We begin this chapter by describing a cost accounting system. We then explain the procedures used to determine costs using a job order costing system. We conclude with a discussion of over and underapplied overhead.
Job order costing is typically used by manufacturers of custom products or providers of custom services. The jobs must be large enough in scope and value to justify the accounting effort to trace costs to the jobs. Job order production can apply to both manufacturing and service companies.
Here you see some examples where job order costing is used. Another example familiar to many of us is an automobile repair shop. When you take your car in for an inexpensive job like an oil change, you expect to be charged the cost of an oil change instead of an expensive engine repair. The shop’s accounting system must be able to handle multiple jobs with differing amounts of materials and labor costs that are incurred each day.
The initial event in a job order system is receipt of a customer order. A less common case is to begin work on a job before the company has a signed contract. This is referred to as jobs produced on speculation.
The sales price of the job may be a cost-plus, such as with a government contract, or may be determined by market factors. The company may then decide whether the price will provide a reasonable profit.
The job is then scheduled, necessary materials are obtained, and the work is begun.
Direct materials and direct labor are traced directly to jobs in the goods in process inventory account. Indirect materials and indirect labor, along with flow through the factory overhead account into goods in process. Completed jobs are transferred from the goods in process inventory account to the finished goods inventory account. When the finished jobs are delivered to customers, the cost of these jobs becomes an expense on the income statement called cost of goods sold.
A job cost sheet is a separate record maintained for each job that is used to account for material, labor, and factory overhead costs for each job. The job cost sheet may be a paper record, but most likely it is a computerized file.
Here’s an example of a job cost sheet showing customer identification, job number, relevant dates, along with materials, labor, and overhead expenditures for the job.
Materials cost entered on the job cost sheet may be summarized from a materials requisition form.
When materials are need for a job, the production manager, C. Luther, prepares a materials requisition and sends it to the materials manager. The materials manager, M. Bateman, will not release materials from the materials storage facility without this authorization.
In addition to the proper signature authorizing the transfer of materials, the job number of the job where the material is to be used is noted on the requisition.
Materials requisitions are sequentially numbered just like checks in a checkbook This feature enhances the control of materials use. The requisition also contains a description of the material along with the inventory stock number.
When material is transferred from the materials storage facility, an accounting entry is made to reduce the material inventory balance. The materials requisition is the source document supporting the accounting entry, which we will see in a subsequent slide.
The materials ledger card is a perpetual inventory record of the material M-347. This record may be a paper record, but most likely it is a computerized file. Here we see that two hundred twenty five dollars of material M-347 has been issued on materials requisition R4705. This entry on the ledger card reduces the inventory balance from six hundred seventy five dollars to four hundred fifty dollars.
Here we see the summary information for the material used on job B15 entered on the job cost sheet. If additional information about this material is needed, it can be found on materials requisition R4705.
Labor cost entered on the job cost sheet is summarized from an employee’s time ticket.
Production managers use labor time tickets to assign labor costs to individual jobs. In addition to the proper signature authorizing the labor cost assignment, the time ticket includes labor time, rate, job number, date, and employee identification. Labor time tickets are the source documents supporting the payroll accounting entries.
Here we see the summary information for the labor cost of job B15 entered on the job cost sheet. If additional information about the labor cost is needed, it can be found on time ticket L3479. This will generate an accounting entry (to be shown later).
Overhead is an indirect manufacturing cost that includes all production costs other than direct materials and direct labor. Entries for various overhead items will be shown on a subsequent slide. Unlike labor and materials, overhead cannot be traced directly to individual jobs. We must use a predetermined overhead rate to allocate overhead to jobs. The predetermined overhead rate may be based on such production factors as direct labor hours, direct labor cost, or machine hours
Road Warriors assigns overhead to jobs using a predetermined overhead rate of one hundred sixty percent of direct labor cost. In other words, for each dollar of direct labor incurred on a job, one dollar and sixty cents of overhead will be charged to the job. For job B15, the labor cost was sixty dollars; so multiplying one dollar and sixty cents times sixty dollars yields ninety six dollars of overhead assigned to the job.
The term predetermined means that the overhead rate is computed before the operating period begins. Overhead costs and labor costs are estimated for the coming period as a part of the company’s budgeting process. The activity chosen for the denominator is known as an allocation base. Overhead and the allocation base are linked such that as the allocation base increases, overhead increases. For Road Warriors, we could say that overhead supports direct labor costs, or that incurrence of direct labor costs causes additional overhead costs.
Let’s look at two flow diagrams that will help us put job order document flows into perspective.
Materials used are classified as either direct or indirect. We place direct materials costs on the job cost sheet. We place indirect materials costs in the factory overhead account. Later the overhead will be applied to the job using a predetermined overhead rate.
Labor costs are also classified as either direct or indirect. We place direct labor costs on the job cost sheet. We place indirect labor costs in the factory overhead account. Later, factory overhead will be applied to the job using a predetermined overhead rate.
T-accounts for a job order system are helpful in visualizing the cost flows.
