COST I Chapter - 3&4

CHAPTER- THREE
COSTING METHODS: THE COSTING OF RESOURCE

OUTPUTS
Several key points from prior chapters:
 Cost objects—services, projects, departments, customers, products,
and so on
 Direct costs and tracing—materials and labor
 Indirect costs and allocation—overhead costs
 Cost pool— A cost pool is a grouping of individual indirect cost
items. Cost pools are often organized in conjunction with cost-
allocation bases.
 Cost-allocation base— a cost driver is used as a basis upon which to
build a systematic method of distributing indirect costs.
Costing Systems
1. Job-costing— system accounting for distinct cost objects called jobs.
 Each job may be different from the next, and Consumes different
resources. Example: Computer repair jobs, aircraft, advertising etc.
2. Process-costing— system accounting for mass production of identical
or similar products. E.g: Oil refining, beverage, juice etc.
3. Operational costing system: In reality, few actual production processes
perfectly match either a job order costing system or a process costing
system.
 Thus, the typical product costing system combines parts of both job
order costing and process costing to create a hybrid system designed
specifically for an organizations particular production process.
3.1 JOB ORDER, BATCH AND CONTRACT COSTING METHODS
Job order costing:
 used to determine the cost of manufacturing each product
 usually adopted when manufacturers produces a variety of products
 Used by entities that make relatively small quantities or distinct batches
 individual job is considered as a cost object
e.g. Printing Co., ship-builders, furniture, Construction, Film-producing,
accounting and law firms, advertising, Medical clinics, etc.
Job cost information used to:
 To determine the profitability of individual jobs
 To assist in bidding on future jobs
 To evaluate professionals who are in charge of managing individual jobs.
FEATURES OF JOB COSTING
Products are produced only against customer's order(NOT

for stock of sales)
The costs are accumulated to each job separately.
A job is performed according to the customer's
specifications.
The job costing method falls under the category of specific
order costing.
Note: Service organizations would most likely use job-order costing to
assign and track costs to each client’s job.
COSTING APPROACHES
1.Actual costing—allocates:
Indirect costs based on the actual indirect-cost rates times the
actual activity consumption.
2.Normal Costing—allocates:
Indirect costs based on the budgeted indirect-cost rates times the
actual activity consumption.
Both methods allocate direct costs to a cost object the same
way: by using actual direct-cost rates times actual consumption
SEVEN-STEP ON JOB COSTING
1. Identify the job that is the chosen cost object.

2. Identify the direct costs of the job.
3. Select the cost-allocation base(s) to use for allocating indirect
costs to the job.
4. Match indirect costs to their respective cost-allocation base(s).
5. Calculate an overhead allocation rate:
6. Allocate overhead costs to the job:

Budgeted Allocation Rate x Actual Base Activity For the Job
7. Compute total job costs by adding all direct and indirect costs
together.
MATERIALS AND COST FLOWS IN A JOB ORDER SYSTEM AND THE
ACCOUNTING TREATMENT
 For manufacturing sector companies, there are three inventories;
1. Raw Materials: Accumulates all costs of raw materials purchased

transfer to the ledger;
Raw materials- Control xx
Account payable/cash – Control xx
(To record the cost of purchasing materials)
N.B. when materials are purchased they are recorded as assets not as
expenses.
2.Work-in-process inventory: accumulates all costs of resources used on jobs that have not
been completed
 When DM, DL are incurred and MOH are applied they immediately entered into the job cost
sheet.
1. For material usage; Requisition of direct and indirect materials (OH) into production:
Work-in-process (for direct materials) – Control xx
Manufacturing overhead (for indirect materials) – Control xx
Raw materials – Control
xx
 IMC are charged to MOH controlling account in the general ledger and separated from WIP
account.
 It is used to accumulate all manufacturing overhead costs as they are incurred during a
period.
2. For Labor Usage; Employees’ time tickets collected, and
forwarded to the accounting department. Either direct/IDL.
Work-in-process – Control( for DL) xx
Manufacturing overhead – Control xx
Salaries and wages payable/CASH – Control
xx
CONT’D
3. Recording various actual indirect costs other than indirect materials and
indirect labor costs.
Manufacturing overhead – Control xx
Accounts payable – Control xx
Prepaid expense xx
Property tax payable xx
Accumulated depreciation xx
4. Allocations of indirect cost to WIP account (overhead application).
Work-in-process – Control xx
Manufacturing overhead applied xx
3.Finished goods inventory: includes the total cost of all jobs completed
and transferred to finished goods during a particular period.
 Accumulates all costs of resources used on jobs that have been
completed.
 When goods are completed the costs of materials and labor held at WIP
inventory account is transferred to FG inventory account
To record cost of products completed
Finished goods – Control xx
To record the sale of finished goods to customers
Accounts receivable/cash - Control xx
Sales
xx
Cost of goods sold xx
CONT’D
5.To record cost of products are completed and transferred out from
production department to the ware house.
Finished goods - Control xx
 Overhead application is the process of charging manufacturing overhead
costs to job cost sheets and to work-in-process account.
5. To record the sale of finished goods to customers
Accounts receivable/cash – Control xx
Sales xx
Cost of goods sold xx
Finished goods – Control xx
JOB ORDER COSTING SYSTEM-ILLUSTRATION
Consider the following transactions for XY-Furniture Company for the month
of January, 2011 and pass the necessary journal entries assuming the company
uses perpetual inventory system.
1. Raw materials were purchased on account for $600,000
2. Raw materials were requisitioned for use in production during the month
costs $500,000 (direct materials of $480,000 and indirect materials of
$20,000)
3.Total payroll of the company for the month was about $200,000 (direct
manufacturing labor, indirect manufacturing labor, sales commission for
marketing personnel and administrative salary of 60%, 15%, 18% and 7%
respectively)
CONT’D
4. Manufacturing overhead application to jobs totals $70,000.

