Job Order Costing

Chapter 5
Product and Service Costing: Job-Order System
Hansen/Mowen, Cornerstones of Cost Management, 4th Edition. © 2018 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives (1 of 2)
1. Differentiate the cost accounting systems of service and manufacturing firms
and of unique and standardized products
2. Discuss the interrelationship of cost accumulation, cost measurement, and
cost assignment
3. Identify the source documents used in job-order costing
Hansen/Mowen, Cornerstones of Cost Management, 4th Edition. © 2018 Cengage. All Rights Reserved. May not
be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives (2 of 2)
4. Describe the cost flows associated with job-order costing, and prepare the
journal entries
5. Explain how activity-based costing is applied to job-order costing
6. Explain how spoiled units are accounted for in a job-order costing system
Manufacturing Firms versus Service Firms
• Manufacturing firms
o Combine direct materials, direct labor, and overhead to produce a new product
o Produce goods that are tangible and can be inventoried and transported
• Service firms
o Service is characterized by its intangible nature
• Not separable from the customer and cannot be inventoried
EXHIBIT 5.1 - Continuum of Services and
Manufactured Products
Features of services
• Intangibility
o Nonphysical nature of services as opposed to products
• Inseparability
o Production and consumption are inseparable for services
• Heterogeneity
o Greater variation in the performance of services than in production of products
• Perishability
o Services cannot be inventoried but must be consumed when performed
EXHIBIT 5.2 - Features of Service Firms and Their
Interface with the Cost Management System
Feature Relationship to Business Impact on Cost Management System
Inseparability Consumer is involved in service Costs are accounted for by customer
Process type.
Services are difficult to mass System must be generated to encourage
produce. consistent quality.
Intangibility Services cannot be stored. There are no inventory accounts.
Services cannot be patented. There is a strong ethical code.
Pricing is complicated. Costs must be related to entire
organization.
Heterogeneity Services are difficult to standardize. A strong systems approach is needed.
It is difficult to ensure quality control of Productivity measurement is ongoing.
services. Total quality management is critical.
Perishability Service benefits expire quickly. There are no inventories.
Service may be repeated often There needs to be a standardized
for one customer. system to handle repeat customers.
Ethics
• Customers may perceive greater risk when buying services than products
• Internal accountant should accurately report the bad news as well as the
good
• Manufacturers can offer warranties or product replacements
• Service providers must be very careful to deliver what they promise
Unique versus Standardized Products and Services
• Degree of uniqueness affects costing methods

o Job-order costing
• Used for unique units with unique costs of production
• Used by both service and manufacturing firms
o Process-costing system
• Used when units are homogeneous
o Operation costing: Hybrid of job-order and process costing
Cost Accumulation
• Refers to the recognition and recording of costs
• Source document: Keeps track of costs as they occur and describes a
transaction
o Data acquired are recorded in a database
• Provides flexibility in analysis of subsets
• Helps identify if relevant costs are recorded in the general ledger and posted to
appropriate accounts
Cost Measurement
• Refers to classifying costs
• Ways to measure costs associated with production include:
o Actual costing system: Uses actual costs for direct materials, direct labor, and
overhead to determine unit cost
o Normal costing system: Uses actual cost of direct materials and labor but
applies overhead using predetermined estimate
Cost Assignment
• Refers to association of production costs with the units produced
• Costs are assigned to units of product manufactured or units of service
delivered
o Once costs have been accumulated, measured, and assigned, unit costs can be
calculated
o Unit cost equals total product cost associated with units divided by the number of
units produced
Importance of Unit Cost
• Helps submit meaningful bids
• Influences decisions regarding product design and new product introduction
• Essential to make decisions about whether to:
o Make or buy a product
o Accept or reject a special order
o Keep or drop a product line
Importance of Unit Costs to Manufacturing Firms
• Essential for:
o Valuing inventory
o Determining income and cost of goods sold
o Disclosing the cost of inventories
• Useful as an input for important internal decisions
o Introduction of new product
o Continuation of current product
o Analysis of long-run processes
Importance of Unit Costs to Nonmanufacturing Firms
• Service firms are required to first identify the service unit being provided
o Use costs to determine profitability and the feasibility of introducing new services
o Do not need to value work-in-process and finished goods inventories
EXHIBIT 5.3 - Relationship of Cost Accumulation, Cost
Measurement, and Cost Assignment
Production of Unit Cost Information
• Both cost measurement and cost assignment are required
o Normal costing is preferred because it provides information on a more timely
basis
o Direct materials and direct labor costs are traced to units of production
o Actual costs are used since the actual costs of materials and labor are known at
any point in time
o Overhead is applied using a predetermined rate
Choosing the activity level
• Expected activity level
o Production level the firm expects to attain for the coming year
• Normal activity level
o Average activity usage that a firm experiences in the long term
• Theoretical activity level
o Absolute maximum production activity of a manufacturing firm
• Practical activity level
o Maximum output that can be realized if everything operates efficiently
EXHIBIT 5.4 - Measures of Activity Level
Overview of the Job-order Costing System (1 of 2)
• Costs are accumulated by job
• Upon completion of a job, the unit cost equals total manufacturing cost
divided by the number of units produced
• Job-order cost sheet: Identifies each job and accumulates its
manufacturing costs
o Created upon receipt of a production order
o Contains a job-order number that identifies the new job
Overview of the Job-order Costing System (2 of 2)
• Work-in-process inventory file: Collection of all job cost sheets
• Job-order costing system must be able to identify the quantity of:
o Direct materials
o Direct labor
o Applied manufacturing overhead
EXHIBIT 5.5 - Job-Order Cost Sheet
Materials Requisition Form
• Source document used to assign direct materials cost to a job
• Includes the description, quantity, unit cost of direct materials issued, and
job number
• Provides essential information for assigning direct materials costs to jobs
• Contain other data items such as requisition number, date, and signature
o Help maintain proper control over a firm’s inventory of direct materials
EXHIBIT 5.6 - Materials Requisition Form
Job Time Tickets
• Source document used to assign direct labor cost to each job
• Includes the name, wage rate, hours worked, and job number of an
employee
• Collected on a daily basis and transferred to the Cost Accounting
Department
• Used only for direct labor
EXHIBIT 5.7 - Time Ticket
Overhead Application
• Jobs are assigned overhead costs with a predetermined overhead rate
o Direct labor hours are used as the measure to calculate overhead
• When overheads are assigned based on drivers other than direct labor, the
other drives must also be accounted for
Unit Cost Calculation
• Total manufacturing cost is calculated by totaling direct materials, direct
labor, and overhead and summing these individual totals
o Provides the cost of finished goods inventory at any point in time
• If there are multiple units in a job, the grand total can be divided by the
number of units produced to obtain the unit cost
Exhibit 5.8 - Summary of Direct Materials Cost Flows
Exhibit 5.9 - Summary of Direct Labor Cost Flows
Accounting for Overhead Application
• Overhead costs flow into work-in-process inventory via the predetermined
overhead rate
o Debited to work-in-process inventory and credited to overhead control
• Main source document - Time tickets
Accounting for Actual Overhead Costs
• Actual overhead is debited to the overhead control account as it is incurred
o Gives the total actual overhead costs at a given point in time
o Balance in overhead control is overhead variance at a given point in time
• Sources of information
o Time tickets
o Predetermined overhead rates based on direct labor hours
Exhibit 5.10 - Summary of Overhead Cost Flows
Note: Information from time tickets; predetermined rate used.
Exhibit 5.11 - Completed Job-Order Cost Sheet
Accounting for Finished Goods Inventory
• Direct materials, direct labor, and applied manufacturing overhead are
totaled for completed jobs
o Yields the manufacturing cost of the job
• Cost of a completed job is debited to finished goods inventory and credited to
work-in-process
o Finished goods inventories are carried at normal cost rather than actual cost
Exhibit 5.12 - Summary of Finished Goods Cost Flow
Exhibit 5.13 - Statement of Cost of Goods Manufactured
Accounting for Cost of Goods Sold
• When a job is shipped to the customer, the cost of the finished job becomes
a cost of goods sold
• Cost of a completed job is:
o Debited to Cost of Goods Sold inventory
o Credited to Finished Goods Inventory
Overhead Variances
• Usually immaterial and is therefore closed to the cost of goods sold account
o Normal cost of goods sold: Cost of goods sold before adjustment for an
overhead variance
o Adjusted cost of goods sold: Result after adjustment for the period’s overhead
variance takes place
Exhibit 5.14 - Statement of Cost of Goods Sold
All Signs Company Statement of Cost of Goods Sold For the Month Ended
January 31, 20×1
Beginning finished goods inventory $ 0

