials directly traceable to items produced
o Materials not directly traceable are indirect materials
• Direct Labor
o Cost of labor directly traceable to items produced
o Labor costs not directly traceable are indirect labor
• Manufacturing Overhead
o Cost of manufacturing activities other than direct materials
and direct labor

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Common Manufacturing Overhead Costs

Indirect factory labor Power, heat, and light in the factory

Indirect material Depreciation of factory equipment
Overtime premium Depreciation of plant
Nightshift premium Insurance on plant and factory equipment
Vacation and holiday pay for factory Repair of factory equipment
workers
Social Security and Medicare taxes Maintenance of factory building and
for factory workers grounds
Health insurance for factory workers Property taxes related to the factory

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Nonmanufacturing Costs

• Nonmanufacturing costs (also known as period costs) are

all costs that are not associated with the production of
goods
o Selling Costs
• Costs associated with securing and filling customer orders
e.g. advertising, sales salaries, depreciation of sales
equipment
o General and Administrative Costs
• Costs associated with the firm’s general management e.g.
human resources, accounting, corporate headquarters and
other support costs

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Product and Period Costs

• Product Costs
o Costs assigned to goods produced (i.e. direct materials,
direct labor, and manufacturing overhead)
o Included in inventory until goods sold
• Period Costs
o Costs identified with accounting periods (i.e. selling and
administrative expenses)
o Expensed in period incurred

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Relationships Among Cost Categories

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 10

Test Your Knowledge 1

Which of the following is not a product cost?

a. Depreciation on manufacturing equipment
b. Indirect materials
c. Insurance on manufacturing equipment
d. Bonus compensation to the company president ←

Answer:
d. Bonus compensation to the company president
(administrative expense)

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11

Test Your Knowledge 2

Which of the following is a period cost?

a. Raw materials costs
b. Manufacturing plant maintenance
c. Depreciation on plant equipment
d. Depreciation on salespersons’ laptops ←

Answer:
d. Depreciation on salespersons’ laptops (selling expense)

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12

Test Your Knowledge 3

Which of the following is a direct materials cost?

a. Steel for a ship builder ←
b. Postage and supplies in the mailroom
c. Factory rent
d. Wages for production line workers

Answer:
a. Steel for a ship builder

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13

Product Cost Information in Financial
Reporting/Decision Making
• Manufacturing companies use product costs to prepare
financial statements and for managerial decisions
o Often the cost information needed is different for the two
purposes
• Decision making relies on incremental analysis – an analysis
of the revenues and expenses that will actually increase or
decrease as a result of the decision
• You will need to separate the variable and fixed costs to do
an incremental analysis

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Decision Making/Incremental Analysis

• Incremental analysis
o Bob Williams, the owner of Eastlake Motorboat Company, is
considering taking out an advertisement in Wooden Boat
magazine
• The ad will cost $25,000
• Bob believes it will result in at least one additional order for a
custom boat
• On average, Eastlake boats sell for $90,000
• He expects $90,000 of incremental revenue and $25,000 of
incremental costs related to the ad
• Bob also needs to consider the incremental production costs
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Incremental Revenues and Expenses

• Incremental analysis
o Direct materials and direct labor are incremental
o Only 10% of overhead ($3,000) is incremental
o Incremental revenue exceeds incremental cost by $17,000.
Thus, Bob should place the ad.

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 16

Learning Objective 2

Discuss the three inventory accounts of a manufacturing firm

and describe the flow of product costs in a manufacturing
firm’s accounts.

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 17

Balance Sheet Presentation of Inventory
Accounts
• Raw materials inventory includes cost of materials on hand
• Work in process inventory includes goods partially complete
• Finished goods inventory includes cost of items ready for sale

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 18

Flow of Product Costs

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Cost of Goods Manufactured and Sold

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Flow of Product Costs in Accounts

1. Purchased materials
2. Requisitioned direct and indirect materials
3. Incurred and paid for direct and indirect labor
4. Incurred and paid other overhead costs
5. Overhead applied
6. Completed goods transferred to finished goods inventory
7. Finished goods sold

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 21

Test Your Knowledge 4

Star Plastics had requisitions for $250,000 of materials related

to specific jobs and $20,000 of indirect materials. Prepare the
journal entry to record the issuance of materials.

