Managerial Lesson 3 Slides Updated
Managerial Lesson 3 Slides Updated
If your dreams don’t scare you, they are not big enough.
If business school doesn’t scare you, you haven’t taken accounting.
- Ellen Sirleaf Johnson
Learning Objectives
• Distinguish between Job-order Costing and Process Costing
Manufacturers must use one of these cost systems (or a hybrid of the two) to
compute COGS and calculate Ending Inventory for GAAP financial statements
• Learn how to apply manufacturing overhead to jobs
We don’t know the actual MOH when we’re calculating the cost of a job, so
we use a predetermined MOH rate to apply MOH to jobs
• Learn how to dispose of under- or overapplied MOH
Because the predetermined MOH rate is calculated using budgeted numbers,
we will apply too much (or too little) MOH and later need to dispose of it
• Track the flow of costs with journal entries
This will help you see how costs flow from Raw Materials into Work-in-
Process, then into Finished Goods, before being expensed through COGS
• Become familiar with the issues/drawbacks of Job-order Costing
Today’s Topics
- What is Job-order Costing?
Job-order Costing - Job-order Costing vs. Process Costing
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Today’s Topics
- What is Job-order Costing?
Job-order Costing - Job-order Costing vs. Process Costing
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Overview When a manufacturer is
computing COGS or
This cost system can only
be used for internal
ending inventory for decision-making (it’s not
• We’re going to GAAP financial GAAP)
discuss several statements, it MUST use
a traditional costing
different cost system
systems over the
next few lessons Job-order Costing
(Chapter 3)
– A cost system is a
way to calculate the
cost of producing a Process Costing Activity-based Costing
(Chapter 6) (Lesson 8)
good or providing a
service
Operation Costing
(Lesson 7)
In Lessons 4 and 5, we will discuss how to allocate support costs and joint
costs. This information pertains to Job-order, Process, and Operation Costing
What is Job-order Costing?
• A system for assigning costs to a job or project
• A “job” could be:
– An order for a piece of furniture
– Catering for an event
– The construction of a building
How do we assign costs to a job?
• When a customer places an order, we create a
job ticket
– We then:
• Charge direct costs to that job
• Allocate indirect costs to that job
The Basics of Job-order Costing
• To determine the production cost per unit at a
manufacturing company, you would:
1. Assign manufacturing costs to a specific job
2. Divide the total cost of the job by the number of units
produced in that specific job
– The manufacturing costs are:
• The cost of Direct Materials used for that specific job
• The cost of Direct Labor performed for that specific job
• The cost of Manufacturing Overhead applied to that specific job
This equation tells you the production cost per unit for this specific job
Please Note
a) We will assume for now that companies use absorption costing.
We’ll discuss this concept more in a few weeks. It simply means
that a manufacturing company assigns both variable and fixed
manufacturing overhead costs to jobs
b) Service companies can use job-order costing as well, but the
calculations only use nonmanufacturing costs
– Law firms, for example, would track the costs by case
Example of Job-order Costing
• A customer orders 3 Blackbird hammocks
from Warbonnet
– What is the cost to produce each hammock?
