Job order costing

Assistant Professor
Finance, Accounting & Control, IIM Sambalpur
[email protected]
Job Order Costing

• Job-order costing systems are used when:

1. Many different products are produced each period.
2. Products are manufactured to order.
3. The unique nature of each order requires tracing or
allocating costs to each job, and maintaining cost records
for each job.
 Examples of Job Costing
Examples of companies that would use job-order costing include:

1. Boeing (aircraft manufacturing)

2. Bechtel International (large scale construction)

3. Vistaprint (business card designer, printer, shipper)

4. Hallmark greeting cards

5. LSG Sky chefs – Caterer for airlines

• Job costing is used by service firms - Law firms, Advertising agencies, Accounting firms,

Consulting firms, Movie studios

Direct Materials cost

• Yost Precision has agreed to produce 2 experimental couplings for Loops

Unlimited manufacturer of roller coaster

• Couplings are important components for connecting the car and for the safety
of the ride

• Blueprint submitted by Loop Unlimited indicates that experimental couplings

require 2 G47 connectors and 1 M46 housing

• So 2 couplings need 4 G47 connectors and 2 M46 housings

Documents
Document 1: Bill of Material – Quantity of material for each job
Document 2: Material requisition note – Specify the type and quantity of material
to be drawn from the storehouse
Job Sheet
After the production order Job cost sheet is automatically updated
Measuring Direct Labor Costs
• Companies rely on computerized systems to maintain employee time tickets
• A completed time ticket is an hour-by-hour summary of employee activities
Job costing & absorption costing
• Under Job costing or absorption costing, the full costs (Fixed & Variable) are
allocated to the product, including:

• Direct Material

• Direct Labor

• Variable Manufacturing Overhead

• Fixed Manufacturing Overhead

• However, it's important to note that under absorption costing, the period costs do not
affect the product costs. These period costs include:

• Variable Selling & Administrative Costs

• Fixed Selling & Administrative Costs

Job Order Costing flow - 1
Direct Costs

Direct Materials Charge direct

Job No. 1 material and
direct labor
Direct Labor
Job No. 2 costs to each
job as work is
Job No. 3 performed.
Job-Order Costing – Cost Flow 2
Manufacturing
Direct Costs
Overhead,
Direct Materials including
Job No. 1 indirect
materials and
Direct Labor indirect labor,
Job No. 2
Indirect Costs are allocated to
Manufacturing all jobs rather
Job No. 3
Overhead than directly
traced to each
job.
 CLO 1 : Synthesize the costing information and describe basic cost terms, Job
Costing techniques of cost estimation, and control

LO 1: To compute a predetermined overhead rate

Manufacturing is an indirect cost

It’s impossible to trace these costs to product or job

Manufacturing overhead costs can be fixed or variable

Allocation is used to assign overhead costs to product

Step 1 : Identify the allocation base or the activity driver that is common to all products and services
 Why Use an Allocation Base?
An allocation base, such as direct labor hours, direct labor dollars, or
machine hours, is used to assign manufacturing overhead to individual
jobs.

We use an allocation base because:

a. It is impossible or difficult to trace overhead costs to particular jobs.
b. Manufacturing overhead consists of many different items ranging
from the grease used in machines to the production manager’s salary.
c. Many types of manufacturing overhead costs are fixed even though
output fluctuates during the period.
Manufacturing Overhead Application
The predetermined overhead rate (POHR) used to apply
overhead to jobs is determined before the period begins .

Estimated total manufacturing

overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

Ideally, the allocation base is a cost

driver that causes overhead.
 The Need for a POHR
Predetermined overhead rates that rely upon estimated
data are often used because:
1. Actual overhead for the period is not
known until the end of the period, thus inhibiting the
ability to estimate job costs during the period.
2. Actual overhead costs can fluctuate seasonally, thus
misleading decision makers.
 Computing Predetermined Overhead Rates
The predetermined overhead rate is computed before the period begins using a four-step process.
1. Estimate the total amount of the allocation base (the denominator) that will be required for next period’s
estimated level of production.
2. Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing
overhead cost per unit of the allocation base.
3. Use the following equation to estimate the total amount of manufacturing overhead:
4. Compute the predetermined overhead rate.

Y = a + bX
Where,
Y = The estimated total manufacturing overhead cost
a = The estimated total fixed manufacturing overhead cost
b = The estimated variable manufacturing overhead cost
per unit of the allocation base
X = The estimated total amount of the allocation base

Determining the Predetermined Overhead Rate =

CLO 2 : Demonstrate business decision-making using costing
techniques like ABC & cost control through budgeting and
standard costing

• LO2 : Apply overhead cost to jobs using a predetermined overhead

rate
 Overhead Application Rate
Yost Precision Machining estimates that it will require 40,000 direct labor-hours to meet the coming
period’s estimated production level. In addition, the company estimates total fixed manufacturing
overhead at $640,000, and variable manufacturing overhead costs of $4.00 per direct labor hour.

