Lecture 3: Product Costing Systems

ACC2706
Managerial Accounting
Semester I, AY 2022/23

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 Learning Objectives & References

Learning Objectives
1. Overview of Product Costing
2. Job Costing and Process Costing
3. Allocating Overhead Costs
4. Differences Between Job Costing and Process
Costing Accounting
5. Job Costing: flow of costs and journal entries
6. Process Costing: flow of costs and journal entries

Reference
• Chapter 4 Product Costing Systems 2
 1. Product costing

Product costing systems accumulate product-related costs to

assign to the organisation’s final products.

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Different product costs for different purposes

• Only production or manufacturing costs (direct labour, direct

material and manufacturing overheads) are included in
product costs for external reporting purposes.

• Types of product costs to be included in managerial

decisions depends on
• Types of decision to be made.
• Whether the decision has short-term or long-term
implications.
• May include upstream, manufacturing and downstream
costs.
(cont.)

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Different product costs for different purposes

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 Designing product costing systems

• Identify the managers’ needs.

• Identify where cost information may come from.

• Cost and benefits of providing various types of cost

estimates.

• 3 types of product costing systems - Job costing,

process costing, and hybrid costing (operation
costing is a common form of hybrid costing).

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 2. Job costing system

1. Products are manufactured to order.

2. Products produced are significantly different and may

be produced in distinct job.

3. The unique nature of each job requires tracing and

allocating costs to each job, and maintaining cost
records for each job.

Examples of companies:
1. Boeing (aircraft manufacturer)
2. Tata Consultancy Services (Information Technology)
3. GuocoLand Group (Real Estate Developer) 7
 Quick Check ✓

Product costing is the process of:

A. accumulating the costs of a production process.

B. assigning costs to a firm's products.
C. placing a value on fixed assets owned by a producer.
D. accumulating the costs of a production process AND
assigning costs to a firm's products.

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 Real World Application
– Job Costing at Boeing Corporation

• https://www.youtube.com/watch?v=oDrVQBgxsrc
• Building the Boeing 777

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 Real World Application
– Job Costing at Aircraft Manufacturer

Developing an appropriate job costing accounting system

requires the following knowledge:

• The nature of work performed in each area.

• Costs that are common across all jets in a particular work area.

• Costs that vary with customization.

• How cost information can be captured by the accounting

system.

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 Real World Application
– Job Costing at Aircraft Manufacturer

2. Design of job-order costing system requires the following

knowledge:
• Categorization of direct and indirect costs within each work
area.

• Methods for tracing direct costs to each customized job.

• Methods for allocating indirect costs.

• Creation of meaningful cost and profit reports.

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Job-order Costing in Service Companies

Job-order costing is used in many different

types of service companies.

Law firm Accounting Advertising

firm firm Hospital
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 Process costing system

1. Mass production of many units of a single product

and repetitive sequential processes environment.
2. One unit of product is indistinguishable from other
units of product.
3. The identical nature of each unit of product
enables assigning the same average cost per unit.

Examples of companies:
1. Asia Pulp & Paper (paper manufacturing)
2. Kang-shi-fu (Instant Noodle Producer)
3. Coca-Cola (mixing and bottling beverages)

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 Process costing system

Process costing involves

– Assigning all production costs to process/
department and averaging them across all units
produced

– Two steps
1. Estimating the cost of production processes
2. Calculating the average cost per unit

– More to be covered in Lecture 4.

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 McClaren versus Telsla

• Watch the 2 videos

on Supercar and
Telsla.

• Observe the
differences in the
factory activities,
equipment and
worker’s functions.

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 Quick Check ✓
Which of the following companies would be likely to
use job-order costing rather than process costing?
a. Scott Paper Company for Kleenex.
b. Architects.
c. Heinz for ketchup.
d. Caterer for a wedding reception.
e. Builder of commercial fishing vessels.

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 3. Allocating overhead costs
to products
• Direct costs are consumed directly in the production of
products and are traced directly to each job or process.
• Overhead costs cannot be traced directly but are to be
allocated to the job or process.
• Aggregate overhead costs into cost pools.
• Identify the overhead cost driver.
• Calculate a predetermined (or budgeted) overhead rate
per unit of cost driver.
• Apply manufacturing overhead costs to job or process
using the cost driver.
(cont.)

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Allocating overhead costs
to products

Job or
Process

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 Compute predetermined overhead rates

The predetermined overhead rate (POHR) used to apply

overhead is determined before the period begins.

