Cost Accounting For Marketing (Tilahun G)

Chapter-3 : Job order costing System

Cost Accounting Systems Overview

Cost accounting systems measure, record, and report product costs. Managers
use product costs for setting product prices, controlling operations, and
developing financial statements.
The two main types of cost accounting systems for manufacturing operations
are:
1. Job order cost systems
2. Process cost systems
A job order cost system provides product costs for each quantity of product that
is manufactured. Each quantity of product that is manufactured is called a job.
Job order cost systems are often used by companies that manufacture custom
products for customers or batches of similar products. Manufacturers that use a
job order cost system are sometimes called job shops.
A process cost system provides product costs for each manufacturing
department or process. Process cost systems are often used by companies that
manufacture units of a product that are indistinguishable from each other and
are manufactured using a continuous production process. Examples would be oil
refineries, paper producers, chemical processors, and food processors.
Job order and process cost systems are widely used. A company may use a job
order cost system for some of its products and a process cost system for other
products.

Job Order Cost Systems for Manufacturing Businesses

A job order cost system records and summarizes manufacturing costs by jobs.
The flow of manufacturing costs in a job order system is illustrated Exhibit 2.
Exhibit 2 indicates that although the materials for Jobs 71 and 72 have been
added, both jobs are still in the production process. Thus, Jobs 71 and 72 are part
of Work in Process Inventory. In contrast, Exhibit 2 indicates that Jobs 69 and 70
have been completed. Thus, Jobs 69 and 70 are part of Finished Goods Inventory.
Exhibit 2 also indicates that when finished guitars are sold to music stores, their
costs become part of Cost of Goods Sold.
In a job order cost accounting system, perpetual inventory controlling accounts
and subsidiary ledgers are maintained for materials, work in process, and
finished goods inventories

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Materials
The materials account in the general ledger is a controlling account. A separate
account for each type of material is maintained in a subsidiary materials ledger.

Exhibit 3 shows Legend Guitars’ materials ledger account for maple. Increases
(debits) and decreases (credits) to the account are as follows:
1. Increases (debits) are based on receiving reports such as Receiving Report
No. 196 for $10,500, which is supported by the supplier’s invoice.
2. Decreases (credits) are based on materials requisitions such as Requisition
No. 672 for $2,000 for Job 71 and Requisition No. 704 for $11,000 for Job
72.

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A receiving report is prepared when materials that have been ordered are
received and inspected. The quantity received and the condition of the materials
are entered on the receiving report. When the supplier’s invoice is received, it is
compared to the receiving report. If there are no discrepancies, a journal entry
is made to record the purchase. The journal entry to record the supplier’s invoice
related to Receiving Report No. 196 in Exhibit 3 is as follows:

The storeroom releases materials for use in manufacturing when a materials

requisition is received. Examples of materials requisitions are shown in Exhibit 3.
The materials requisitions for each job serve as the basis for recording materials
used. For direct materials, the quantities and amounts from the materials
requisitions are posted to job cost sheets. Job cost sheets, which are also
illustrated in Exhibit 3, make up the work in process subsidiary ledger.
Exhibit 3 shows the posting of $2,000 of direct materials to Job 71 and $11,000
of direct materials to Job 72.Job 71 is an order for 20 units of Jazz Series guitars,
while Job 72 is an order for 60 units of American Series guitars.
A summary of the materials requisitions is used as a basis for the journal entry
recording the materials used for the month. For direct materials, this entry increases
(debits) Work in Process and decreases (credits) Materials as shown below.
Many companies use computerized information processes to record the use of

materials. In such cases, storeroom employees electronically record the release

of materials, which automatically updates the materials ledger and job cost
sheets.
Example Exercise -1
On March 5, Hatch Company purchased 400 units of raw materials at $14 per
unit. On March 10, raw materials were requisitioned for production as follows:
200 units for Job 101 at $12 per unit and 300 units for Job 102 at $14 per unit.
Journalize the entry on March 5 to record the purchase and on March 10 to record
the requisition from the materials storeroom.

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Factory Labor
When employees report for work, they may use clock cards, in-and-out cards, or
electronic badges to clock in. When employees work on an individual job, they
use time tickets to record the amount of time they have worked on a specific job.
Exhibit 4 illustrates time tickets for Jobs 71 and 72.
Exhibit 4 shows that on December 13, 2014, D. McInnis spent six hours working
on Job 71 at an hourly rate of $10 for a cost of $60 (6 hrs. × $10). Exhibit 4 also
indicates that a total of 350 hours was spent by employees on Job 71 during
December for a total cost of $3,500. This total direct labor cost of $3,500 is posted
to the job cost sheet for Job 71, as shown in Exhibit 4.
Likewise, Exhibit 4 shows that on December 26, 2014, S. Andrews spent eight
hours on Job 72 at an hourly rate of $15 for a cost of $120 (8 hrs. × $15). A total
of 500 hours was spent by employees on Job 72 during December for a total cost
of $7,500. This total direct labor cost of $7,500 is posted to the job cost sheet for
Job 72, as shown in Exhibit 4.

