COST MANAGEMENT

(PRODUCT COSTS: JOB COSTING)

Samit Paul
IIM, Calcutta

Learning goals
Explain the flow of manufacturing costs in job
costing system

Compute pre-determined overhead rate and

allocate overheads

Learn the disposition of under-applied and over-

applied overheads

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Job Order Costing (JOC)
Method of costing applied in industries where
production is measured in completed jobs. It supports
job-shop or batch-production operations
Cost is compiled for a job or work order- not for
units i.e. printing of 5000 ledger sheets, repairs of 50
computers.
Production is against the customers order- not
for stock.
Application- Printing press, automobile garage, ship
building, repair workshop, Foundry, and other similar
manufacturing units which manufacture to customers
specific requirements.
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Cost Treatment
Cost treatment
Prime cost (DM, DL, and DE) directly charged to
the particular job.

Overhead charged to a job is apportioned at

predetermined departmental absorption rates
and recorded in the cost sheet.

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Documents
1. Production order/ manufacturing order: work
order- authorizing the production department to
produce a specified quantity of a product.

2. Cost sheet For recording costs- statement of

cost.

3. Other document: documents used as control

mechanism: material requisition, tool orders,
inspection order etc.

Job Cost Accounting Procedure

Cost Source

1. Direct material Copies of material requisition

maintained by Stores Accounting
section.
2. Direct wages Time tickets costed by payroll
department
3. Direct expenses Concerned department

Note: Manufacturing overheads are then applied at

predetermined departmental absorption rates and recorded in
the cost sheet.
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Accounting for Materials- Purchase

Methods to determine the value of

an ending inventory
1. Specific identification method : Keeping the
record of purchase price of each specific unit
and the quantity of specific units used. Hence a
price tag is attached for the identification.
Applicable: Dealing with expensive material i.e.
Diamond
But what about inexpensive material.
Other methods:
1. Average cost
2. FIFO method
3. LIFO Method

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 Costs included in labor
Principal labor cost is wages paid to the workers.
Wage payments made on Time/Period or piece work
basis.
Following are the other components of wage
payments:
a. Overtime and shift premium
b. Bonus
c. Vacation and holiday pay
d. Pension
e. Fringe costs

Wage system
1. Wages on time basis (WOTB)
2. Wages on piece basis (WOPB)
WOTB are determined per unit of time that a
worker spends in the factory. Applicable in artistic
works where quality is of utmost important.
WOPB: Time spent is immaterial and payment is
made according to the quantity of work done.
Good deal of incentive to do the best.
Output will thus be maximized and the cost per
unit of output will be lowered.

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 Factory or Works Overheads (FO)
All expenses incurred inside factory and for the
benefit of manufacturing
Some important elements included in factory
overheads:
1. Depreciation
2. Rent
3. Royalties
4. Repairs
5. Fuel and power

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Some important FOs & Implication

Depreciation Must be included in expenses.

Rent Rent should always be included in expenses even if the premises

are the property of the firm.
Royalties Royalties have to be included in expenses. Royalties based on
output is a part of manufacturing cost as direct charge and
royalties based on sales will form part of selling expenses.

Repairs Included in expenses. On the basis of machine hour run.

Fuel and Power house should be treated as a separate department and

power the cost of running it compiled as such: the cost should be
included in total factory overheads and apportioned to
production departments according to the horse power of the
machinery installed.

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Collection and Absorption of overheads

1. Make an estimate of the overheads:

Collection of overheads

2. Spread the amount of overheads over the

various cost units: also called as
absorption/application or recovery of overheads

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I. Collection of factory overheads

The process of ascertaining the amount of
overheads for a period is called collection of
overheads.

Allocation: Process of identification of overheads

with respective cost centres. Ex- Wages to
indirect workers, depreciation and insurance to
plant and machinery

Apportionment: Allotment of the common items

of cost to two or more cost centres in
proportions of the estimated benefit received

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Departmentalization of Factory
Overheads
Departmentalization helps in estimation of indirect
expenses.
Departments are known as cost centres.
Some of the factory or work expenses are confined to
a department and independent of other departments.
Wages paid to indirect workers
Normal idle wages
Contribution to provident fund and social
security schemes
Depreciation and repair of plant and
machinery.
Insurance of plant and machinery
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Implication
Expenses not incurred by the departments
separately but will be incurred by the factory as
a whole.
Estimate such expenses for the whole factory
and then to allocate them to the departments.
(The word allocate should be used when the
basis is exact, if it is an estimate, the word used
should be appropriate). Such expenses are
allocated in the following manner:

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Expenses Basis of allocation

1. Works canteen and welfare

Example:
expenses

2. Works managers salary and

fees paid to technical directors

3.Factory rent, rates,

depreciation, repairs, and
insurance of factory premises

4. Fuel and power

5. Factory lighting

6. Carriage inward on materials

purchased, store keeping
expenses, buying expenses and
normal losses of materials

7. Materials of small value,

stationery and other sundries
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Expenses Basis of allocation

1. Works canteen and welfare Numbers of workers benefited
expenses
Example
2. Works managers salary and Estimated time devoted to each
fees paid to technical directors department
3.Factory rent, rates, Floor space occupied by each
depreciation, repairs, and department
insurance of factory premises
4. Fuel and power Meter consumption, horse power
of machinery
5. Factory lighting Number of points in each
department, or according to
separate meter reading.
6. Carriage inward on materials Value of materials used in each
purchased, store keeping department
expenses, buying expenses and
normal losses of materials
7. Materials of small value, Actual consumption or according
stationery and other sundries to the judgment of works
manager
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II. Application of factory overheads
Application is allotment of overhead to cost
units. It is the apportionment of overheads to
the various cost units i.e. jobs, products.

