CHAPTER 3: Job-Order Costing
The way a product is costed can have an impact on net income and management decisions.
The purpose is to provide cost data to help managers plan, control, direct, and make
decisions. However, external financial reporting and tax requirements may affect how costs
are summarized in managerial reports.
Absorption Costing – a method of costing that includes ALL manufacturing costs – direct
materials, direct labour, and both variable and fixed overhead – as part of the cost of a
finished product. Basically the FULL COST (most common approach)
Process Costing System – used in manufacturing situations where a single, homogeneous
product is produced for long periods of time (like paper, bottles, and hot dogs). Unit product cost
is calculated by dividing total manu cost by the total units produced
Job-Order Costing System – used in situations where many different products, jobs, or
services are produced each period. Usually products are done in batches or jobs. Costs are
traced and allocated to jobs and then the costs of that job are divided by the number of units to
get the avg cost per unit. (e.g. construction projects, greeting cards, airline meals). Service
industries use this a lot, but they don’t have raw materials.
Job-Order Costing Overview:
Measuring Direct Materials Cost
Usually there will be a bill of materials, a doc that shows the type and qty of each major type of
material required to make one product. A production order is issued when an agreement has
been reached about qty, price, and shipment date. Then, the Production Dep’t prepares a
materials requisition form, which specifies the type of qty of materials needed from the
storeroom, and the job itself.
Then, the accounting dep’t prepares a job cost sheet, which is a form prepared for each job
that records the amterials, labour, and overhead costs charged. It is a key part of accounting
records because they serve as a subsidiary ledger to the Work in Process account.
Direct labour must be added too. Workers use time tickets, a summary of an employee’s hours
during a day. Only direct labour is added Job Cost Sheet, while indirect is charged to overhead.
Manufacturing overhead is an indirect cost that is hard to trace to a job, and tend to stay
constant to the presence of fixed costs. Therefore, an allocation base is selected to measure
activity such as direct labour-hours or machine-hours that is used to assign overhead costs, that
is common to all of the company’s products. Manufacturing overhead is commonly applied using
a predetermined overhead rate, which is the total estimated manufacturing overhead divided
by the allocation base. Assigning overhead costs to jobs before the start of them is called
Normal Cost System – a costing system in which overhead costs are applied to jobs by
multiplying a predetermined overhead rate by the actual amount of the allocation base incurred
by the job. Of course, the overhead cost is not the actual amount, because it’s immeasurable.
Another method is to wait until the end of the period to calculate the actual overhead rate.
However, managers like using predetermined overhead rates more BECAUSE: 1. Managers like to know the valuation of completed jobs before the end of the period.
2. If actual overhead rates are computed frequently, seasonal issues will provide too much
fluctuation, and can be misleading.
3. Predetermined rates simplify record-keeping.
Choice of an Allocation Base – this should drive the overhead cost/affect it most, such as
labour-hours or labour cost. However, direct labour is decreasing due to new technology and
the importance of knowledge workers like engineers who do indirect research. Therefore,
managers have developed activity-based costing principles to redesign their accounting
The Flow of Docs in a Job-Order Costing System
•A sales order is Order •Materials
prepared as a •A production order •Direct Labour Time
basis for initiates work on a Ticket Job Cost Sheet
issuing... job, where costs •Predetermined
are charged Overhead Rates
Sales Order through:
Job Order Costing- The Flow of Costs
1. Raw materials are acquired as assets
2. Requisitioned direct material is debited to Work in Progress, while indirect material is
debited to Manufacturing Overhead. Raw Materials is credited. (The work in progress
account is the control account that is the total of individual job cost sheets for the period)
3. Direct Labour is credited as Work in Progress and Indirect Labour is credited as
Manufacturing Overhead. Salaries/Wages Payable is credited.
4. When new costs are found, debit Manufacturing Overhead and credit Account Payable
(property tax, prepaid insurance, acc. Dep, etc.)
Predetermined Overhead Rate is used to apply overhead costs to jobs. Multiply the number of
direct hours by that rate to get the manufacturing overhead (credit). Debit Work in Progress.
It’s used as a clearing account because actual costs are debited to Manufacturing Overhead
as they incur.
*Note: Actual overhead costs are not charged to jobs and DO NOT appear on the job cost
sheet or work in process account – only the applied overhead cost based on the
predetermined overhead rate does.
Advertising and selling costs should not go into the manufacturing overhead account, but the
income statement as an expense. Depreciation on office equipment is a period cost on the
income statement, while depreciation on factory equip’t is a product cost and debited to
Cost of Goods Manufactured When a job is completed, the work in progress account is credited and finished goods are
debited. As those goods are shipped to customers, their cost is transferred from the
Finished Goods account to the COGS account and revenue is recognized.
Steps: Debit A/R, Credit Sales. Debit COGS (for the amount sold, unit price x unit qty), and
credit Finished Goods.
*Note: The schedule of COGS manufactured is the overhead applied to jobs, not actual
overhead because it’s easier to trace back to a journal entry.
Complications of Overhead Application
There could be over or under-applied overhead because it’s only an estimate at the beginning.
Therefore, you could 1. Close out the COGS, 2. Allocate evenly b/w work in process, finished
goods, and COGS, or 3. Carry it to the next period.
The second allocation is more accurate – you find the percentage of applied overhead of the
total, and then multiply that by the over or under-applied overhead amount.
Plantwide Overhead Rate – a single predetermined overhead rate that is used throughout a
plant. In large companies, multiple predetermined overhead rates are often used.
CHAPTER 4: Systems Design – Process Costing
Process Costing is used in in