Comprehensive Notes on Job-Order Costing Systems

Overview of Cost Assignment and Job-Order Costing

• Definition of Job-Order Costing: Job-order costing is a cost assignment system focused on tracing and assigning costs directly to a specific batch or lot of identifiable cost objects.
• Conceptual Simplicity: This method is considered the simplest form of cost assignment due to its direct focus on identifiable batches.
• Contrast with Process Costing:     * Process Costing: Traces and associates costs according to the process rather than the individual products. Calculations are generally more complicated.     * Shared Goal: Both systems aim to gather costs and divide them among a set of goods under production.
• Scope of Application:     * Job-order costing parallels the physical flow of goods through a manufacturing operation.     * It is directly applicable to tracing costs in various service sectors.
• Core Approaches to Overhead: The system can measure overhead through actual, normal, or standard cost approaches.

Production Environments and the Applicability of Job-Order Costing

• Intended Environments: Job-order costing was developed for production involving custom, job-shop, and batch production.
• Batch Definition: Production "batches" or lots can range from a single unit to many dozens of units.
• Reasons for Batching:     * Different customer orders.     * Varied specifications.     * Differences in seasonal demand.     * Production convenience.
• Integration with Process Costing: Large organizations may use both systems.     * Example: Computer Diskette Manufacturers:         * Internal components (metal hubs, doors, magnetic disks) are uniform and costed via process costing on continuous lines.         * Final assembly, involving specific labels, sleeve colors, and brand-specific markings, occurs in batches to meet customer orders and is costed via job-order costing.
• Suitability for Customization:     * When virtually every product differs from the next (made-to-order), job-order costing is required.     * Construction Examples: Swimming pools, bridges, and environmental control systems for large buildings.     * Service Industry Examples: Professional law or accounting work, software installation, and photocopier repair.     * Unique Production Examples: Aircraft assembly (often lots of one unit) and book printing/binding (unique, limited runs).

The Accounting Flow of Costs through Inventories

• Concept of Assets: Expenditures for manufacturing are recorded as assets until the goods produced are sold.
• Three Basic Inventory Classes:     1. Raw Materials Inventory: Reflects purchase and inbound logistics costs of materials prior to involvement in production.     2. Work-in-Process (WIP) Inventory: Represents costs currently in the manufacturing process. Systems modify the recorded cost of WIP as goods move through production.     3. Finished Goods Inventory (FGI): Holds the costs that "exit" from WIP once the physical goods are complete.
• The Cost Transformation: Once the accumulation process for a batch is finished, the total cost is removed from WIP and placed into FGI.

Mechanisms and Documentation of Job-Order Costing

• Direct Cost Gathering: Direct material (DM) and direct labor (DL) costs are gathered per batch and assigned directly to the units in that batch.
• Assigning Overhead (OH): General overhead is assigned to a job through an allocation procedure using job-specific data (e.g., labor hours, machine hours, or "touches").
• Job Cost Sheet:     * A document used to record the costs of materials pulled from inventory for a specific job.     * It may summarize information from several "material requisition forms."     * In bookkeeping, it serves as a subsidiary ledger page for the WIP inventory account.
• The Bookkeeping Entry:     * When materials are issued: Debit Work-in-Process; Credit Raw Materials Inventory.     * Current systems use computers to record these in a file for the specific job rather than a physical sheet.
• Labor Tracking: As direct laborers work, their hours and related pay are recorded in the job's specific file.
• Departmental Movement: Costs are added from every department or part added throughout the factory; the specific location is less important than the cumulative addition to the job's file.

