Job Costing - Study Notes (CU Boulder Leeds)

• Purpose: Understand how costs are accumulated, allocated, and reported in job costing systems used for customized or batch-produced products/services.

Key Building Blocks of a Costing System

• Cost Object: A product, service, or job to which direct costs are traced and indirect costs are allocated.

• Cost Pool: A logical grouping of related indirect cost items to simplify allocation.

• Cost Allocation Base: A cost driver used to distribute indirect costs to cost objects.

\text{Overhead Allocation Rate per Pool} = \frac{\text{Budgeted Total Overhead in Cost Pool}}{\text{Budgeted Total Activity Level of Allocation Base}}

• Examples of allocation bases include direct labor hours, machine time, or other activity measures.

Costing System 1: Job Costing

• Used by firms that produce relatively unique products/services or distinct batches (customers may differ).

• Costs are attached to a specific cost object (the “job”) as it moves through production.

• Provides an estimated cost for each job.

• Examples of firms using job costing:

  • Public accounting firms, consulting firms, advertising agencies, government contractors, custom manufacturers (tool & die), etc.

• Key implication: Each job has its own cost sheet capturing direct and allocated indirect costs.

Costing System 2: Process Costing

• Used for mass production of large quantities of substantially identical goods.

• Costs are accumulated by department (process) over a period.

• At period end, costs are allocated to units completed and units in process.

• Does not provide a unit-specific cost; provides an average cost per unit for the period.

• Examples of firms using process costing:

  • Oil refiners, steel producers, automobile manufacturers, grain producers, etc.

Costing Systems Illustrated (Industry Examples)

• Job Costing used in: audit engagements, consulting engagements, advertising campaigns, legal cases, computer repair, film production, mail-order items, Boeing aircraft assembly, shipbuilding, etc.

• Process Costing used in: bank check clearing, postal delivery, grain/dealing, lumber, oil refining, beverage production, etc.

Practice Question

• Q: For which industry would job costing be less appropriate?

  • a) Small business printing

  • b) Cereal production

  • c) Home construction

  • d) Aircraft assembly

• Answer: cereal production (mass production; better suited to process costing).

Approach to Job Costing (Seven Steps)

1) Identify the job to be the cost object (e.g., consulting engagement, product, or batch).

2) Identify direct costs traced to the cost object.

3) Identify indirect cost pools for the cost object.

4) Select reasonable cost-allocation base(s) (cost drivers) to allocate indirect costs to the cost object (e.g., direct labor hours, machine time).

5) Calculate the allocation rate for each indirect cost pool (indirect-cost allocation rate).

6) Compute the indirect costs allocated to the job.

7) Assign costs to the cost object by summing direct costs and allocated indirect costs.

• In formula form:

\text{OH Allocation per Pool} = \text{Rate per Pool} \times \text{Actual Activity for Job (Base)}

\text{Total Cost}{\text{Job}} = \text{Direct Costs}{\text{traced}} + \text{Sum of Indirect Costs Allocated}_{\text{to Job}}

Job Costing Data Example (Job #123)

• Scenario: A tool-and-die manufacturer received an order to produce a specialized die (Job #123).

• Direct costs for Job #123:

  • Direct labor = 50 hours @ $25/hr = 1250

  • Direct materials = 30,000

• Indirect costs (manufacturing OH) for all operations: 20,000

• Total direct labor used for all manufacturing operations = 1,000 hours

• Allocation base: direct labor hours (DLH)

• Allocation rate (OH per DLH):

\text{OH Rate} = \frac{20,000}{1,000} = 20 \text{ per DLH}

• Indirect costs allocated to Job #123 (based on 50 DLH):

\text{OH Applied}_{123} = 50 \times 20 = 1,000

• Total cost under Normal Costing for Job #123:

\text{Total Cost}_{123}^{\text{Normal}} = 30,000 + 1,250 + 1,000 = 32,250

• If Actual costing were used with the same data (and if the actual OH rate matched the above), the OH allocated would be the same; otherwise, it would be based on the actual OH rate and actual activity.

• Note: A separate example (later in the material) uses machine hours as the OH base with budgeted vs. actual OH to illustrate variance and shutdown of overhead accounts.