Work in Process-------------250,000
Manufacturing Overhead---20,000
Raw Materials-------------------270,000

You could also prepare two separate journal entries.

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Schedule of Cost of Goods Manufactured

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Test Your Knowledge 5

The formula to determine cost of goods sold is:

a. Beginning Work in Process + Cost of Goods Manufactured – Ending
Finished Goods
b. Beginning Work in Process + Cost of Goods Manufactured – Ending
Finished Goods
c. Beginning Finished Goods + Cost of Goods Manufactured – Ending
Finished Goods ←
d. Beginning Work in Process + Current Manufacturing Cost – Ending
Work in Process
Answer:
c. Beginning Finished Goods + Cost of Goods Manufactured –
Ending Finished Goods
LO 2 Copyright ©2020 John Wiley & Sons, Inc. 24
Test Your Knowledge 6

Cost of Goods Manufactured is $200,000, beginning Finished

Goods is $50,000, ending Finished Goods is $100,000, and ending
Work in Process is $10,000. What is the Cost of Goods Sold?
a. $100,000
b. $250,000
c. $50,000
d. $150,000 ←

Answer:
d. $150,000 ($50,000 + $200,000 – $100,000)

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 25

Learning Objective 3

Discuss the types of product costing systems and explain the

relation between the cost of jobs and the Work in Process
Inventory, Finished Goods Inventory, and Cost of Goods Sold
accounts.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 26

Job Order versus Process Costing

• Job Order Costing

o Companies produce goods to a customer’s unique
specifications
o Cost of job accumulated on job cost sheet
• Process Costing
o Companies produce large quantities of identical items
o Cost accumulated by each operation
o Unit cost of items determined dividing costs of production
by number of units produced

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Relating Product Costs to Jobs

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 28

Job Costs and Financial Statement Accounts

• The inventory accounts of a manufacturing company that will

reflect job costs on the financial statements
o Work in Process Inventory
• Balance sheet
o Finished Goods Inventory
• Balance sheet
o Cost of Goods Sold
• Income statement

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Learning Objective 4

Describe how direct material, direct labor, and manufacturing

overhead are assigned to jobs.

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 30

Job Order Costing System

• Job order costing begins when a company decides to

produce a specific product
• A job cost sheet accumulates the cost of the item or items
and contains detailed information on the three categories
of product costs
• Direct materials
• Direct labor
• Manufacturing overhead
o The next slide shows an example of a job cost sheet

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Job Cost Sheet

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Material Requisition

• A material requisition form is used to request the release

of materials from a company’s storage area
• Removal of materials from storage for use on a specific job
decreases Raw Materials and increases Work in Process
Inventory
o The next slide illustrates the journal entry and general
ledger postings assuming $60,000 of materials are issued to
specific jobs

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 33

Requisition of Materials Journal Entry

Requisition of raw materials for use on a specific job

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 34

Material Requisition Form

When these items are released from storage, the total cost is
posted to the job cost sheet

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Job Costs – Direct Labor

• Workers in a company that uses a job-order costing system

fill out time tickets to keep track of the amount of time
spent on each job
• Incurring direct labor costs increases Work in Process
Inventory and increases Wages Payable
o The next slide illustrates the journal entry and general
ledger postings assuming $10,000 of direct labor cost is
incurred

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 36

Direct Labor Cost Journal Entry

Cost of direct labor related to a particular job

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Labor Time Ticket

Workers fill out time tickets to keep track of the amount of

time spent on each job

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Labor Cost Summary

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Job Costs – Manufacturing Overhead

• Apply manufacturing overhead to jobs

o Choose an allocation base, for example direct labor hours or
direct labor cost
o Calculate overhead allocation rate
• Estimated overhead divided by estimated quantity of the
allocation base
o Use rate to apply overhead to jobs based on actual quantity
of base used