Y = a + bX
Y = $640,000 + ($4.00 per direct labor-hour × 40,000 direct labor-hours)
Y = $640,000 + $160,000
Y = $800,000

$800,000 estimated total manufacturing overhead

POHR =
40,000 estimated direct labor hours (DLH)

POHR = $20.00 per direct labor-hour

CLO 2 : Demonstrate business decision-making using Plantwide
Predetermined Overhead Rates

• LO3 : Compute the total cost and the unit product cost of a job
using a plantwide predetermined overhead rate
Example
• 27 direct labour hours (i.e. DLHs ) were charged to Job 2B47. Total of
manufacturing overhead cost would be applied to the job

• Overhead applied to Job 2B47 : Predetermined overhead rate x Actual

direct labor hours

• = $20 per DLH (Direct Labor Hour) x 27 DLHs (Direct Labor Hours)
• = $540 of overhead applied to Job 2B47
Calculating Total Cost of Job
Quick Check
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total manufacturing overhead for the year was
$760,000 and estimated direct labor hours were 20,000.
What would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
Quick Check
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000 and
estimated direct labor hours were 20,000. What would be
recorded as the cost of job WR53?
a. $200. POHR = $760,000/20,000 hours $38
b. $350. Direct materials $200
c. $380. Direct labor $15 x 10 hours $150
Manufacturing overhead $38 x 10 hours $380
d. $730. Total cost $730
Job-Order Costing – A Managerial Perspective – Part 1

Inaccurately assigning manufacturing costs to jobs adversely

influences planning and decisions made by managers.
1. Job-order costing systems can accurately trace direct materials and direct
labor costs to jobs.
2. Job-order costing systems often fail to accurately allocate the
manufacturing overhead costs used during the production process to their
respective jobs.
Calculating Plantwide overhead rate
• Redhawk company has 2 manufacturing departments – Assembly and
Fabrication. They consider all of its manufacturing overheads to be
fixed. The first set of data is considered for the overall level of output
and the second set of data is considered for the Job A200
Assembly Fabrication Total
Manufacturing $3,00,000 $4,00,000 $7,00,000
overhead costs
Direct labor hours 25,000 15,000 40,000
Machine hours 10,000 50,000 60,000
JOB A200
Direct material $110 $50 $160
Direct labor $70 $45 $115
Direct labor hours 10 hours 2 hours 12 hours
Machine hours 1 hour 7 hour 8 hours
Question for example
• If Redhawk uses a predetermined plantwide overhead rate with direct
labor hours as the allocation base, how much manufacturing overhead
rate will be applied to Job A200
• If Redhawk uses predetermined departmental overhead rates with
direct labor hours as the allocation base in Assembly and machine
hours as the allocation base in Fabrication, how much total
manufacturing overhead cost would be applied to Job A200
• Assumed that Redhawk uses the departmental overhead rates
mentioned in requirement 2 and Job A200 includes 50 units. What is
the unit product cost for job A200
Part A Calculation of predetermined overhead rate

• Predetermined overhead rate =

= $17.50 per direct labor hours

Job-Order Costing – A Managerial Perspective – Part 2

Choosing an Allocation Base

Job-order costing systems often use allocation bases that do not reflect
how jobs actually use overhead resources. The allocation base in the
predetermined overhead rate must drive the overhead cost to improve job
cost accuracy. A cost driver is a factor that causes overhead costs.

Many companies use a single predetermined plantwide overhead rate to allocate

all manufacturing overhead costs to jobs based on their usage of direct-labor
hours.
1. It is often overly-simplistic and incorrect to assume that direct-labor hours is a
company’s only manufacturing overhead cost driver.
2. If more than one overhead cost driver can be identified, job cost accuracy is
improved by using multiple predetermined overhead rates.
Part B Calculation of departmental overhead rate

Pre determined overhead rate (Assembly Department)

= = $12 per direct labor hours

Part B Calculation of departmental overhead rate

• Fabrication department

= $8.00 per machine hours

Manufacturing Overhead is applied to Job A200

Overhead rate Actual hours used Applied Overhead

Assembly department $12 per DLH 10 hours 120
Fabrication department $8 per MH 7 hours 56
Total applied overhead $176

Job A200 Assembly Fabrication Total

Direct Material $110 $50 $160
Direct Labor $70 $45 $115
MOHS $120 $56 $176
Total job costs $451
Number of units 50
Per unit cost $9.02
CLO 2: Demonstrate business decision-making using
multiple predetermined overhead rates
LO3 : Compute the total cost and the unit product cost of a job multiple
plantwide predetermined overhead rate
 Step 1: Calculating the Predetermined Overhead Rate

• The predetermined overhead rate is calculated at the beginning of the

year by dividing the total estimated annual overhead by the total
estimated level of associated activity or cost driver:

Estimated Annual Overhead

Predetermined Overhead Rate 
Estimated Annual Activity Level

• Notice that the predetermined overhead rate includes estimated

amounts in both the numerator and the denominator
 Step 1: Calculating the Predetermined Overhead Rate

