Chapter 20 - Job Order Costing

Cost Accounting Systems

• Cost accounting involves measuring, recording, and reporting product costs.

• Accounts are integrated into the general ledger.

• A perpetual inventory system provides up-to-date product cost information.

• Two basic types:

  • Process cost system

  • Job order cost system

Process Cost System

• Used for large volumes of similar products (e.g., cereal, petroleum refining, ice cream production).

• Costs are accumulated for a time period (week or month).

• Costs are assigned to departments or processes for a specified period.

Job Order Cost System

• Costs are assigned to each job or batch.

• Each job or batch has its own unique characteristics.

• Objective: Compute the cost per job.

• Measures costs for each job completed, not for set time periods.

Job Order Cost Flow

• The flow of costs parallels the physical flow of materials as they are converted into finished goods.

• Manufacturing costs are assigned to the Work in Process (WIP) Inventory account.

• The cost of completed jobs is transferred to the Finished Goods Inventory account.

• When units are sold, the cost is transferred to the Cost of Goods Sold account.

Accumulating Manufacturing Costs

Raw Material Costs

• Example: Wallace Company purchases 2,000 lithium batteries at 5 each ( 10,000) and 800 electronic modules at 40 each (32,000), totaling$42,000.

• Journal entry:

  • Debit: Raw Materials Inventory $42,000

  • Credit: Accounts Payable $42,000

Factory Labor Costs

• Consists of:

  • Wages payable to factory workers.

  • Employer payroll taxes on these wages.

  • Fringe benefits (sick pay, pensions, vacation pay).

• Example: Wallace incurs 32,000 in factory labor costs, with 27,000 for wages and 5,000 for payroll taxes.

• Journal entry:

  • Debit: Factory Labor 32,000

  • Credit: Factory Wages Payable 27,000

  • Credit: Employer Payroll Taxes Payable 5,000

Manufacturing Overhead Costs

• Includes property taxes, depreciation, insurance, and repairs related to manufacturing.

• Costs unrelated to manufacturing are expensed.

• Manufacturing-related costs accumulate in the Manufacturing Overhead account and are assigned to work in process.

• Example: Wallace Manufacturing's summary entry for manufacturing overhead:

  • Debit: Manufacturing Overhead 13,800

  • Credit: Utilities Payable 4,800

  • Credit: Prepaid Insurance 2,000

  • Credit: Accounts Payable (repairs) 2,600

  • Credit: Accumulated Depreciation 3,000

  • Credit: Property Taxes Payable 1,400

Assigning Manufacturing Costs

• Assigning manufacturing costs to work in process results in:

  • Debits to Work in Process Inventory.

  • Credits to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

Job Cost Sheet

• Used to record costs chargeable to specific jobs.

• It's a subsidiary ledger for the Work in Process Inventory account.

• Each entry to Work in Process Inventory is accompanied by a posting to one or more job cost sheets.

Raw Material Costs

• Assigned to a job when materials are issued in response to requests via a materials requisition slip.

• Materials requisition slip: written authorization for issuing raw materials.

• Direct materials: Charged to Work in Process Inventory.

• Indirect materials: Charged to Manufacturing Overhead.

• Example: Wallace uses 24,000 of direct materials and 6,000 of indirect materials.

• Journal entry:

  • Debit: Work in Process Inventory 24,000

  • Debit: Manufacturing Overhead 6,000

  • Credit: Raw Materials Inventory 30,000

Factory Labor Costs

• Assigned to jobs based on time tickets.

• Time tickets indicate:

  • Employee.

  • Hours worked.

  • Account and job charged.

  • Total labor cost.

• Example: 32,000 total factory labor cost consists of 28,000 of direct labor and 4,000 of indirect labor.

• Journal entry:

  • Debit: Work in Process Inventory 28,000

  • Debit: Manufacturing Overhead 4,000

  • Credit: Factory Labor 32,000

Predetermined Overhead Rate

• Manufacturing overhead costs relate to production operations as a whole and are assigned to work in process using a predetermined overhead rate.

• Based on the relationship between estimated annual overhead costs and expected annual operating activity.

• Expressed in terms of an activity base (direct labor costs, direct labor hours, machine hours, etc.).

• Established at the beginning of the year.

• Small companies use a single, company-wide rate; large companies use different rates for each department.

• Formula:

  • (\text{Predetermined Overhead Rate} = \frac{\text{Estimated Annual Overhead Costs}}{\text{Expected Annual Operating Activity}})

• Example: Wallace Company uses direct labor cost as the activity base. Expected annual overhead costs are 280,000, and direct labor costs are 350,000.

  • Overhead rate = 280,000 / 350,000 = 0.80 (80%)

• For every dollar of direct labor, Wallace assigns 80 cents of manufacturing overhead to a job.

• If direct labor costs are 28,000, applied overhead is 28,000 * 0.80 = 22,400.

• Journal entry:

  • Debit: Work in Process Inventory 22,400

  • Credit: Manufacturing Overhead 22,400

Entries for Jobs Completed and Sold

Assigning Costs to Finished Goods

• When a job is completed, the costs are summarized, and an entry is made to transfer the total cost to finished goods inventory.

• Example: Wallace completes Job No. 101 with a total cost of 39,000.

• Journal entry:

  • Debit: Finished Goods Inventory 39,000

  • Credit: Work in Process Inventory 39,000

Assigning Costs to Cost of Goods Sold

• When a job is sold, entries are made to record the sale and recognize the cost of goods sold.

• Example: Wallace sells Job 101 (cost: 39,000) on account for 50,000.

• Journal entries:

  • Debit: Accounts Receivable $50,000

  • Credit: Sales Revenue $50,000

  • Debit: Cost of Goods Sold $39,000

  • Credit: Finished Goods Inventory $39,000

Advantages and Disadvantages of Job Order Costing

Advantages

• More precise in assigning costs to projects than process costing.

• Provides more useful information for determining the profitability of particular projects and for estimating costs when preparing bids on future jobs.

Disadvantage

• Requires a significant amount of data entry.

Under- or Overapplied Manufacturing Overhead

• A debit balance in manufacturing overhead means overhead is underapplied.

• A credit balance means overhead is overapplied.

• Any year-end balance in manufacturing overhead is eliminated by adjusting the cost of goods sold.

  • Underapplied overhead: Debited to COGS.

  • Overapplied overhead: Credited to COGS.

• Example: Wallace has a $1,400 debit balance in Manufacturing Overhead.

• Adjusting entry:

  • Debit: Cost of Goods Sold $1,400

  • Credit: Manufacturing Overhead $1,400

Formulas

• Predetermined Overhead Rate = (\frac{\text{Estimated Annual Overhead Costs}}{\text{Expected Annual Operating Activity}})$$