MODULE FOR MANAGERIAL ACCOUNTING

For the period of March 16-20, 2020

JOB ORDER COSTING and PROCESS COSTING

In managerial accounting, there are two general types of costing systems to assign
costs to products or services that the company provides: “job order costing” and “process
costing”.

Job order costing is used in situations where the company delivers a unique or
custom job for its customers. Every customer is treated uniquely and delivered products to
specifically suit their individual needs.

Job order costing or job costing is a system for assigning and

accumulating manufacturing costs of an individual unit of output. The job order costing system
is used when the various items produced are sufficiently different from each other and each
has a significant cost.

Job order costing system is generally used by companies that manufacture a

number of different products. It is a widely used costing system in manufacturing as well as
service industries.

Manufacturing companies using job order costing system usually receive orders for
customized products and services. These customized orders are known as jobs or batches.

When companies accept orders or jobs for different products, the assignment of cost
to products becomes a difficult task. In these circumstances, the cost record for each
individual job is kept because each job have a different product and, therefore, different cost
associated with it.

The per unit cost of a particular job is computed by dividing the total cost allocated to
that job by the number of units in the job.

The per unit cost formula is given below:

Per unit cost = Total cost applicable to job / Number of units in the job

Examples of Companies using Job Order Costing

 Law firms or accounting firms use job order costing because every client is different
and unique
  A company that designs and produces custom-made machines and/or machine
tooling
 A company that constructs custom-designed buildings
 A company that modifies trucks to meet customers' special needs
 A clothing factory, for example, may receive an order for men shirts with particular
size, color, and design.

Process costing, on the other hand, is used when companies offer a more
standardized product. No matter who the customer is, they all end up receiving the same
product.
For example, Coca-Cola may use process costing to track its costs to produce its
beverages. In job order costing, the company tracks the direct materials, the direct labor, and
the manufacturing overhead costs to determine the cost of goods manufactured (COGM).

Actual Costing (form of job order costing)

One type of job-order costing is called actual costing. The actual costing system, like
the name implies, is a costing system that traces direct and indirect costs to a cost object by
using the actual costs incurred in the job.
Although this system is much more simplistic, actual costing systems are not
commonly found in real-world situations because actual costs cannot usually be determined
in a timely manner because they are often not known until long after the job has been
completed.

Normal Costing
Due to the practical difficulties of using actual costing, many companies instead utilize
a normal costing system to obtain a close approximation of the costs on a timelier basis,
especially manufacturing overhead costs. Direct materials and direct labor are much more
feasible in terms of access to actual costs from materials requisition forms and labor time
sheets, while manufacturing overhead costs pose difficulties in determining actual costs.
Due to the need for immediate access to job costs, many companies use a
predetermined/budgeted, manufacturing overhead rate to estimate manufacturing overhead
costs.
Commonly, predetermined rates may be derived from the company applying overhead
costs on the basis of labor hours or machine hours. This means that the company uses labor
hours or machine hours (i.e., the primary cost driver) to reasonably estimate manufacturing
overhead costs.
The formula to determine this overhead rate:
Overhead rate = Estimated manufacturing overhead
 Estimated cost allocation base

Where the cost allocation base refers to the estimated machine hours or estimated
labor hours, depending on which one the company chooses to estimate its overhead costs
be.
Example of calculating overhead rate
XYZ Company estimates that for the current year, it will work 75,000 machine hours
and incur P450,000 in manufacturing overhead costs. The company applies overhead cost
on the basis of machine hours worked.
a. What is the manufacturing overhead cost?
b. If the company actually worked 5000 machine hours, what is the estimated overhead
costs?
Solution:
a. Manufacturing Overhead Costs = P450,000
75,000
= P6 machine/hour
b. Estimated overhead costs = P6 X 5,000 machine hours
= P 30,000

Job Order Costing – Under or Over Estimated Overhead

Because the predetermined overhead rate used by companies is purely based on
estimates, the actual overhead cost incurred during the year may be higher or lower than the
amount estimated. This is referred to as “under or overapplied overhead.”

When overhead is underapplied, manufacturing overhead costs have been

understated and upward adjustments need to be made to inventory and/or expense accounts,
depending on which method the company decides to use.

In contrast, when overhead is overapplied, manufacturing overhead costs have

been overstated and therefore inventories and/or expenses need to be adjusted downward.
There are two ways to adjust for the under or overapplied overhead amounts.

Job cost sheet is a document used to record manufacturing costs and is prepared by
companies that use job-order costing system to compute and allocate costs to products and
services.

The accounting department is responsible to record all manufacturing costs (direct

materials, direct labor, and manufacturing overhead) on the job cost sheet. A separate job
cost sheet is prepared for each individual job.
 All necessary details about the job and costs incurred to complete the job are written
on the job cost sheet.