Mathematical Procedures for Assigning Overhead

• Basis Activity Measure: Overhead is included in a job's file using a rate related to an allocation basis (e.g., direct labor hours).
• Formula for Overhead Rate ($OHr$):$OHr = \frac{\text{Total Overhead}}{\text{Total Basis}}$
• Formula for Overhead Assigned to a Job:$\text{Overhead Assigned} = OHr \times \text{Basis in Job}$
• Total Job Cost Calculation: At a minimum, three cost numbers must be summed:     1. Direct Labor Cost.     2. Direct Material Cost.     3. Overhead Cost.
• Per Unit Cost Formula:$\text{Per Unit Cost} = \frac{\text{Total Job Cost}}{\text{Number of Units in Batch}}$

Comparative Analysis: Actual vs. Normal Costing Methodologies

• Actual Costing:     * Definition: Computed after the fact based on recorded costs (ex post).     * Timing: Requires waiting for the end of the period to determine total actual overhead and total actual basis activity.     * Weakness: Delays in costing (e.g., waiting for monthly utility bills).
• Normal Costing:     * Definition: Uses estimates to compute overhead associated with a job (a priori).     * Predetermined Overhead Rate (PDOR): Calculated at the start of the year. $\text{PDOR} = \frac{\text{Estimated Total Annual Overhead}}{\text{Estimated Total Annual Activity Level of Basis}}$     * Applied Overhead: The amount assigned using the PDOR ($\text{Basis in Job} \times PDOR$).     * Advantages:         * Speed: Jobs can be costed immediately upon completion.         * Smoothing: Averages overhead effects across the year, preventing units made in busy months from appearing cheaper than units made in slow months (e.g., avoiding January heating costs spiked in actual costing).

Detailed Case Study: Framingham Framis Company

• Company Context: Make-to-order framises; variable overhead parallels direct labor hours (DLH).
• Job 930503 Data:     * Units: $2000$     * Direct Materials (Plastic Resin): $5000$ lbs with value of $11200$     * Direct Labor: $4200$ DLH at a total cost of $49000$     * Prime Costs: $11200 + 49000 = 60200$
• Actual Costing Application (May):     * Factory total DLH in May: $16800$     * Factory total OH in May: $280000$     * Calculation:         * Job 930503 used $\frac{4200}{16800} = 25\%$ of basis.         * $Actual Rate = \frac{280000}{16800} = 16.6667 \, \text{per DLH}$         * $Assigned OH = 4200 \times 16.6667 = 70000$     * Total Actual Cost: $11200 + 49000 + 70000 = 130200$     * Per Unit Cost: $\frac{130200}{2000} = 65.10$
• Normal Costing Application:     * Estimated Annual OH: $5000000$     * Estimated Annual DLH: $200000$     * $PDOR = \frac{5000000}{200000} = 25 \, \text{per DLH}$     * $Applied OH = 4200 \times 25 = 105000$     * Total Normal Cost: $11200 + 49000 + 105000 = 165200$     * Per Unit Cost: $\frac{165200}{2000} = 82.60$

Comparative Example: Light-Pro Custom Replacement Window Factory

• Context: Upstate New York, January (9th year of operations).
• Job Data (January Orders):     * Job 901: DM: $1450$, DL: $550$, DLH: $50$, MH: $30$, Windows: $8$     * Job 902: DM: $2235$, DL: $825$, DLH: $75$, MH: $20$, Windows: $12$     * Job 903: DM: $1120$, DL: $275$, DLH: $25$, MH: $10$, Windows: $5$     * Job 904: DM: $4325$, DL: $1100$, DLH: $100$, MH: $40$, Windows: $10$     * Job 905: DM: $2280$, DL: $550$, DLH: $50$, MH: $20$, Windows: $6$
• Factory-Wide Data:     * Actual January OH: $12000$     * Actual Total DLH: $300 \, (50+75+25+100+50)$     * Actual Total Machine Hours (MH): $120 \, (30+20+10+40+20)$     * Estimated Annual OH: $146000$     * Estimated Total DLH: $4000$     * Estimated Total MH: $1600$
• Costing of Job 901 across Methods:     1. Actual DLH Basis:         * $Rate = \frac{12000}{300} = 40/DLH$         * $OH = 50 \times 40 = 2000$         * $Total = 1450 + 550 + 2000 = 4000 \, (500/unit)$     2. Normal DLH Basis:         * $PDOR = \frac{146000}{4000} = 36.50/DLH$         * $OH = 50 \times 36.50 = 1825$         * $Total = 1450 + 550 + 1825 = 3825 \, (478.125/unit)$     3. Actual Machine Hour (MH) Basis:         * $Rate = \frac{12000}{120} = 100/MH$         * $OH = 30 \times 100 = 3000$         * $Total = 1450 + 550 + 3000 = 5000 \, (625/unit)$     4. Normal MH Basis:         * $PDOR = \frac{146000}{1600} = 91.25/MH$         * $OH = 30 \times 91.25 = 2737.50$         * $Total = 1450 + 550 + 2737.50 = 4737.50 \, (592.19/unit)$