Warbonnet Hammocks
• Let’s say this order is Job #357
– The company uses $50 of direct materials to create the 3
hammocks
This is $275
divided by 3
Job Order Costing
Tra o ea
ce ch
t
d d jo
ire b
Direct
ctl
Materials Manufacturing
y Overhead
THE JOB
Applied to each job using a
c t ly predetermined overhead rate
dire ob
ced ch j
Tra to ea
Direct Labor
Process Costing
• Not all manufacturers
use Job-order Costing
• Some companies use
Process Costing
– The decision of which
method to use is based
on the nature of the
products being
manufactured
Job-order vs. Process Costing
Job-order Costing Process Costing
2. For a typical manufacturer, which costs are listed on the job cost sheet?
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Determining the Cost of a Job
1. Determine the cost of direct materials used for
the job
2. Determine the cost of direct labor that was
performed for the job
$60 = $15 × 4
Overhead Applied to a Job = Predetermined Rate × Actual Activity for the Job
Summary: How to Apply MOH to a Job
– Stage 2
• Assign manufacturing overhead to jobs using the departmental
rate when a job passes through a department
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Underapplied or
Overapplied Overhead
• Option 2
– Allocate the over- or underapplied overhead among:
• WIP inventory
• Finished goods inventory
• COGS
– We don’t allocate MOH to raw materials inventory because raw materials
inventory doesn’t include any MOH; it’s just raw materials
• Option 1 is easier
• Option 2 is more accurate
Transferring to COGS
• Let’s say a company applied $95,000 of
manufacturing overhead during the
period. Yet, the actual manufacturing
overhead turned out to be $102,000
– Manufacturing overhead was underapplied
– We can dispose of the underapplied balance
by increasing COGS by $7,000
Account Debit Credit
Cost of Goods Sold 7,000
Manufacturing Overhead 7,000
Prorating Among Accounts
• A more accurate approach
is to allocate the under- or
overapplied amount
among WIP inventory,
finished goods inventory,
and COGS
– MOH passes through these 3
accounts, so you prorate the
amount to each account as it
should have been done (had
the estimate been correct)
Example
• Your company had 2 jobs: Job A and Job K
– $100 of MOH was applied to Job A (WIP)
– $300 of MOH was applied to Job K (WIP)
– Job K was completed (Finished Goods)
– 50% of the units from Job K were sold (COGS)
• Thus:
– $100 of MOH applied this period is in WIP
– $150 of MOH applied this period is in Finished Goods
– $150 of MOH applied this period is in COGS
– Actual manufacturing overhead turns out to be $450
The Proration Process
• MOH was underapplied by $50
– This means we didn’t allocate enough overhead. WIP, FG, and
COGS are lower than they should be
• We fix this by adding a portion of the $50 to each account
– E.g., at the end of the period, $100 of the $400 of manufacturing
overhead applied during the period is in WIP inventory. This is 25% of
the total MOH applied during the period; thus, we add 25% of the
under-applied amount (25% * $50) to WIP inventory
Underapplied Amount to
Amount Percentage Overhead be added
Work-in-Process Inventory $100 25.0% $50 $12.50
Finished Goods Inventory $150 37.5% $50 $18.75
Cost of Goods Sold $150 37.5% $50 $18.75
Total $400 100.0% $50.00
Underapplied Increase
Work-in-Process
Increase
(applied MOH is less than
Finished Goods Cost of Goods Sold
actual MOH)
Cost of Goods Sold
Overapplied Decrease
Work-in-Process
Decrease
(applied MOH is more than
Finished Goods Cost of Goods Sold
actual MOH)
Cost of Goods Sold
A Third Approach
• You could hypothetically go back and re-measure the
cost of each job once you know what the actual
manufacturing overhead is at the end of the period
– This is the Adjusted Allocation-Rate Approach
• We will NOT do this method in class
• A company does NOT have to do this
Quiz C
1. Why would we have underapplied or overapplied
manufacturing overhead?
2. What are the 2 methods for disposing of an under-
or overapplied MOH balance?
3. Assume a firm completed 100% of its jobs and sold
100% of its inventory. If the firm has an
overapplied MOH balance of $300, how do we deal
with this and how would it affect the financial
statements?
Quiz C
4. If the firm described below disposes of under- or overapplied MOH by
closing the balance to COGS, what is the effect?