The information about a job or order that is shown on job cost sheet usually includes
job number, product name, starting date, completing date, number of units completed etc.

The information about manufacturing costs that is shown on job cost sheet usually
includes materials requisition number, cost of direct materials issued, time tickets, direct labor
hours, direct labor rate per hour and total cost, manufacturing overhead rate per direct labor
or machine hour and total cost etc.

Job cost sheet is not only used to charge cost to jobs but is also a part of the company’s
accounting record. It is used as a subsidiary ledger to the work in process account because
it contains all details about the job in process.

Example of a Job Cost Sheet:

After accepting a job or order, the first step in a job order costing system is to determine
the direct materials requirement to complete the job. The type and quantity of direct materials
required to manufacture a product can be determined either by using a bill of materials or by
production staff.

Bill of materials is a document that lists the type and quantity of direct materials
required to manufacture a standard product. But companies using job order costing system
frequently receive orders that require customization in design, size and color etc. In such
circumstances, the bill of materials cannot be used to determine the type and quantity of
materials required to complete the job. Therefore the production department determines
materials requirement using the information provided by customers.

After direct materials requirement has been determined, the production process starts
with issuance of direct materials. For this purpose, production department prepares a
document known as ‘materials requisition form‘. An authorized person from production
department writes the type, quantity, and job number (to which the materials cost is to be
charged) on materials requisition form. A signed copy of this form is then sent to the storeroom
clerk who completes the form by entering on it per unit and total cost of materials to be issued.
After necessary verification, storeroom clerk issues direct materials to production department.

A complete materials requisition form is also used by accounting department to

record direct materials cost on the job cost sheet of the related job order.

An example/sample of materials requisition form is given below:

Journal entries to record the flow of materials:

Normally two types of journal entries are made for direct materials cost. One at the
time of purchase of direct materials from suppliers and one at the time of issuance of direct
materials from storeroom to production department. These two entries are given below:

When materials are purchased:

When materials are issued:

In job order costing system, the method of measuring and recording direct labor cost
is similar to measuring and recording direct materials cost.

Direct labor hours worked, direct labor rate per hour, and total amount in dollars for
each individual job or task is recorded on a document known as time ticket or employee time
ticket. A separate time ticket is prepared by each worker for every working day.

Accounting department collects all time tickets at the end of the day. These time tickets
are used to enter direct labor cost on the job cost sheet of each individual job order. An
example/sample of complete time ticket is given below:

Employee Time Ticket

In job order costing system, any labor charges that are not directly traceable to a
particular job are known as indirect labor cost. In example of time ticket given above
“maintenance” is indirect labor.

Other examples of indirect labor are clean-up costs and supervision etc. Indirect labor
is not included in direct labor cost and, therefore, becomes a part of the manufacturing
overhead.

These days, many companies have replaced the manual process of recording direct
materials cost with the computerized approaches. They use a bar code technology to enter
data into a computer. This technology increases the speed and accuracy of the whole
process.

Journal entry to record direct labor cost:

After collecting time tickets by accounting department, wages of workers are computed
and labor costs are classified as direct or indirect on the basis of information provided by time
tickets. As discussed earlier, indirect labor is a part of manufacturing overhead and its
accounting treatment has been discussed in “measuring and recording manufacturing
overhead” article. The journal entry of direct labor cost is made as follows:

Manufacturing costs other than direct materials and direct labor are known as
manufacturing overhead (also known as factory overhead). It usually consists of both variable
and fixed components. Examples of manufacturing overhead cost include indirect materials,
indirect labor, depreciation, salary of production manager, property taxes, fuel, electricity,
grease used in machines, and insurance etc.

Unlike direct materials and direct labor, manufacturing overhead is an indirect cost that
cannot be directly assigned to each individual job. This problem is solved by using a rate that
is computed at the beginning of each period. This rate is known as predetermined overhead
rate.

Application of manufacturing overhead:

The predetermined overhead rate is computed at the beginning of the period and is
used to apply manufacturing overhead cost to jobs throughout the period.
Manufacturing overhead cost is applied to jobs as follows:

Overhead applied to a particular job = Predetermined overhead rate × Amount of the

allocation base incurred by the job

Example:

Suppose the GX company has completed a job order. The time tickets show that the
workers have worked for 27 hours to complete the job. The predetermined overhead rate
computed at the beginning of the year is P50 per direct labor hour. The manufacturing
overhead cost would be applied to this job as follows:

Overhead applied to a particular job = Predetermined overhead rate × Amount of the

allocation base incurred by the job

= P50.00 × 27 DLH

= P 1,350

The manufacturing overhead cost assigned to the job is recorded on the job cost sheet of that
particular job.