• This estimation is necessary because the predetermined overhead rate is

calculated in advance, usually at the beginning of the year
• Estimated overhead is the firm’s best estimate of the amount of
overhead (utilities, indirect labor, depreciation, etc.) to be incurred in
the coming year
o Estimates may be based on last year’s figures adjusted for anticipated changes in the
coming year
• The associated activity level depends on which activity is best
associated with overhead
o The number of machine hours could be a good choice of activity level for the overhead
of a company that has automated production
Step 2 : Applying Overhead to Production
• Once the overhead rate has been computed, the company can begin to
apply overhead to production
• Applied overhead is found by multiplying the predetermined overhead
rate by the actual use of the associated activity for the period:
• Applied Overhead = Predetermined Overhead Rate × Actual Activity Level

• Once this is calculated, the total cost of the product for the period is the
actual direct materials and direct labor, plus the applied overhead:
• Total Normal Product Costs = Actual Direct Materials + Actual Direct Labor+
Applied Overhead
Step 3: Reconciling Actual Overhead with Applied Overhead

• Remember that two types of overhead are recorded:

o Actual overhead: Costs are tracked throughout the year in the overhead account
o Applied overhead: Costs are computed throughout the year and added to actual direct
materials and actual direct labor to get the total product cost
o At the end of the year, however, it is time to reconcile any difference between actual and
applied overhead and to correct the cost of goods sold the account to reflect actual
overhead spending
o Applied overhead will rarely equal actual overhead
Step 3: Reconciling Actual Overhead with Applied Overhead

• The difference between actual overhead and applied overhead is called

an overhead variance
• If actual overhead is $400,000 for the year but $390,000 was applied to
production, we would say that the variance is underapplied overhead
by $10,000
• If actual overhead is $400,000 for the year but $410,000 was applied to
production, we would say that the variance is overapplied overhead
by $10,000
• If overhead has been underapplied, then product cost has been
understated
Step 3: Reconciling Actual Overhead with Applied Overhead

• If overhead has been overapplied, then product cost has been overstated
• Something must be done with the overhead variance at year-end to
report costs at actual amounts on the financial statements
• Generally, the entire overhead variance is assigned to Cost of Goods
Sold, since the amount is usually small or immaterial
o Underapplied overhead is added to Cost of Goods Sold
o Overapplied overhead is subtracted from Cost of Goods Sold

• If the overhead variance is material, or large, the variance would be

allocated among the ending balances of Work in Process, Finished
Goods, and Cost of Goods Sold
Actual Overhead and Applied Overhead
Information to Calculate Multiple Predetermined Overhead Rates

• Dickson Company has two production departments, Milling and Assembly. The company uses a job-
order costing system and computes a predetermined overhead rate in each production department.
• The predetermined overhead rate in the Milling Department is based on machine-hours and in the
Assembly Department it is based on direct labor-hours.
• The company uses cost-plus pricing (and a markup percentage of 75% of total manufacturing cost)
to establish selling prices for all of its jobs. At the beginning of the year, the company made the
following estimates:
Step 1 – Calculate the Predetermined Overhead Cost for Each Department

• During the current month the company started

and completed Job 407. It wants to use its
predetermined departmental overhead cost and
rate for the Milling and Assembly Departments.
Milling Department = $390,000 + ($2.00 per MH ×60,000 MHs) = $510,000
Assembly Department = $500,000 + ($3.75 per DLH ×80,000 DLHs) = $800,000
Step 2 – Calculate the Predetermined Overhead
Rate for Each Department
• Use the amounts determined on the previous slide
to calculate the predetermined overhead rate
(POHR) of each department.
Milling Department = $510,000 ÷ 60,000 MHs = $ 8.50 per MH
Assembly Department = $800,000 ÷ 80,000 DLHs = $10.00 per DLH
 Step 3 – Calculate the Amount of Overhead
Applied from Both Departments to a Job
• Use the POR calculated on the previous slide to determine the
overhead applied from both departments to Job 407:

Milling Department = 90 MHs×$8.50 per MH = $765

Assembly Department = 20 DLHs×$10 per DLH = $200
Step 4 – Calculate the Total Job Cost for Job 407
• We can use the information given to calculate the
amount of the total cost of Job 407. Here is the
calculation:
Step 5 – Calculate the Selling Price for Job 407
The selling price of Job 407 assuming a 75% markup.

It is important to emphasize that using a departmental approach to

overhead application results in a different selling price for Job 407 than
would have been derived using a Plantwide overhead rate based on
either direct labor-hours or machine-hours.

The appeal of using predetermined departmental overhead rates is that

they presumably provide a more accurate accounting of the costs
caused by jobs, which in turn, should enhance management planning
and decision making.
Multiple Predetermined Overhead
Rates—An Activity-Based Approach

• When a company creates overhead rates based on the

activities that it performs, it is employing an approach
called activity-based costing.

Activity-based costing is an alternative approach to

developing multiple predetermined overhead rates.
Managers use activity-based costing systems to more
accurately measure the demands that jobs, products,
customers, and other cost objects make on overhead
resources.
Assignment Thanks!
Exercise 2-1
Exercise 2-3
Exercise 2-4
Exercise 2-7
Exercise 2-10
Thanks You