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Custom Cat Furniture
• Let’s do an example to understand the flow of
costs using journal entries
– Custom Cat Furniture
• It’s the firm’s 1st month in business
Example
• On 1/3/2022, the firm purchases $20,000 of raw
materials for cash
Date Account Debit Credit
1/3/2022 Raw Materials Inventory $20,000
Cash $20,000
underapplied $1,000
balance
Example
• We can close the $1,000 underapplied MOH balance to COGS or prorate
it among WIP, finished goods, and COGS
– If we close it to COGS, here’s our journal entry:
Account Debit Credit Closing the balance to
Cost of Goods Sold $1,000 COGS increases COGS from
Manufacturing Overhead $1,000 $25,000 to $26,000
– If we prorate it among accounts, here’s our journal entry:
Account Debit Credit Prorating the
Cost of Goods Sold $833.33 balance increases
Work-in-Process Inventory $166.67 COGS from $25,000
Manufacturing Overhead $1,000 to $25,833.33
- Nonmanufacturing Costs
Advanced Concepts -
-
Job-order Costing for a Service Firm
Issues with Job-order Costing
Nonmanufacturing Costs
• With a manufacturing firm, Job-order Costing
typically focuses on manufacturing costs only
• However, in some cases it might make sense to
include nonmanufacturing costs if they are related
to a specific job
– e.g., the cost of a marketing campaign, warranty costs,
field service repair costs, customer service costs, sales
commission costs
– The inclusion of nonmanufacturing costs would not be
acceptable when it comes to GAAP (e.g., for calculating
COGS) but can be useful for internal decision-making
Job-order Costing for a Service Firm
• You have been hired as a consultant to…
• Ashley Madison
– They want to develop an image that is “family-friendly”
Determining the Cost of a Job
• A consulting engagement can be treated as
a “job” just like regular Job-order Costing
– There are no manufacturing costs, but:
• You charge direct costs to the job
• You allocate indirect costs to the job
– The sum of these two amounts is the cost of the job
Charging Direct Costs to the Job
• You might incur the following direct costs:
– Employee wages (aka, billable hours)
– Travel costs
– Lodging and meal costs
– Office supplies
Allocating Indirect Costs to the Job
• You could allocate indirect costs based on staff hours
• Indirect costs might include:
– The cost of administrative staff (e.g., receptionist)
– Depreciation of furniture and computers
– Office rent
Example
• Let’s look at Batman Law Firm
Batman Law Firm
• Batman’s client was given the
wrong pair of pants by the
cleaners
• The client hired Batman to sue
for $67 million
Charging Direct Costs
• The case resulted in the
following direct costs:
– $25,000 in printing costs and
filing fees
– Two attorneys from Batman’s
staff worked on the case for 200
hours at a rate of $150/hour
Allocating Indirect Costs
• The case also required assistance from staff (e.g.,
paralegals, assistants, receptionists)
– These indirect costs cannot be traced to this specific case
– However, the company expected to incur $1 million of these
costs (for the entire firm) at the beginning of the year
• The firm allocates these costs to cases on the basis of billable hours
• At the beginning of the year, the firm expected to have 20,000
billable hours (for the whole firm) over the course of the year
Cost of the Case
• Here is the total cost of this case
Case #501 (The Pants Case)
Direct
Direct Costs:
Costs:
Printing costs and filing fees $ 25,000
Attorney time (200 hours @ $150/hour) $ 30,000
Indirect Costs:
Support costs (200 hours @ $50/hour) $ 10,000
Total cost of the case $ 65,000
Issues/drawbacks related to
Job-order Costing
• Seasonal overhead
costs
• Infrequent overhead
costs
• Time-consuming
• High cost of data
entry
Seasonal Overhead Costs
• A company might incur more overhead
during certain months of the year
– e.g., utility costs might be higher in winter
• If the predetermined overhead rate is determined on
a monthly basis, the same job could appear more
expensive in one month than another month
• Solution
– Compute the overhead rate using annual
budgeted overhead costs
Infrequent Overhead Costs
• The bunching of overhead costs in certain
periods might distort the overhead rate
– e.g., if you overhaul equipment at year-end, this
would lead to a higher predetermined overhead
rate for the final month of the year
• This doesn’t make sense because the equipment
overhaul benefits multiple periods
• Solution
– Compute the overhead rate using annual
budgeted overhead costs
Time-consuming
• It is time-consuming to keep
track of the costs billed to
each job and to keep track of
all the different jobs
– e.g., imagine being asked to
track how many minutes you
spend on each job throughout
the workday—sometimes
people jump back and forth
between tasks without thinking
about it
High Cost of Data Entry
• Even if you successfully track all the costs, the cost of
data entry will be high if you have millions of jobs
How to Know if a Cost System is Obsolete
Difficult-to-produce
Managers want to products have high
Profit margins are hard
drop “profitable” margins, even though
to explain
product lines the company doesn’t
charge a premium price