Journal entry to record manufacturing overhead cost:

The manufacturing overhead cost applied to the job is debited to work in process
account. The journal entry for the applied manufacturing overhead cost, computed in the
above example, would be made as follows:

The reason of using a predetermined overhead rate rather than actual overhead costs:

Notice that the procedure of manufacturing overhead application described above is

based on an estimated overhead rate (predetermined overhead rate). The manufacturing
overhead cost applied to the job is, therefore, not actual manufacturing overhead cost
incurred by the job. The reason is that the total actual manufacturing overhead costs are
usually not known to managers before the end of the year. The application of manufacturing
overhead based on a predetermined overhead rate helps in computing cost of goods sold of
a particular job before it is shipped to the customer.

The use of predetermined overhead rate to apply manufacturing overhead cost to

products or job orders is known as normal cost system.

Predetermined overhead rate is used to apply manufacturing overhead to products

or job orders and is usually computed at the beginning of each period by dividing
the estimated manufacturing overhead cost by an allocation base (also known as activity
base or activity driver). Commonly used allocation bases are direct labor hours, direct labor
dollars, machine hours, and direct materials.

Formula:

The formula of predetermined overhead rate is written as follows:

Example:

Suppose GX company uses direct labor hours to assign manufacturing overhead cost
to job orders. The budget of the GX company shows an estimated manufacturing overhead
cost of P8,000 for the forthcoming year. The company estimates that 1,000 direct labors hours
will be worked in the forthcoming year.

Using the above information, we can compute the predetermined overhead rate as follows:

Predetermined overhead rate = Estimated manufacturing overhead cost/Estimated total units

in the allocation base

Predetermined overhead rate = P8,000 / 1,000 hours

= P8.00 per direct labor hour
 Notice that the formula of predetermined overhead rate is entirely based on estimates.
The overhead applied to products or job orders would, therefore, be different from the actual
overhead incurred by jobs or products. This difference is eliminated at the end of the period.
The elimination of difference between applied overhead and actual overhead is known as
disposition of over or under applied overhead.

The over or under-applied manufacturing overhead is defined as the difference

between manufacturing overhead cost applied to work in process and manufacturing
overhead cost actually incurred during a period.

If the manufacturing overhead cost applied to work in process is more than the
manufacturing overhead cost actually incurred during a period, the difference is known as
over-applied manufacturing overhead. On the other hand; if the manufacturing overhead cost
applied to work in process is less than the manufacturing overhead cost actually incurred
during a period, the difference is known as under-applied manufacturing overhead.

The occurrence of over or under-applied overhead is normal in manufacturing

businesses because overhead is applied to work in process using a predetermined overhead
rate. A predetermined overhead rate is computed at the beginning of the period using
estimated information and is used to apply manufacturing overhead cost throughout the
period.

The procedure of computing predetermined overhead rate and its use in applying
manufacturing overhead has been described in “measuring and recording manufacturing
overhead cost” article.

Recording actual and applied overhead cost in manufacturing overhead account:

Over or under-applied manufacturing overhead is actually the debit or credit balance

of manufacturing overhead account (also known as factory overhead account).
 Actual manufacturing overhead costs are debited and applied manufacturing overhead
costs are credited to manufacturing overhead account. Actual overhead costs are debited as
they are incurred and applied overhead costs are credited as they are applied to work in
process. At the end of a period, if manufacturing overhead account shows a debit balance, it
means the overhead is under-applied. On the other hand; if it shows a credit balance, it
means the overhead is over-applied. For further explanation of the concept, consider the
following example:

The debit or credit balance in manufacturing overhead account at the end of a month
is carried forward to the next month until the end of a particular period – usually one year.

Disposition of over or under-applied manufacturing overhead:

At the end of the year, the balance in manufacturing overhead account (over or under-
applied manufacturing overhead) is disposed off by either allocating it among work in
process, finished goods and cost of goods sold accounts or transferring the entire amount to
cost of goods sold account. These two methods are:

Allocation among work in process, finished goods and cost of goods sold
account:

Under this method, the amount of over or under-applied overhead is disposed off by
allocating it among work in process, finished goods and cost of goods sold accounts on the
basis of overhead applied in each of the accounts during the period. The following journal
entry is made to dispose off an over or under-applied overhead:
When overhead is under-applied:

When overhead is over-applied:

This method is more accurate than second method. The only disadvantage of this
method is that it is more time consuming.

