Job Order Costing vs Process Costing predetermined/budgeted, manufacturing

overhead rate to estimate manufacturing

As an example, law firms or accounting firms
overhead costs.
use job order costing because every client is
different and unique. Commonly, predetermined rates may be derived
from the company applying overhead costs on
Process costing, on the other hand, is used when
the basis of labor hours or machine hours. This
companies offer a more standardized product.
means that the company uses labor hours or
No matter who the customer is, they all end up
machine hours (i.e., the primary cost driver) to
receiving the same product.
reasonably estimate manufacturing overhead
For example, Coca-Cola may use process costs.
costing to track its costs to produce its
 
beverages. In job order costing, the company
tracks the direct materials, the direct labor, and The formula to determine this overhead rate:
the manufacturing overhead costs to determine
Overhead rate = estimated manufacturing
the cost of goods manufactured (COGM).
overhead  / estimated cost allocation base
 
Where the cost allocation base refers to the
Actual Costing (form of job order costing) estimated machine hours or estimated labor
hours, depending on which one the company
One type of job-order costing is called actual
chooses to estimate its overhead costs by.
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
Example of calculating overhead rate
the actual costs incurred in the job.
XYZ Company estimates that for the current
Although this system is much more simplistic,
year, it will work 75,000 machine hours and
actual costing systems are not commonly found
incur $450,000 in manufacturing overhead costs.
in real-world situations because actual costs
The company applies overhead cost on the basis
cannot usually be determined in a timely manner
of machine hours worked.
because they are often not known until long after
the job has been completed. This means that the company would estimate $6
in manufacturing overhead costs for every one
 
machine hour worked. So, if the company
Normal Costing actually worked 5000 machine hours, the
estimated overhead costs would be $30,000.
Due to the practical difficulties of using actual
costing, many companies instead utilize a  
normal costing system to obtain a close
The Role of Work in Process (WIP) Inventory
approximation of the costs on a timelier basis,
especially manufacturing overhead costs. Direct The WIP inventory asset account is where the
materials and direct labor are much more actual direct materials cost, actual direct labor
feasible in terms of access to actual costs from cost, and estimated manufacturing overhead
materials requisition forms and labor time costs are recorded in order to determine
sheets, while manufacturing overhead costs pose the COGM. This can be clearly seen through a
difficulties in determining actual costs. WIP Inventory T-account.
Due to the need for immediate access to job The T-account would look like this:
costs, many companies use a
  are two ways to adjust for the under or
overapplied overhead amounts.
Work in Process (WIP) Inventory

Beginning Balance                                               a  
Direct Materials                                                    b
Direct Labor                                                          c
Manufacturing Overhead (estimated)              d

Ending Balance                                                     e

 
 
On the credit side of the T-account is COGM.
By knowing the opening and closing balances of
the inventory account in addition to the actual
DM and DL costs and the estimated MOH costs,
the COGM can be calculated.
The estimated manufacturing overhead value
can be compared to the actual manufacturing
overhead value in a separate manufacturing T-
Account to determine any significant
differences.
 
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