The chapter includes descriptions of how managers need to rely upon different
classifications of costs for different purposes. This chapter emphasizes four main purposes
of cost classification:
• For preparing external reports such as the balance sheet and income
• To predict cost behaviour—how costs will react to changes in activity.
• For purposes of assigning costs to cost objects such as products or
• To aid in making business decisions
Additionally, a portion of this chapter is on the use of job-order costing to track costs of
products or services in organizations that offer many different products or services.
1. Assignment of costs is done by using:
• documents such as materials requisitions forms and labour time tickets to assign
direct materials and direct labour costs
• predetermined overhead rates to assign manufacturing overhead costs to help
smooth out fluctuations and ensure timeliness of overhead application
2. Cost flows are summarised in the schedules of costs of goods manufactured and
cost of goods sold.
3. Underapplied or overapplied overhead costs are closed to the appropriate
Costing Systems. Two major types of costing systems are used in manufacturing and
many service firms: process costing and job-order costing.
1. Process Costing. A process costing system is used where a single, homogeneous
product or service is produced. In a process costing system, total manufacturing
costs are divided by total number of units produced during a given period. The unit
cost that results is a broad, average figure.
2. Job-Order Costing. Job-order costing is used when different types of products,
jobs, or batches are produced, typically over a rather short period of time. In a job-
order costing system, direct materials costs and direct labour costs are usually
www.notesolution.com “traced” directly to jobs. Overhead is applied to jobs using a predetermined rate.
Actual overhead costs are not “traced” to jobs.
Overview of Job-Order Costing. Cost and other data are recorded on materials
requisition forms, time tickets, and job cost sheets. Many companies now enter cost and
other data directly into computer databases and have dispensed with these paper
1. Job Cost Sheet. Each job has its own job cost sheet on which are recorded the costs
that have been charged to the job. The job cost sheet will have some code or
descriptive data to identify the particular job and will contain spaces to collect costs
of materials, labour, and overhead.
2.Materials Costs. When a job is started, materials that are needed to complete the
job are withdrawn from the storeroom. The document that authorizes these
withdrawals and that specifies the types and amounts of materials withdrawn is
called the materials requisition form. The materials requisition form identifies
the job to which the materials are to be charged. Care must be taken when
charging materials to distinguish between direct and indirect materials.
3.Labour. Labour costs are recorded on a document called a time ticket or a time
sheet. Each employee records the amount of time he or she spends on each job
and each task on a time ticket. The time spent on a particular job is considered
direct labour and its cost is “traced” to that job. The cost of time spent on other
tasks, not traceable to any particular job, is usually considered part of
4. Manufacturing Overhead. Manufacturing overhead includes all of those costs
incurred in the manufacturing process which are not “traced” to a particular job. By
definition, manufacturing overhead usually consists of all manufacturing costs other
than direct materials and direct labour. Since manufacturing overhead costs are not
traced to jobs, they must be allocated to jobs if absorption costing is used.
a. In order to allocate overhead costs, some type of allocation base common to all
products being produced must be identified. The most widely used allocation
bases are direct labour-hours, direct labour costs, and machine-hours. In the
costing system illustrated in the chapter, a predetermined overhead rate is
computed by dividing the estimated total overhead for the upcoming period by
the estimated total amount of the allocation base.
b. Ideally overhead cost should be strictly proportional to the allocation base; in
other words, an X% change in the allocation base should cause an X% change
www.notesolution.com in the overhead cost. Only then will the allocated overhead costs be useful in
decision-making and in performance evaluation.
c. The actual amount of the allocation base incurred by a job is recorded on the job
cost sheet. The actual amount of the allo