Estimated total manufacturing

overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

Ideally, the allocation base

is a cost driver that causes
overhead.

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 Compute predetermined overhead rates

$640,000
POHR =
160,000 direct labor hours (DLH)

POHR = $4.00 per DLH

For each direct labor hour worked on a particular job,

$4.00 of factory overhead will be applied to that job.

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 Application of Overhead to Job

Based on estimates, and

determined before the
period begins.

Overhead applied to Job = POHR × Actual activity

Overhead applied is based on the

actual level of activity

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 Computation of applied
manufacturing overhead

$ 236
$ 118

Manufacturing overhead applied = POHR x Actual DLHs = $4 x 8 = $32 22

 Documents Used in Job costing

• Bill of materials—lists all the materials required for a job.

• Material requisition form—authorises the movement of raw

materials from the warehouse to the jobs. These provide the
basis for charging direct material cost to jobs.

• Direct labour time sheets – record the labour hours spent on

the job. These provide the basis for charging direct labour cost
to jobs.

• Job cost sheet—summarises the costs of direct material, direct

labour and manufacturing overhead for a particular job.
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4. Differences Between Job-Order and Process Costing
• Job-order costing systems accumulated costs by individual jobs.

• Process costing systems accumulated costs by departments or

processes.

• Job-order costing systems compute unit costs by job on the job cost
sheet.

• Process costing systems compute unit costs by departments or

processes.

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 5. Flow of Costs in Job costing
(in journal entries form)
• Purchase of materials

Raw material inventory xxxx

Accounts payable xxxx

• Transferring direct material to job 1

Work in process inventory-Job 1 xxxx

Raw material inventory xxxx (cont.)

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 Flow of Costs in Job costing
(in journal entries form)
• Charging direct labour to job 1

Work in process inventory-Job 1 xxxx

Wages payable xxxx

• Application of manufacturing overhead

Work in process inventory-Job 1 xxxx

Manufacturing overhead (applied) xxxx (cont.)

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 Flow of Costs in Job costing
(in journal entries form)
Accounting for actual manufacturing overhead – supplies,
indirect labour, rental and depreciation.

Manufacturing overhead (actual) xxxx

Manufacturing supplies xxxx

Manufacturing overhead (actual) xxxx

Wages payable xxxx

Manufacturing overhead (actual) xxxx

Prepaid rent xxxx (cont.)
Acc. Depreciation on equipment xxxx 27
 Flow of Costs in Job costing
(in journal entries form)
• Completion of production job 1
Finished goods inventory xxxx
Work in process inventory xxxx

• Sale of goods
Accounts receivable xxxx
Sales revenue xxxx

Cost of goods sold xxxx

Finished goods inventory xxxx (cont.)

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 Flow of Costs in Job costing

At the end of the period, under-applied overhead (actual

overhead is more than the applied overhead) is charged to
the COGS. COGS increases as a result.

Cost of goods sold xxxx

Manufacturing overhead xxxx (underapplied)

Or the reverse entry if overhead is over-applied (actual overhead is less

than the applied overhead). COGS decreases as a result.

The under- or over- applied overhead can also be allocated to

WIP, FGI and COGS (later slides).

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 Flow of Costs in Job Costing (T-accounts)

TMC
COGM COGS

TMC = Total Manufacturing Cost, COGM = Cost of Goods Manufactured, COGS = Cost of Goods Sold
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 Accounting for Manufacturing Overhead

Credits to various accounts include

Accumulated Depreciation, Payables/Liabilities,
Manufacturing Supplies, Accruals (Rent,
Insurance), Cash at bank and others.
 Overhead Application Example
PearCo’s actual overhead for the year was $650,000
with a total of 170,000 direct labour hours worked
on jobs.
How much total overhead was applied to PearCo’s
jobs during the year? Use PearCo’s predetermined
overhead rate of $4.00 per direct labour hour.

Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labour Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
 Disposition of Overapplied Overhead to
COGS

Method 1
PearCo’s Cost PearCo’s
of Goods Sold Mfg. Overhead
Unadjusted Actual Overhead
Balance overhead applied
costs to jobs
$30,000
$650,000 $680,000
Adjusted $30,000 $30,000
Balance overapplied

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 Disposition of Overapplied Overhead to
Three Accounts
Method 2

Assume the applied overhead remaining in each account end of

the period are as shown below. We would complete the following
allocation of $30,000 overapplied overhead:
Percent of Allocation
Amount Total of $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000
 Quick Check ✓
Tiger, Inc. had actual manufacturing overhead costs of
$1,210,000 and a predetermined overhead rate of
$4.00 per machine hour. Tiger, Inc. worked 290,000
machine hours during the period. Tiger’s
manufacturing overhead is
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.