A Practical Two-Account Model for Overhead (Normal Costing)

• Overhead Control (actual overhead costs incurred)

  • Debited when actual overhead costs are incurred (e.g., utilities, depreciation, indirect materials, indirect labor).

• Overhead Applied/Allocated (to reflect overhead assigned to WIP)

  • Debited to WIP for the amount of overhead applied; credited to the Overhead Applied account.

• At period end:

  • Compare Overhead Applied to Overhead Control.

  • If Over-applied (applied > actual), the difference is typically closed to Cost of Goods Sold (C.O.G.S.) under the Write-off approach.

  • If Under-applied (applied < actual), the difference may be charged to COGS or prorated among WIP, Finished Goods, and COGS (depending on company policy).

• Common closing methods for the overhead control account:

  1) Write-off approach: close the balance to COGS.

  2) Proration approach: allocate the balance proportionally to WIP, Finished Goods, and COGS.

  3) Adjusted allocation-rate approach: recalculate with the actual allocation rate.

• Important note: In practice, only the Write-off approach to COGS is often shown in simplified examples.

• Definitions:

  • Over-applied overhead: when overhead applied to jobs exceeds actual overhead incurred.

  • Under-applied overhead: when overhead applied is less than actual overhead incurred.

Actual Costing vs Normal Costing (Key Formulas)

• Actual costing:

  • Indirect costs allocated to a job based on the actual overhead rate and actual usage:

\text{OH}_{\text{Actual}} = \text{Actual Overhead Rate} \times \text{Actual Activity}

• Normal costing:

  • Indirect costs allocated based on the budgeted overhead rate and actual usage:

\text{OH}_{\text{Normal}} = \text{Budgeted Overhead Rate} \times \text{Actual Activity}

• Actual overhead rate:

\text{Actual Overhead Rate} = \frac{\text{Actual Total Overhead in Cost Pool}}{\text{Actual Total Activity Level of Allocation Base}}

• Budgeted overhead rate:

\text{Budgeted Overhead Rate} = \frac{\text{Budgeted Total Overhead in Cost Pool}}{\text{Budgeted Total Activity Level of Allocation Base}}

• Why use normal costing instead of actual costing:

  • To incorporate indirect costs into decision-making before the period ends (actual rates are known only after the period).

  • To mitigate gaming by department managers when performance is evaluated using cost data.

• Example illustrating the incentive issue (simplified):

  • Budgeted fixed costs and utilization by two departments can lead to different allocations if actual utilization changes, making actual costing sensitive to others’ behavior whereas normal costing stabilizes allocations to budgeted levels.

• Over/under-allocation variance: a period-end balance that reflects the difference between OH actually incurred and OH allocated to jobs.

The Flow of Costs in a Job-Costing System (Product Cost Flow)

• Job cost sheet documents track:

  • Direct materials costs traced to the job

  • Direct labor costs traced to the job

  • Overhead costs allocated to the job

• Source documents include:

  • Materials requisition records

  • Labor time records (time cards)

• The subsidiary WIP (Work-in-Process) inventory account for each job tracks:

  • Cost of Direct Materials Traced

  • Cost of Direct Labor Traced

  • Cost of Overhead Allocated

• Product cost flow through inventory accounts (simplified):

  • Beginning DM + Purchases − DM Used = DM Available

  • DM Used + DL Incurred + OH Allocated = Cost of Goods Manufactured (COGM)

  • COGM + Beg FG − End FG = COGS (Cost of Goods Sold) + Ending WIP adjustments

• Journal entries are made at each production step to reflect the actual state of inventories and production activity.

• All product costs are accumulated in the Work-in-Process control account until transfer to FG and ultimately to COGS.

Journal Entries: A Typical Sequence (Conceptual)

• 1) Record actual costs as they occur:

  • Dr. Work-in-Process (DM) for actual direct materials used

  • Dr. Work-in-Process (DL) for actual direct labor incurred

  • Dr. Manufacturing Overhead Control for actual overhead incurred

  • Cr. Raw Materials Inventory, Wages Payable, and other relevant accounts

• 2) Allocate overhead to jobs (apply overhead):

  • Dr. Work-in-Process for the amount of overhead allocated to active jobs

  • Cr. Manufacturing Overhead Applied (or similar).

