LECTURE 3 – PRODUCT COSTING
Accounting Entries for Actual and Normal Absorption Job Costing
Product costing involves:
(1) Determining which cost items to include for the particular costing system employed by
the firm, and
(2) Determining the dollar value of these cost items, and
(3) Entering these costs in the accounts.
Which Cost Items to Include
Whether an item is inventoriable depends on whether the firm is using absorption or
For absorption costing systems (the focus at this stage) the costs included will be all
manufacturing costs and only manufacturing costs, i.e. the answer to the question “which
cost items to include” is: direct material, direct labour, and all overhead (both fixed and
What is the Dollar value?
There are three different methods:
o Actual costing
o Normal costing
o Standard costing
Job Costing Systems
Each product or job has a unique job cost sheet, and all DM, DL and OH incurred on that job
are recorded on the job cost sheet for that job.
o Dates on the job cost sheet indicate the stage of production at which the job is at
any particular time, i.e. work still in process, completed and not sold, or completed
Other documentation which you need to be aware of includes:
(1) The OH cost sheet is a detailed record of individual OH costs incurred.
o The OH account in the ledger shows limited detail – all detail is provided on the OH
o All overheads incurred would be recorded on an OH COST SHEET, which typically has
a very large number of columns to represent all the overhead costs incurred.
o While the various credit accounts (e.g. rent payable, salary payable) will appear in
the firm’s general ledger, the general ledger will not show individual debit accounts
for all these items. They will INSTEAD be recorded on the debit side of one account,
the OH account. (See lecture example.)
(2) Note also various documentation such as MATERIALS STOCK CARDS recording details of
entries in and out of MATERIALS ACCOUNT; TIMESHEETS supporting payroll entries.
Manual or Automated Records
Where manual systems exist, the documents provide both source documentation and
subsidiary ledger records for the summary entries in the Materials Control, Overhead
Control, Work in Process (WIP) Control, Finished Goods (FG) Control, and Cost of Goods Sold
o In other words, entries will be made in total, rather than for each individual
transaction. With automated systems, the entries can be made on the source documents and/or
subsidiary ledgers and in the general ledger simultaneously, with account balances
continually being updated.
Accounts used to Record Production
In a traditional cost accounting system, the accounting entries follow the logical sequence of
manufacturing, and will follow these steps:
o firms buy materials, hire labour, and incur OH costs
o factors of production (DM, DL and OH) are combined as work is commenced (WIP)
o goods are completed (out of WIP, into FG)
o goods are sold (out of FG into COGS)
Inventoriable costs Factors combined Goods finished Goods sold
Materials a/c → Work in process a/c → Finished goods a/c → Cost of goods sold a/c
(inventory a/c) (inventory account) (inventory account) (expense account)
DM + IM
Wages a/c →
DL + IM
OH a/c →
For absorption costing systems, DM, DL and OH, and only these costs are treated in this way
Period costs (non-manufacturing costs) go straight to P/L
o Do NOT ever go into WIP, FG or COGS
Note also that goods are either:
o Not started, in which case no costs have been charged to the products
o Started (in any period) and not finished at the end of the period. (Costs of these
goods are in WIP)
o Finished (in any period) but not sold at the end of the period. (Costs of these goods
are in FG)
o Sold in this period. (Costs of these goods are in COGS (regardless of when they were
This means that the total of DM + DL + OH for a period will be sitting in either WIP, FG or
COGS at the end of that period.
o Also note the composition of account balances: WIP and FG balances, and the
amount in COGS, will consist of only DM + DL + OH used, and no other costs
This is useful to know when reconstructing accounts
Accounting Entries for Lecture Example
Summary journal entries for a manufacturer:
These entries will ALWAYS look the same
(1) When materials, wages and overhead costs are incurred (for simplicity assume for cash),
these three accounts are debited and cash is credited.
(2) When direct costs are used on particular jobs, they are immediately (directly) taken to WIP,
i.e. WIP is debited and materials and wages are credited.
o Each time direct material is used it will be recorded on the job card.
o Therefore, the total of DM on all job cards is the amount to be recorded for
the period. (3) When indirect costs are used, OH account will be debited with all actual overhead incurred.
(4) OH is not taken to WIP directly, but indirectly via the OH account.
(5) When jobs are completed, FG is debited and WIP is credited.
o The total labour incurred will be treated differently depending on whether it is
direct or indirect labour.
Direct Labour Used in Production
o Direct labour is recorded on the job cards, therefore the total of direct labour can be
found on the job cards.
Indirect Labour Used in Production
o All indirect labour incurred is transferred out of wages account and entered on the
debit side of the OH account.
(6) When jobs are sold, COGS is debited and FG is credited.
o “Other OH” means overhead incurred other than indirect materials and indirect
labour, e.g. factory rent, factory electricity.
o All actual OH incurred (no matter what it is, and in all costing systems) will always
be entered on the debit side of the OH account.
(7) Overhead charged to Production (to Jobs/Products)
o This is commonly called overhead allocated, or overhead applied.
o Everything we have done up until this point is identical whether the firm uses actual
costing or normal costing, i.e.:
Treatment of direct material,
Treatment of direct labour, and
Treatment of actual overhead incurred (entered on the debit side of the
o OH charged to production differs depending on whether the firm uses ACTUAL,
NORMAL, or STANDARD COSTING.
Overhead Applied – Actual Costing
The actual OH incurred (now on the debit side of the OH account) will be allocated to jobs,
and therefore into WIP, FG and COGS.
This is done by calculating an actual OH rate using the actual (known) data as followsActual
OH rate = Actual OH ($94,000)
Actual DL hours (1,000)
= $94 per DL hour
When can this rate be calculated? Only at the end of the period after all production for the
period has been completed.
Under actual costing, OH allocated/applied/charged to the job and then to WIP is always:
actual activity (here DL hours) x actual OH rate.
Overhead Applied – Normal Costing
The amount on the debit side of the OH account will not be the amount allocated to jobs.
Instead, the firm calculates a budgeted overhead rate (also called a pre-determined