A summary of the time tickets is used as the basis for the journal entry recording
direct labor for the month. This entry increases (debits) Work in Process and
increases (credits) Wages Payable, as shown below.

As with direct materials, many businesses use computerized information

processing to record direct labor. In such cases, employees may log their time
directly into computer terminals at their workstations. In other cases, employees
may be issued magnetic cards, much like credit cards, to log in and out of work
assignments.

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Example Exercise -2
During March, Hatch Company accumulated 800 hours of direct labor costs on
Job 101 and 600 hours on Job 102. The total direct labor was incurred at a rate
of $16 per direct labor hour for Job 101 and $12 per direct labor hour for Job
102. Journalize the entry to record the flow of labor costs into production during
March.

Factory Overhead
Factory overhead includes all manufacturing costs except direct materials and
direct labor. Factory overhead costs come from a variety of sources, including
the following:
1. Indirect materials comes from a summary of materials requisitions.
2. Indirect labor comes from the salaries of production supervisors and the
wages of other employees such as janitors.
3. Factory power comes from utility bills.
4. Factory depreciation comes from Accounting Department computations of
depreciation.
To illustrate the recording of factory overhead, assume that Legend Guitars
incurred $4,600 of overhead during December, which included $500 of indirect
materials, $2,000 of indirect labor, $900 of utilities, and $1,200 of factory
depreciation. The $500 of indirect materials consisted of $200 of glue and $300
of sandpaper. The entry to record the factory overhead is shown below.

Allocating Factory Overhead

Factory overhead is different from direct labor and direct materials in that it is
indirectly related to the jobs. That is, factory overhead costs cannot be identified
with or traced to specific jobs. For this reason, factory overhead costs are allocated
to jobs. The process by which factory overhead or other costs are assigned to a cost
object, such as a job, is called cost allocation.
The factory overhead costs are allocated to jobs using a common measure related to
each job. This measure is called an activity base, allocation base, or activity driver.
The activity base used to allocate overhead should reflect the consumption
or use of factory overhead costs. Three common activity bases used to allocate
factory overhead costs are direct labor hours, direct labor cost, and machine
hours.

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Predetermined Factory Overhead Rate

Factory overhead costs are normally allocated or applied to jobs using a
predetermined factory overhead rate. The predetermined factory overhead rate is
computed as follows:

Estimated total factory overhead costs

Predetermined Factory Overhead Rate =
Estimated Activity Base
To illustrate, assume that Legend Guitars estimates the total factory overheadcost
as $50,000 for the year and the activity base as 10,000 direct labor hours.The
predetermined factory overhead rate of $5 per direct labor hour is computed as
follows:
Estimated total factory overℎead costs
Predetermined Factory Overℎead Rate =
Estimated Activity Base
$50,000
Predetermined Factory Overℎead Rate =
10,000 direct labor ℎours

Predetermined Factory Overℎead Rate = $5 per direct labor ℎour

As shown above, the predetermined overhead rate is computed using estimated

amounts at the beginning of the period. This is because managers need timely
information on the product costs of each job. If a company waited until all
overhead costs were known at the end of the period, the allocated factory
overhead would be accurate, but not timely. Only through timely reporting can
managers adjust manufacturing methods or product pricing.

Applying Factory Overhead to Work in Process

Legend Guitars applies factory overhead using a rate of $5 per direct labor hour.
The factory overhead applied to each job is recorded in the job cost sheets, as
shown in Exhibit 5.
Exhibit 5 shows that 850 direct labor hours were used in Legend Guitars’
December operations. Based on the time tickets, 350 hours can be traced to Job
71, and 500 hours can be traced to Job 72.

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Using a factory overhead rate of $5 per direct labor hour, $4,250 of factory overhead
is applied as follows:
As shown in Exhibit 5, the applied overhead is posted to each job cost sheet.
Factory overhead of $1,750 is posted to Job 71, which results in a total product
cost on December 31, 2014, of $10,250. Factory overhead of $2,500 is posted to
Job 72, which results in a total product cost on December 31, 2014, of $21,000.
The journal entry to apply factory overhead increases (debits) Work in Process
and credits Factory Overhead. This journal entry to apply overhead to Jobs 71
and 72 is as follows:

To summarize, the factory overhead account is:

1. Increased (debited) for the actual overhead costs incurred, as shown earlier
for transaction (d)
2. Decreased (credited) for the applied overhead, as shown above for
transaction (e).

The actual and applied overhead usually differ because the actual overhead costs
are normally different from the estimated overhead costs. Depending on whether
actual overhead is greater or less than applied overhead, the factory overhead
account will either have a debit or credit ending balance as follows:
1. If the applied overhead is less than the actual overhead incurred, the
factory overhead account will have a debit balance. This debit balance is
called underapplied factory overhead or underabsorbed factory overhead.
2. If the applied overhead is more than the actual overhead incurred, the
factory overhead account will have a credit balance. This credit balance is
called overapplied factory overhead or overabsorbed factory overhead.