5. Work completed and transferred to finished goods considering from
goods started 90% were completed.
6. Sales for the period total $650,000 (40% is received in cash) and 90% of
the sales price represents cost of goods sold)
7. Other overhead costs consists of depreciation for $10,000 (80%, 20%
related to factory operation and selling and administrative activities
respectively), insurance expired during the year total $2,000 and other
manufacturing overheads costs of $27,000 (70% is paid in cash).
CONTROLLING ACCOUNTS FROM ACQUISITION TO SALES
 To track materials and cost flows from the acquisition stage to the sale of finished goods to customers, the accounting
system use different controlling accounts in the general ledger and other special accounts in the subsidiary ledger.
1. General ledger
2. Subsidiary ledger- summary of the job-cost record.
A. Materials records by type of materials:
B. Labor records by employee
C. Manufacturing department overhead records by month
D. Work-in-process inventory records by jobs:
E. Finished goods inventory records by jobs:
F. Other subsidiary records:

3. ACCOUNTING FOR MANUFACTURING OVERHEAD COSTS
 It Is the process of assigning the overhead costs from manufacturing
overhead to the work-in-process account.
 Recall that two different overhead accounts were used in the preceding
journal entries:
A) Manufacturing overhead control was debited for the actual overhead
costs incurred.
B) Manufacturing overhead allocated was credited for estimated (budgeted)
overhead applied to production through the work-in-process account.
There are five allocation bases to allocate MOH costs among different jobs
1. Physical output allocation base- Allocate IDMC depending on the No.
units produced & convenient for single type producers.
*Predetermined MOH cost rate = Estimated total MOH cost/Estimated units of production
*Indirect cost allocated to a job = predetermined MOH cost rate * Actual of a job
2. Direct materials cost: allocate indirect labor costs based on the %ge of DM cost
3. Direct labor cost: allocate indirect labor costs as %ge of direct labor/DL cost.
4. Direct labor hour: If there is a cause and effect relationship between direct labor hour
and MOH cost, direct labor hour is used as an allocation base.
*Predetermined MOH rate= estimated total MOH/estimated total DL hour available
*Indirect cost allocated to a job= predetermined MOH rate x actual Dl hour consumed
5. Machine hours: if the job is machine intensive, machine hours can be taken as
allocation base.
Predetermined MOH rate= estimated total MOH/ estimated machine hours available
Indirect cost allocated to a job= predetermined MOH rate x actual machine hour
consumed for a job

CONT’D
 Actual costs will almost never equal budgeted costs. Accordingly, an imbalance
situation exists between the two overhead accounts.
 If Overhead Control > Overhead Allocated, this is called Under allocated
Overhead
 If Overhead Control < Overhead Allocated, this is called Overallocated
Overhead
 exists in normal costing approach only.
 This difference will be eliminated in the end-of- period adjusting entry process,
using one of three possible methods.
 The choice of method should be based on such issues as materiality, consistency,
and industry practice.
THREE METHODS FOR ADJUSTING OVER /UNDER APPLIED
 Disposition of under applied and over applied overhead is the process of
removing under/over applied overhead from manufacturing overhead
account at the end of an accounting period.
1. Adjusted allocation rate approach—all allocations are recalculated
with the actual, exact allocation rate.
2.Proration approach—the difference is allocated
 between cost of goods sold, work-in-process, and finished goods based
on their relative sizes.
3. Write-off approach—the difference is simply written off to cost of
goods sold.
Required:
1) compute the over/under applied overhead

2) present the required closing entry assuming
a) Adjusted allocation rate approach

b) Proration approach
the MOH applied to each account
end balance of the selected accounts
c) Write – off to cost of goods sold approach

CHAPTER FOUR
4. THE PROCESS AND OPERATION OR SERVICE COSTING
METHODS
 Process costing methods

CHAPTER FIVE
5. JOINT PRODUCTS AND BYPRODUCTS COSTING
CHAPTER SIX
6. ACTIVITY-BASED COSTING AND MANAGEMENT

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CHAPTER- THREE

COSTING METHODS: THE COSTING OF RESOURCE

Products are produced only against customer's order(NOT

1. Identify the job that is the chosen cost object.

6. Allocate overhead costs to the job:

1. Raw Materials: Accumulates all costs of raw materials purchased

4. Manufacturing overhead application to jobs totals $70,000.

2. Subsidiary ledger- summary of the job-cost record.

A. Materials records by type of materials:

B. Labor records by employee

C. Manufacturing department overhead records by month

D. Work-in-process inventory records by jobs:

E. Finished goods inventory records by jobs:

F. Other subsidiary records:

consumed for a job

1) compute the over/under applied overhead

a) Adjusted allocation rate approach

c) Write – off to cost of goods sold approach

 Process costing methods

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