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 40

Test Your Knowledge 7

Lollah Mfg Company expects annual mfg. overhead to be $800,000,

50,000 direct labor hours costing $1,600,000 and machine run time
of 25,000 hours. Calculate overhead allocation rates based on
direct labor hours, direct labor cost, and machine time.
Overhead allocation rate based on direct labor hours
$800,000 / 50,000 = $16 per direct labor hour
Overhead allocation rate based on direct labor cost
$800,000 / $1,600,000 = 50% of direct labor cost
Overhead allocation rate based on machine time
$800,000 / 25,000 = $32 per machine hour
LO 4 Copyright ©2020 John Wiley & Sons, Inc. 41
Manufacturing Overhead Journal Entries
Step 1

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Manufacturing Overhead Journal Entries
Step 2

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Assigning Costs to Jobs: A Summary

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Eastlake: Decision Making

• Actual cost of Job 20124 is $31,600 + $25,200 + $39,816

= $96,616
• Suppose the customer is only willing to pay $115,000.
Should the sale be turned down? Probably not.
o Assuming 10% of overhead is variable and the remainder
is composed of fixed costs such as depreciation, the
incremental costs are $31,600 + $25,200 + $3,982 =
$60,782

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 45

Eastlake: Incremental Analysis

• The incremental profit of the job is $54,218, which is the

$115,000 the customer will pay minus the incremental
cost of $60,782
• Turning the job down would hurt financial performance
o The incremental revenues are higher than the
incremental costs

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The Flow of Costs

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The Flow of Costs – Journal Entry

• Suppose the cost of jobs completed is $160,000 and the

cost of jobs sold is $85,000. The journal entries are:

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Overhead Allocation Rates

• Overhead is made up of cost items indirectly related to

jobs produced
• Need to develop means of assigning overhead to jobs
o The rate is calculated as overhead cost divided by allocation
base
o A company had $50,000 of overhead cost and used 10,000
labor hours
• Its rate is $50,000 / 10,000 = $5 per labor hour

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Choices of Allocation Bases

• Choices of allocation bases include:

o Direct labor hours
o Direct labor cost
o Machine hours
o Direct material cost, among others
• Jobs with greater quantities of an allocation base will
receive larger allocations of overhead
• The allocation base used should be strongly associated
with overhead cost

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Activity Based Costing (ABC)

• Most firms use a single overhead rate

• Activity Based Costing (ABC) assigns overhead costs to
products using a number of allocation bases
o The major activities which create overhead costs are
identified and grouped (pools)
o Multiple rates calculated by dividing each pool by its
corresponding activity (driver)

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 51

Learning Objective 5

Explain the role of a predetermined overhead rate in applying

overhead to jobs, and explain the treatment of the difference
between actual overhead and overhead allocated to jobs
using a predetermined rate.

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 52

Predetermined Overhead Rates

• Companies can develop rates using actual overhead and

quantities of the base
o Most do not do this because actual costs are not known
until the end of the period
• Overhead rates are typically based on estimates of
overhead cost and the base
o Overhead rates calculated this way are called
predetermined overhead rates
Estimated total overhead cost
Predetermined overhead rate 
Estimated levelof allocation base

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 53

Overapplied Overhead

Manufacturing Overhead Manufacturing Overhead

Actual Overhead Overhead costs
Applied overhead is greater
costs incurred applied to jobs
than actual overhead

• If applied overhead is greater than actual overhead, overhead

is overapplied
• Eliminate overapplied overhead by:
o If a small amount, debit Manufacturing Overhead and credit Cost
of Goods Sold
o If relatively large amount, apportion and close to Work in
Process, Finished Goods and COGS

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 54

Underapplied Overhead

Manufacturing Overhead Manufacturing Overhead

Actual overhead is greater Actual overhead Overhead costs
than applied overhead costs incurred applied to jobs

• If actual overhead is greater than applied overhead, overhead

is underapplied
• Eliminate underapplied overhead by:
o If a small amount, debit Cost of Goods Sold and credit
Manufacturing Overhead
o If a relatively large amount, apportion and close to Work in
Process, Finished Goods and COGS

