Job-order costing - A costing system used in situations where many different products, jobs, or services are
produced each period. In a job-order costing system, costs are traced and allocated to jobs and then the costs
of the job are divided by the number of units in the job to arrive at an average cost per unit. Job-order costing is
also used extensively in service industries. For example, hospitals, law firms, movie studios, accounting firms,
advertising agencies, and repair shops all use a variation of job-order costing to accumulate costs.
Computing Predetermined Overhead Rates
Recall that product costs include manufacturing overhead as well as direct materials and direct labor.
Therefore, manufacturing overhead also needs to be recorded on the job cost sheet. However, assigning
manufacturing overhead to a specific job involves some difficulties. There are three reasons for this:
1. Manufacturing overhead is an indirect cost. This means that it is either impossible or difficult to trace these
costs to a particular product or job.
2. Manufacturing overhead consists of many different items ranging from the grease used in machines to the
annual salary of the production manager.
3. Because of the fixed costs in manufacturing overhead, total manufacturing overhead costs tend to remain
relatively constant from one period to the next even though the number of units produced can fluctuate widely.
Consequently, the average cost per unit will vary from one period to the next.
Given these problems, allocation is used to assign overhead costs to products.Allocation is accomplished by
selecting an allocation base that is common to all of the company's products and services.
An allocation base is a measure such as direct labor-hours (DLH) or machine-hours (MH) that is used to assign
overhead costs to products and services. The most widely used allocation bases in manufacturing are direct
labor-hours, direct labor cost, machine-hours and (where a company has only a single product) units of product.
Manufacturing overhead is commonly assigned to products using a predetermined overhead rate. The
predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost for the
period by the estimated total amount of the allocation base.
The predetermined overhead rate is computed before the period begins using a four-step process:
1. .Estimate the total amount of the allocation base (the denominator) that will be required for next period's
estimated level of production.
2. Estimate the total fixed manufacturing overhead cost for the coming period and the variable
manufacturing overhead cost per unit of the allocation base.
3. Use the cost formula to estimate the total manufacturing overhead cost (the numerator) for the coming