Material purchases are entered as debits (left side) in the raw materials inventory account. A credit entry (right side) in the materials inventory account is recorded when material is withdrawn. Direct materials usage is recorded in the goods in process inventory account and on the job cost sheet for an individual job. Indirect material usage is recorded in the factory overhead account.
Direct labor and applied factory overhead are the remaining product costs that we must record.
Direct labor cost is recorded in the goods in process inventory account and on the job cost sheet for an individual job. Indirect labor cost is recorded in the factory overhead account. Factory overhead is applied to jobs in the goods in process inventory account using a predetermined overhead rate. Because of the estimating process used in calculating the predetermined overhead rate, the amount of overhead assigned to all jobs in an operating period may differ from the actual overhead costs incurred in the same period.
Once we have combined proper amount of direct labor and factory overhead to convert material into a finished product, we will move the product out of the factory and prepare it for sale.
Direct material, direct labor, and factory overhead are combined in goods in process. As jobs are completed, they are transferred to finished goods and then sold (delivered to customers). The dollar amount of the transfer from the goods in process inventory account to the finished goods inventory account is called cost of goods manufactured.
Overhead is an indirect manufacturing cost. Unlike labor and material, overhead cannot be traced directly to individual jobs. We must use a predetermined overhead rate to assign overhead to jobs. Road Warriors uses an overhead rate of one hundred sixty percent of direct labor cost. For each dollar of direct labor incurred on a job, Road Warriors will assign one dollar and sixty cents of overhead to the job.
OK, you asked for an example so take a few minutes to answer the following two questions. They deal with calculating a predetermined overhead rate and applying overhead to jobs. Check your progress on these concepts before moving on.
Here is the first of your two questions.
The predetermined overhead rate is computed by dividing estimated overhead by estimated activity.
Here is your second question.
We assign overhead to jobs by multiplying the predetermined overhead rate times the actual amount of activity, direct labor hours in this question.
We cannot wait until the end of the period when all actual overhead costs are known to charge overhead costs to jobs. Jobs are completed continually during the year. Perpetual inventory records must be updated in a timely manner, not at the end of the period. Customers expect to know the total cost of jobs at the time jobs are delivered, not at the end of the period. Using a predetermined overhead rate allows us to assign overhead in a timely and consistent fashion to accomplish these objectives.
Because of the estimating process used in calculating the predetermined overhead rate, the amount of overhead assigned to all jobs in an operating period may differ from the actual overhead costs incurred in the same period. The difference between actual and applied overhead is referred to as either overapplied or underapplied overhead. Cost of goods sold is adjusted for these amounts at the end of the period..
When the amount of overhead applied to all jobs in a period is greater than the actual amount of overhead incurred, overhead is overapplied.
When the amount of overhead applied to all jobs in a period is less than the actual amount of overhead incurred, overhead is underapplied.
If overhead is underapplied, the cost of goods sold does not include all production costs incurred. Therefore, the end-of-period adjustment for underapplied overhead increases cost of goods sold.
If overhead is overapplied, the cost of goods sold includes more costs than were incurred. The end-of-period adjustment for overapplied overhead decreases cost of goods sold.
Take time to answer the next two questions before we proceed.
Since the applied overhead is greater than the actual amount of overhead incurred, FishCo’s overhead is overapplied by twelve thousand dollars.
Here is your second question.
Overhead is overapplied resulting in a cost of goods sold amount that is too high. The adjustment will reduce cost of goods sold to the proper amount.
The following journal entries illustrate the recording process for a job order cost system.
To record material purchased on account, we increase the raw materials inventory account with a debit entry and we increase accounts payable with a credit entry.
When direct material is used, we decrease the raw materials inventory account with a credit entry. If the materials used are direct materials, we increase the goods in process inventory account with a debit entry. If the materials used are indirect materials, we increase factory overhead with a debit entry.
When salaries and wages are paid, we record the amount in the factory payroll account with a debit entry and we reduce cash with a credit entry.
The portion of factory payroll that is classified as direct labor increases the goods in process inventory account while the portion that is indirect labor increases the factory overhead account. We record the increases to goods in process and to factory overhead with debit entries.
Other actual costs for factory overhead items are recorded with a debit entry to the factory overhead account. Prepaid insurance is an asset account that is reduced with a credit as the insurance coverage is used. Accrued liabilities payable is a liability account that is increased with a credit. Cash is an asset account that is reduced with a credit indicating that cash has been paid. Accumulated depreciation is an contra asset account that is increased with a credit to reflect the adjusting entry for depreciation on factory buildings and equipment..
Factory overhead is applied to jobs using a predetermined overhead rate, resulting in an increase in the goods in process inventory account.
Completed goods are transferred from the goods in process inventory account to the finished goods inventory account. We record the increase in finished goods with a debit entry and we record the decrease in goods in process with a credit entry.
When the goods are sold, we reduce the finished goods inventory account with a credit entry. Cost of goods sold is an expense account that is recorded with a debit entry.
Now that we have mastered some of the basic concepts of Job Order Cost Accounting, we are ready to move on to the next chapter.