Choice of Allocation Basis and Accounting Implications

• Consistency: A company cannot change bases job-to-job; one must be chosen and used consistently for all jobs throughout a year.
• Selecting a Basis: Decisions depend on what drives overhead costs (e.g., machine power vs. human support, supply usage).
• Overapplied/Underapplied Overhead:     * Result of using normal costing (estimating errors and variations).     * Underapplied: Actual OH > Applied OH.     * Overapplied: Actual OH < Applied OH.     * Calculated at year-end, not monthly.     * Disposed of by adjusting the Work-in-Process, Finished Goods, or Cost of Goods Sold (COGS) accounts.

Standard Cost Approach

• Definition: Uses estimates or a priori values for all three components: direct material, direct labor, and overhead.
• Methodology: Records what material and labor should have been used and what they should have cost, rather than actual usage.
• Primary Purposes:     * Micro-budgets: Allows estimation of future activity.     * Pricing: Assists in pricing decisions by knowing planned costs beforehand.     * Performance Monitoring: Acts as a "standard" for comparison to see how far actual usage/cost deviates from the ideal.

Solved Problems

Problem 1: Warren Company

• Data: Normal costing; PDOR = $25/DLH$ (includes $10$ variable); Expected Level = $200000$ DLH. February actuals: OH = $550000$, DLH = $25000$. Job 301-C: DM = $50000$, DLH = $7000$ at $15/hour$.
• Requirement 1 (Normal Cost):     * $DM = 50000$; $DL = 7000 \times 15 = 105000$; $Applied OH = 7000 \times 25 = 175000$.     * Total = $330000$.
• Requirement 2 (Actual Cost):     * $Actual Rate = \frac{550000}{25000} = 22/DLH$.     * $OH = 7000 \times 22 = 154000$.     * Total = $309000$.
• Reasoning for Normal Costing: Smoother month-to-month costs and faster cost assignment for jobs.

Problem 2: Kramit Tool and Dye Corporation (KTD)

• Data: Normal Costing; DL rate = $8/hr$; Actual OH = $1545$; PDOR = $5/DLH$. Jobs 278, 282, 305 completed.
• Job Calculations (DM + DL + OH):     * Job 278: $250 + (46 \times 8) + (46 \times 5) = 250 + 368 + 230 = 848$.     * Job 282: $412 + (32 \times 8) + (32 \times 5) = 412 + 256 + 160 = 828$.     * Job 305: $1215 + (81 \times 8) + (81 \times 5) = 1215 + 648 + 405 = 2268$.     * Job 307 (WIP): $346 + 144 + 90 = 580$.     * Job 309 (WIP): $1440 + 496 + 310 = 2246$.
• Applied OH Total: $230+160+405+90+310 = 1195$.
• Underapplied OH: $1545 - 1195 = 350$.

Problem 3: Sellfirst Incorporated

• Data: Estimated annual OH = $2000000$; Budgeted DLH = $500000$. Job #045: DM = $40000$; Labor costs ($5/DLH$) = $15000$. Actual Year-end: DLH = $540000$; OH = $1995000$.
• Predetermined Rate: $\frac{2000000}{500000} = 4/DLH$.
• Job #045 Transfer to FGI:     * $DLH = \frac{15000}{5} = 3000$.     * $Cost = 40000 (DM) + 15000 (DL) + (3000 \times 4) (Applied OH) = 67000$.
• Year-end Over/Underapplied:     * $Applied = 540000 \times 4 = 2160000$.     * $Actual = 1995000$.     * $Overapplied = 2160000 - 1995000 = 165000$.