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 55

Test Your Knowledge 8

Overapplied overhead is:

a. Overhead applied to production greater than actual
overhead ←
b. Overhead in excess of standard overhead
c. Equal to the predetermined overhead rate
d. Overhead in excess of the amount in the previous
period
Answer:
e. Overhead applied to production greater than actual
overhead
LO 5 Copyright ©2020 John Wiley & Sons, Inc. 56
Test Your Knowledge 9

Actual overhead was $1,500.000. The predetermined overhead

rate was $17 per direct labor hour, and there were 100,000 direct
labor hours. Overhead was:
a. Underapplied by $200,000
b. Overapplied by $200,000 ←
c. Underapplied by $20,000
d. Overapplied by $20,000
Answer:
b. Applied overhead = 100,000 X $17 = $1,700,000. Actual minus
applied = $1,500,000 − $1,700,000 = $200,000 overapplied

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Eliminating Underapplied Overhead

• Suppose a company had $50,000 actual overhead and

$48,000 applied overhead
o Overhead is underapplied by $2,000
o The journal entry to close manufacturing overhead

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Apportioning Overapplied or Underapplied
Overhead
• The amount of under- or overapplied overhead should be
apportioned among Work in Process, Finished Goods and
Cost of Goods Sold
o Accomplished based on relative costs in the accounts
o The company from the previous slide has Work in Process of
$10,000, Finished Goods $10,000 and Cost of Goods Sold
$20,000
• Rate = 2,000 / (10,000 + 10,000 + 20,000) = $0.05 per dollar
in the account

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Eliminating Overapplied or Underapplied
Overhead
• The amount applied to each account is:
o Work in Process $10,000 * 0.05 = $500
o Finished Goods $10,000 * 0.05 = $500
o Cost of Goods Sold $20,000 * 0.05 = $1,000
• The journal entry to close manufacturing overhead

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Learning Objective 6

Explain how service companies can use job-order costing to

calculate the cost of services provided to customers.

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Job-Order Costing for Service Companies

• Service companies use the same process

o Allocate costs incurred to jobs
o Use predetermined rate to apply overhead to jobs
• Examples
o Hospitals
o Repair Shops
o Consulting Firms

LO 6 Copyright ©2020 John Wiley & Sons, Inc. 62

Service Company Example

• ICMS has a contract with RCP Communications

o Contract is for $4.2 million per year or $350,000 per month
o ICMS needs to determine the cost of providing services to
RCP
• The details follow on the next slide

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Job-Order Cost for Call Center

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Customer Profitability

• Is RCP a profitable customer?

o Cost of the job is $337,108.05
o Monthly revenue is $350,000
• Profit from the job is $12,891.95
• Markup is only 3.8%, which is lower than the company’s goal
of 30%
o This information is useful the next time the contract is up
for negotiation, especially if RCP presses for price
concessions!

LO 6 Copyright ©2020 John Wiley & Sons, Inc. 65

Learning Objective 7

Discuss modern manufacturing practices and how they affect

product costing.

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Modern Manufacturing Practices (1 of 2)

• Just-in-Time Production (JIT)

o Minimize raw materials and work in process inventories
o Develop flexible, balanced production that is flexible and
allows for smooth, rapid flow of materials
o Concentrate on improving quality
o Implications for over- and underapplied overhead
• Work in Process and Finished Goods Inventories are very
small
• Close difference into Cost of Goods Sold

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Modern Manufacturing Practices (2 of 2)

• Lean Manufacturing
o Similar to JIT
o JIT focus is inventory management
o Lean focus is elimination of waste
• Computer-Controlled Manufacturing
o Use computers (including robots) to control equipment and
achieve flexible and accurate production process
• Total Quality Management (TQM)
o Ensure products are of highest quality
o Production processes are efficient
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Full and Incremental Cost of a Job

Decision-Making Insight
When using job cost information to make a decision, care
must be taken because some costs going into a job are fixed
(e.g., depreciation on equipment that is included in
manufacturing overhead) and some costs are variable (e.g.,
direct material costs). Thus, the full cost of a job is not the
same as the incremental cost of a job.

LO 7 Copyright ©2020 John Wiley & Sons, Inc. 69

Copyright

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Copyright ©2020 John Wiley & Sons, Inc. 70