• 3) Transfer completed jobs to Finished Goods:

  • Dr. Finished Goods

  • Cr. Work-in-Process (for the cost of completed jobs)

• 4) Record delivery of goods (or revenue from services) and close FG to COGS when sold:

  • Dr. Cost of Goods Sold

  • Cr. Finished Goods

• 5) Closing overhead accounts at period end (examples):

  • If Over-applied: close to COGS or prorate as per policy.

  • If Under-applied: adjust COGS or prorate as per policy.

Job Costing for Service Firms

• Job costing is not limited to manufacturing; service organizations can use it for projects like auto repair, advertising campaigns, hospitals, legal cases, or accounting engagements.

• Simplest service job costing model:

  • Direct costs: traced to the job (usually direct labor).

  • Indirect costs: pooled and allocated to the job using a single allocation base (often direct labor hours).

• Example diagram for a consulting job:

  • Cost Object: Job for Consulting Client X

  • Direct costs: Professional labor traced to the job

  • Indirect costs: Client support, admin, facilities, etc. allocated using a base like professional labor hours

  • Budgeting and pricing considerations include: budgeted income margin and overhead rate calculations.

Budgeted Income Statement Perspective (Service Firm Example)

• Buff Consulting firm (budgeted):

  • Revenue: 20,000,000

  • Direct costs (professional labor): 5,000,000

  • Indirect costs (overhead): 13,000,000

  • Operating income: 2,000,000

  • Operating income margin:

    \text{Margin} = \frac{\text{Operating Income}}{\text{Revenue}} = \frac{2,000,000}{20,000,000} = 0.10 = 10\%

• Budgeted overhead rate (example concept):

  • If overhead is allocated by direct labor hours, OH rate = \frac{\text{Budgeted Overhead}}{\text{Budgeted Direct Labor Hours}} (specific numbers depend on the budget).

• Budgets can be used to set target markups and pricing to achieve a desired operating income margin.

• Example pricing exercise (for a hypothetical consulting job):

  • Budgeted direct labor hours and rates by role (Director, Partner, Associate, Assistant) are given.

  • Total direct labor cost for the job = sum(rate \times hours) across roles.

  • OH allocated to the job = OH rate \times actual hours (or budgeted hours, depending on policy).

  • Desired operating margin: e.g., 10% of price.

  • Price determination formula (simple approach):

P = \frac{D + OH}{1 - M}

• Where:

  • D = total direct labor cost on the job

  • OH = overhead allocated to the job (budgeted rate \times hours)

  • M = desired operating margin (as a decimal)

  • Practical steps:

• Compute D from the sum of labor-category costs.

• Compute OH from the chosen OH rate and the job’s hours.

• Solve for P to achieve the target margin.

Summary of Key Formulas (LaTeX)

• Overhead allocation rate per pool:

  \text{Rate per Pool} = \frac{\text{Budgeted Overhead in Pool}}{\text{Budgeted Activity Level of Allocation Base}}

• Actual vs Normal costing rates:

  \text{OH}{\text{Actual}} = \text{Actual Overhead Rate} \times \text{Actual Activity} \text{OH}{\text{Normal}} = \text{Budgeted Overhead Rate} \times \text{Actual Activity}

• Actual Overhead Rate:

  \text{Actual Overhead Rate} = \frac{\text{Actual Total Overhead in Cost Pool}}{\text{Actual Total Activity Level of Allocation Base}}

• Budgeted Overhead Rate:

  \text{Budgeted Overhead Rate} = \frac{\text{Budgeted Total Overhead in Cost Pool}}{\text{Budgeted Total Activity Level of Allocation Base}}

• Overhead applied to a job (per pool):

  \text{OH Applied} = \text{Rate per Pool} \times \text{Actual Activity for Job}

• Total cost for a job:

  \text{Total Cost}_{\text{Job}} = \text{Direct Costs Traced} + \text{Sum of Indirect Costs Allocated to Job}

• Over/Under-applied overhead (definitions):

• If \text{Overhead Applied} > \text{Actual Overhead} \implies \text{Over-applied}

• If \text{Overhead Applied} < \text{Actual Overhead} \implies \text{Under-applied}

• For service pricing (target price):

  P = \frac{D + OH}{1 - M}

If you’d like, I can turn these notes into a printable PDF or add additional worked Exercises (with step-by-step solutions) based on the examples in the slides (e.g., Job #123, Job A, and the Buff Consulting scenario).