Cost of goods manufactured 1,840
Goods available for sale $1,840
Less: Ending finished goods inventory 0
Normal cost of goods sold $1,840
Add: Underapplied overhead 75
Adjusted cost of goods sold $1,915
Closing the Overhead Variance Account (1 of 2)
• Done once at the end of a year
• Variances are expected each month because of non uniform production and
overhead actual costs
o Over time, these costs should largely offset each other
Closing the Overhead Variance Account (2 of 2)
• Debiting Cost of Goods Sold is equal to adding the underapplied amount to
the normal cost of goods sold
o If overhead variance had been overapplied, Cost of Goods Sold would be
credited
Exhibit 5.15 - All Signs Company Summary of Manufacturing
Cost Flows
(1) Purchase of direct materials $2,500

(2) Issue of direct materials 1,500
(3) Incurrence of direct labor cost 850
(4) Application of overhead 340
(5) Incurrence of actual overhead cost 415
(6) Transfer of Job 101 to finished goods 1,840
(7a) Cost of goods sold of Job 101 1,840
(8) Closing out underapplied overhead 75
Accounting for Nonmanufacturing Costs
• Nonmanufacturing costs include selling and general administrative expenses
o Period costs and are never assigned to inventory accounts
o Do not belong to the overhead category
o Accumulated in the controlling accounts
o Flow to the income statement at the end of the period
Exhibit 5.16 - Income Statement
All Signs Company Income Statement For the Month Ended January 31, 20×1
Sales $2,760
Less: Cost of goods sold 1,915
Gross margin $ 845
Less selling and administrative expenses:
Selling expenses $200
Administrative expenses 550 750
Operating income $ 95
Job-Order Costing with Activity-Based Costing
• Using a single rate based on direct labor hours may result in inaccurate cost
assignments
o Solved by assigning departmental overhead rates and using activity-based
costing
• Affect only the application of overhead
• Activity cost is applied to each job by multiplying the activity rate by the job’s use of
the associated driver
Accounting for Spoiled Units in a Traditional Job-
Order Costing System
• Normal spoilage: Caused because of the nature of the production process
o When spoilage doesn’t result from a particular job, it is subsumed in the
overhead rate and spread across all jobs through applied overhead
o When spoilage is caused due to the exacting nature of the job, extra cost is
added to that job’s cost
• Abnormal spoilage: Unexpected and not part of normal operations
o Charged to Loss from Abnormal Spoilage

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Chapter 5

Product and Service Costing: Job-Order System

• Degree of uniqueness affects costing methods

Note: Information from time tickets; predetermined rate used.

Beginning finished goods inventory $ 0

(1) Purchase of direct materials $2,500

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