The terms recovery and absorption of overheads

mean the same thing-the apportionment of
overheads to the various cost units-jobs,
products.

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Over/Under applied overhead

In order to close the manufacturing overhead

account, one needs to adjust the over or under
applied overhead to zero by either:

1. Disposing to cost of goods sold (COGS)

- Simple and widely used
- Suitable when under/over applied OH is small
- Most of the products are sold

2. Prorating among WIP, FG and COGS

- More accurate but difficult to compute

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Over/Under applied OH: Summary
When Manufacturing OH Disposition to PRORATA based
COGS Allocation
UNDERAPPLIED INCREASE INCREASE

(Applied OH < Actual OH) COGS Work in Process

Finished Goods
COGS
OVERAPPLIED DECREASE DECREASE

(Applied OH > Actual OH) COGS Work in Process

Finished Goods
COGS

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Problem 3-42

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 Predetermined Overhead Rate
OH is applied to jobs using a predetermined
overhead rate (POHR) based on estimates made
at the beginning of the accounting period

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Methods of application of FO
1. The percentage on materials or direct
materials cost basis:

Assumption that for various jobs the relationship

between materials and overheads will not change.
Ratio of overheads to direct materials =
overheads/direct materials

Applicability: only one simple product is turned out.

Stability in the prices of materials used.

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 Methods of application of FO
2. The percentage on direct wages or direct
labor cost basis:
From past experience estimate what percent are
factory overheads of direct wages.
Assumption: there is a logical connection between
direct wages and factory expenses.

Note: Calculation of factory expenses on the basis

of direct wages is likely to give stable results.
Over-costing and under-costing will be avoided.

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Methods of application of FO
3. The percentage on prime cost basis:
Assumption: Both materials and labor give rise to
factory overheads. Both should be taken into
consideration.
Ratio = Factory overheads/ prime cost

Note: In common with previous two systems ,

done by skilled labor and unskilled labor and

between machine production and hand
production.

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Some implication
A combination of the percentage on materials
and on wages. Some FO are connected with
materials and some others are connected with
labor is of some interest.

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Methods of application of FO
4. Unit of production basis:
Using the units of production.
Computation formula = FO/Units of production
The usefulness of this method is limited
normally to those situations where only one
product is produced.

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Methods of application of FO
5. Hourly Rate Basis: Direct wages is quite good
for ordinary use. If the work is of a very
complicated nature then this system will not
give good result. For this purpose the following
systems are used:
a. The machine Hour Rate
b. The Direct Labor Hour Rate

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a. The Machine Hour Rate

Under machine hour rate treat the machine as a
small department and to apportion the various
expenses to the machine just as the expenses are
charged to bigger departments.
Used where the work is performed primarily on
machines.
Machine hour rate= Factory Overhead/Machine
hours
Some expenses i.e. depreciation, repairs, and
electricity or oil are peculiar to one machine, while
certain other expenses are common to the whole
department and have to be apportioned to each
machine suitably. Example-
etc.

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Expenses Basis

1. Rent, rates and other expenses

Implication Effective area occupied by each
connected with premises machine including the surrounding
space.

2. Lighting and heating The number of points used.

3. oil, waste and sundries Past experience/ equally

4. Supervision Estimated time devoted by the

supervisory staff to each machine.

5. Insurance Actual value of machine being

known and the rate of premium
being known.

6. Steam Horse power of the machine

7. Labor welfare Number of workers engaged in

each machine.
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Implication

Two types of machine hour rate may be calculated:

1. Ordinary machine hour rate: Takes into
account only those overhead expenses which
are directly attributed to the running of the
machine. Such expenses are power, fuel,
repair, maintenance and depreciation.
2. Composite machine hour rate: This method
takes into account not only expenses directly
connected with the machine , but also other
expenses which are known as standing or fixed
charges., i.e. rent and rates, supervisory, labor,
lighting and heating.

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One of the most widely used methods.
The data on labor hours for each department, job

Direct labor hour rate = Total overheads/Total labor

hours.

manufacturing processes, the direct labor hours

method is useful .
This method cannot be used where machines are
used extensively for production.
 Problem 3-48

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Video: Film Making

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Items excluded from cost accounts
1. Matters of pure finance- interest paid and
received, dividend received on investments,
rent received, loss or profit on sale of

2. Appropriation of profits- income tax,

dividends paid, transfer to sinking fund or
reserve fund, excessive depreciation with a
view to create secret reserves, goodwill or other
fictitious assets written off.
3. Arbitrary or abnormal items: Excessive
salary to some one. But normal expenses
should be included, i.e. salary to a partner.
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Challenges in Job order costing

Considerable detailed clerical work
Chances of errors are more
JOC cannot be efficiently operated without
highly developed production control system.
Also requires intricate factory organization
system.
Cost ascertained as historical cost, hence

with standard costing system.

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