Transferring the entire amount of over or under-applied to cost of goods sold:

Under this method the entire amount of over or under applied overhead is transferred
to cost of goods sold. The following entry is made for this purpose:

When overhead is under-applied:

When overhead is over-applied:

 This method is not as accurate as first method. Companies use this method because
it is less time consuming and easy to use.

Example:

During the year 2018, Beta company started two jobs – job A and job B. Job A consisted of
1,000 units and job B consisted of 500 units. At the end of the year 2012, job A was completed
but job B was in process. The information about manufacturing overhead cost applied to job
A and B was as follows:

The actual manufacturing overhead cost incurred by the company during 2018 was
P108,000. Out of 1,000 units in job A, 750 units had been sold before the end of 2018.

Required: Calculate over or under applied manufacturing overhead and make journal entries
required to disposed-off over or under applied manufacturing overhead assuming:

1. It is disposed-off by allocating between inventory and cost of goods sold accounts.

2. It is disposed-off by transferring to cost of goods sold.

Solution:

Calculation of over or under-applied manufacturing overhead:

In our example, manufacturing overhead is under-applied because actual overhead is more

than applied overhead. The under-applied overhead has been calculated below:

Under-applied manufacturing overhead = Total manufacturing overhead cost actually

incurred – Total manufacturing overhead
applied to work in process

= P108,000 – P 100,000

= P 8,000
Journal entries to dispose off under-applied overhead:

(i). Allocation of under-applied overhead among work in process, finished goods, and cost of
goods sold accounts:

(ii). Transfer of entire under-applied overhead to cost of goods sold account:

Name:

QUIZ

Multiple Choice: Shade the circle at the left for the correct answer.

1. Which of the following manufacturers is most likely to use a job order

accounting system?

a. a brewery
b. a ship builder of oil tankers
c. an oil refinery
d. a sugar refinery

2. In a job order cost accounting system, which account would be debited

in recording a purchase invoice for raw materials?

a. Raw Materials Inventory

b. Goods in Process Inventory
c. Factory Overhead
d. Finished Goods Inventory

3. In a job order cost accounting system, which account would be debited

in recording a materials requisition for direct materials?

a. Raw Materials Inventory

b. Factory Overhead
c. Raw Materials Purchases
d. Goods in Process Inventory

4. The predetermined overhead rate is P 6.10 per direct labour hour. Job
213 required 210 direct labour hours of which 150 hours were incurred
during the current accounting period. How much overhead should be
applied to Job 213 during the current accounting period?

a. P 366
b. P 915
c. P1,218
d. P1,281
 5. Production reports for the second quarter show the following data:

Month Machine- Direct Direct Direct Actual

Hours Labour Labour Materials Overhead
Hours Cost Cost
April 9,000 12,000 P60,000 P32,000 P45,020
May 12,000 10,000 P50,000 P28,500 P60,000
June 10,000 9,000 P44,000 P45,000 P50,100

Which variable would be the most likely basis for allocating overhead?

a. Machine-hours
b. Labour Hours
c. Labour Cost
d. Materials Cost

6. Direct materials used: P20,000

Factory overhead: P40,000
Beginning goods in process: P0
Ending goods in process: P12,000
Cost of goods manufactured: P65,000
What was the amount of direct labour?

a. P17,000
b. P77,000
c. P 5,000
d. P48,000

7. Company records show the following data:

Month Labour Actual

Cost Overhead
May P60,000 P91,020
June P50,000 P74,850
July P44,000 P66,120

Overhead is applied at 150% of direct labour cost. At the end of July, the
balance of the overhead account would be:

a. P1,290, debit
b. P1,050, debit
c. P 960, debit
d. P 990, debit
8. Job 21 was unfinished at the end of the accounting period. The total cost
assigned to the job is P12,000 of which P3,000 is direct material. Factory
overhead is allocated to goods in process at 150% of direct labour cost.
What was the amount of direct labour charged to Job 21?

a. P9,000
b. P3,600
c. P4,000
d. P3,000

9. The production costs to produce one unit of finished goods was P45.
Direct materials were 1/3 of the total cost, and direct labour was 40% of
the combined total of direct labour and direct materials. The cost for direct
materials, direct labour, and factory overhead was:

a. P15, P18, and P12, respectively

b. P15, P12, and P18, respectively
c. P15, P16, and P14, respectively
d. P15, P10, and P20, respectively

10. The overapplied balance of the Factory Overhead ledger account is

P36,000, a significant amount. The ending balances of Goods in Process
Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts
are P12,000, P8,000, and P60,000, respectively. On the basis of ending
balances, how much of the overapplied balance should be allocated to
each of these accounts?

a. P5,400, P3,600, P27,000

b. P12,000, P12,000, P12,000
c. P12,000, P4,000, P20,000
d. P3,600, P5,400, P24,000

**** End ****