The factory overhead account for Legend Guitars, shown below, illustrates both
underapplied and overapplied factory overhead. Specifically, the December 1, 2014,
credit balance of $200 represents overapplied factory overhead. In contrast, the
December 31, 2014, debit balance of $150 represents underapplied factory
overhead.

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Example Exercise -4
Hatch Company estimates that total factory overhead costs will be $100,000 for
the year. Direct labor hours are estimated to be 25,000. For Hatch Company, (a)
determine the predetermined factory overhead rate using direct labor hours as
the activity base, (b) determine the amount of factory overhead applied to Jobs
101 and 102 in March, using the data on direct labor hours from Example Exercise
19-2, and (c) prepare the journal entry to apply factory overhead to both jobs in
March according to the predetermined overhead rate.
Disposal of Factory Overhead Balance
During the year, the balance in the factory overhead account is carried forward
and reported as a deferred debit or credit on the monthly (interim) balance sheets.
However, any balance in the factory overhead account should not be carried over
to the next year. This is because any such balance applies only to operations of the
current year.

If the estimates for computing the predetermined overhead rate are reasonably
accurate, the ending balance of Factory Overhead should be relatively small. For this
reason, the balance of Factory Overhead at the end of the year is disposedof by
transferring it to the cost of goods sold account as follows:
1. If there is an ending debit balance (underapplied overhead) in the factory
overhead account, it is disposed of by the entry shown below.

2. If there is an ending credit balance (overapplied overhead) in the factory

overhead account, it is disposed of by the entry shown below.

To illustrate, the journal entry to dispose of Legend Guitars’ December 31, 2014,
underapplied overhead balance of $150 is as follows:

Work in Process
During the period, Work in Process is increased (debited) for the following:
1. Direct materials cost
2. Direct labor cost
3. Applied factory overhead cost
To illustrate, the work in process account for Legend Guitars is shown in Exhibit
6. The balance of Work in Process on December 1, 2014 (beginning balance), was
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$3,000. As shown in Exhibit 6, this balance relates to Job 71, which was the
only job in process on this date. During December, Work in Process was debited
for the following:
1. Direct materials cost of $13,000 [transaction (b)], based on materials
requisitions.
2. Direct labor cost of $11,000 [transaction (c)], based on time tickets.
3. Applied factory overhead of $4,250 [transaction (e)], based on the
predetermined overhead rate of $5 per direct labor hour.
The preceding Work in Process debits are supported by the detail postings to job cost sheets
for Jobs 71 and 72, as shown in Exhibit 6.

During December, Job 71 was completed. Upon completion, the product costs
(direct materials, direct labor, factory overhead) are totaled. This total is divided
by the number of units produced to determine the cost per unit. Thus, the 20 Jazz
Series guitars produced as Job 71 cost $512.50 ($10,250/20) per guitar.
After completion, Job 71 is transferred from Work in Process to Finished Goods
by the following entry:

Job 72 was started in December, but was not completed by December 31, 2014.
Thus, Job 72 is still part of work in process on December 31, 2014. As shown in
Exhibit 6, the balance of the job cost sheet for Job 72 ($21,000) is also the
December 31, 2014, balance of Work in Process.
Example Exercise -5
At the end of March, Hatch Company had completed Jobs 101 and 102. Job 101
is for 500 units, and Job 102 is for 1,000 units. Using the data from Example
Exercises 19-1, 19-2, and 19-4, determine (a) the balance on the job cost sheets
for Jobs 101 and 102 at the end of March and (b) the cost per unit for Jobs 101
and 102 at the end of March.
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Finished Goods
The finished goods account is a controlling account for the subsidiary finished
goods ledger or stock ledger. Each account in the finished goods ledger contains
cost data for the units manufactured, units sold, and units on hand. Exhibit 7
illustrates the finished goods ledger account for Jazz Series guitars.

Exhibit 7 indicates that there were 40 Jazz Series guitars on hand on December
1, 2014. During the month, 20 additional Jazz guitars were completed and
transferred to Finished Goods from the completion of Job 71. In addition, the
beginning inventory of 40 Jazz guitars was sold during the month.

Sales and Cost of Goods Sold

During December, Legend Guitars sold 40 Jazz Series guitars for $850 each,
generating total sales of $34,000 ($850 × 40 guitars). Exhibit 7 indicates that the cost
of these guitars was $500 per guitar or a total cost of $20,000 ($500 × 40 guitars).
The entries to record the sale and related cost of goods sold are as follows:

In a job order cost accounting system, the preparation of a statement of cost of

goods manufactured is not necessary. This is because job order costing uses the
perpetual inventory system and, thus, the cost of goods sold can be directly
determined from the finished goods ledger as illustrated in Exhibit 7.
Example Exercise -6
Nejedly Company completed 80,000 units during the year at a cost of $680,000. The
beginning finished goods inventory was 10,000 units at $80,000. Determine the cost
of goods sold for 60,000 units, assuming a FIFO cost flow.

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