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Chapter 3

Chapter 3- Notes.docx

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York University
ACTG 2020
Ben Kelly

Chapter 3 Notes A. Two basic costing systems are commonly used in manufacturing and in many service organizations: process costing and joborder costing. 1. Process costing is used in situations where a single homogeneous product such as bricks is produced for long periods of time. 2. Joborder costing is used in situations where many different products or services are produced each period. Examples include special order printing and furniture manufacturing where products are typically produced in small batches. For example, fifty units of a particular type of sofa might be made in one batch. Each batch is called a job. These concepts also extend to service companies. For example, in a consulting company, a job would be a particular consulting project. B. We begin our discussion of joborder costing with raw materials. When materials are purchased, their costs are recorded in the Raw Materials inventory account, which is an asset. If the materials are paid for with cash, the journal entry would look like this: Raw Materials Inventory XXX Cash XXX 1. Materials are withdrawn from storage using a materials requisition form as authorization. The form lists all the materials required to complete a specific job. The journal entry to record withdrawal of raw materials from the storeroom for use in production is: Work in Process Inventory (direct materials)XXX Manufacturing Overhead (indirect materials) XXX Raw Materials Inventory XXX Materials that are traced directly to jobs are classified as direct materials and are debited to Work in Process. Any materials that are not directly traced to jobs are classified as indirect materials and are debited to a special control account called Manufacturing Overhead. 2. When materials are placed into production, they are recorded on a job cost sheet, which summarizes all production costs assigned to a particular job. Exhibit 32 illustrates a job cost sheet. C. Labour costs are recorded on time tickets or time sheets that are filled out by employees. These documents list the amount of time each employee works on specific jobs and tasks. 1. Labour time spent working directly on specific jobs is termed direct labour. Labour time spent working on supportive tasks (e.g., supervision, maintenance, janitorial) is termed indirect labour. The entry to record labour costs is: Work in Process Inventory (direct labour) XXX Manufacturing Overhead (indirect labour) XXX Salaries and Wages Payable XXX Direct labour costs are debited to Work in Process. Indirect labour costs are debited to the control account Manufacturing Overhead. 2. Direct labour costs are added to the individual job cost sheets at the same time they are recorded in the formal accounts. D. As explained in Chapter 2, manufacturing overhead is an indirect cost and therefore must be allocated in order to be assigned to units of product. This allocation is usually done with a predetermined overhead rate. 1. The predetermined overhead rate is computed before the year begins and is based entirely on estimated data. Ordinarily, the rate is computed for an entire year to eliminate seasonal fluctuations. The formula is: Estimated total manufacturing Predetermined overhead cost overhead rate = Estimated total amount (POHR) of the allocation base An allocation base is a measure of activity, such as direct labourhours, direct labour cost, or machine-hours. The allocation base is something that all jobs have in common for example, all jobs may require direct labourhours. Ideally, the allocation base should actually cause the overhead cost, but in practice this ideal is often ignored. 2. For example, suppose direct labourhour is used as the allocation base and that the estimated total manufacturing overhead cost for next year is $400,000 and the estimated total number of direct labourhours is 10,000. Then the predetermined overhead rate would be $40 per direct labourhour ($400,000 10,000 direct labourhours). 3. To assign overhead costs to a job, the pre-determined overhead rate is multiplied by the amount of the allocation base used by the job. For example, suppose that a particular job uses 20 direct labour-hours and the predetermined overhead rate is $40 per direct labour-hour. Then $800 (20 direct labour-hours $40 per direct labour-hour) of overhead cost would be applied to that job. This $800 is called overhead applied. Note that this is not actual overhead spending on the job. The $800 may have little to do with any overhead that is actually used by the job. Instead, it is simply a way of assigning the overhead costs that were estimated at the beginning of the year to the jobs worked on during the year. 4. The overhead that is applied to a job is entered on its job cost sheet and is recorded in the company's formal accounts with the following journal entry: Work in Process Inventory XXX Manufacturing Overhead XXX Note that in this case, the Manufacturing Overhead control account is credited, rather than debited. 5. Review Exhibit 38 to see how overhead costs flow through the accounts and onto the job cost sheets. Notice from the exhibit that applying overhead to jobs and recording actual overhead costs represent two separate and distinct processes. This is a key concept that you must understand. 6. Actual overhead costs are not charged to Work in Process. Instead, they are charged to the Manufacturing Overhead control account as we saw in the entries for indirect labour and indirect materials above. Note that actual overhead costs all appear as debits to Manufacturing Overhead. E. When jobs are completed, their costs are transferred from Work in Process to Finished Goods. The journal entry is: Finished Goods Inventory XXX Work in Process Inventory XXX When completed products are sold, their costs are transferred from Finished Goods to Cost of Goods Sold. The journal entry is: Cost of Goods Sold XXX Finished Goods Inventory XXX F. Exhibits 3-9, 310, 311 and 312 are key exhibits that summarize much of the material in the chapter. Study these exhibits carefully. Note particularly how the manufacturing overhead costs are handled. G. Generally there will be a difference between the amount of overhead cost applied to Work in Process and the amount of actual overhead cost incurred for a period. This difference is reflected in a de
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