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 Quick Check ✓
The following information relates to Lonoca Engineering for July 2022:
• Budgeted direct labour costs $ 90,000
• Actual direct labour costs $ 80,000
• Actual direct labour rate per hour $ 10
• Budgeted factory overhead rate per direct labour hour $ 12
• Factory overhead incurred $ 106,000

Assuming underapplied or overapplied overhead is transferred to cost of goods sold

at the end of the period, which of the following would be the entry to the cost of
goods sold account?

A. $ 12,000 debit
B. $ 12,000 credit
C. $ 10,000 credit
D. $ 10,000 debit
E. None of the above

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 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process - Department A XXXXX
Work in Process - Department B XXXXX
Raw Materials XXXXX
To record the use of direct material.

(cont.)

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 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process - Department A XXXXX
Work in Process - Department B XXXXX
Salaries and Wages Payable XXXXX
To record direct labor costs.

(cont.)

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 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process - Department A XXXXX
Work in Process - Department B XXXXX
Manufacturing Overhead XXXXX
To apply overhead to departments.

(cont.)

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 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process - Department B XXXXX
Work in Process - Department A XXXXX
To record the transfer of goods from
Department A to Department B.

(cont.)

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 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Finished Goods XXXXX
Work in Process - Department B XXXXX
To record the completion of goods
and their transfer from Department B
to finished goods inventory.

(cont.)

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 Process Cost Flows:
Transfers from WIP-Dept. A to WIP-Dept. B (in T-account
form)

Work in Process Work in Process

Department A Department B
•Direct Transferred •Direct
Materials to Dept. B Materials
•Direct •Direct
Labor Labor
Transferred In
•Applied Cost •Applied
Overhead Overhead
•Transferred
from Dept. A

The cost of units processed in Department A are transferred into

Department B for further processing. The transferred-in costs from
Department A are added to the manufacturing costs incurred in
Department B. 42
 6. Flow of Costs in Process Costing
(in journal entries form)

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Cost of Goods Sold XXXXX
Finished Goods XXXXX
To record the transfer of finished
goods inventory to cost of goods
sold.

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Flow of costs in process costing (in T-accounts)

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 COGM
Schedule
See Exhibit
4.15

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 COGM
Schedule
An alternative

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47
 Quick Check ✓

What effect will the adjustment of overapplied overhead

to Cost of Goods Sold have on PearCo’s net operating
income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.

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 Summary

• Different measures of product costs are appropriate for

different purposes.
• Overhead costs are allocated to product costs according to
their consumption of an overhead cost driver.
• The choice of product costing system depends on the
characteristics of the product and production environment
which may range from job costing to process costing.

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 Lecture Suppl. Question 1
Dancer Corporation, which uses a job-costing system, had two jobs in process at the start of 20x1: job
no. 59 ($95,000) and job no. 60 ($39,500). The following information is available:
• The company applies manufacturing overhead on the basis of machine hours. Budgeted overhead
and machine activity for the year were anticipated to be $720,000 and 20,000 hours, respectively.
• The company worked on three jobs during the first quarter. Direct materials used, direct labor
incurred, and machine hours consumed were:

• Manufacturing overhead during the first quarter included charges for depreciation ($20,000),
indirect labor ($50,000), indirect materials used ($4,000), and other factory costs ($108,700).
• Dancer completed job no. 59 and job no. 60. Job no. 59 was sold for cash, producing a gross profit of
$24,600 for the firm.
Required:
A. Determine the company's predetermined overhead application rate.
B. Prepare journal entries as of March 31 to record the following. (Note: Use summary entries
where appropriate by combining individual job data.)
1. The issuance of direct material to production, and the direct labor incurred.
2. The manufacturing overhead incurred during the quarter.
3. The application of manufacturing overhead to production.
4. The completion of job no. 59 and no. 60.
5. The sale of job no. 59.
 Lecture Suppl. Question 2
Dodger Products uses a job-costing system for its units, which pass from the Machining Department, to
the Assembly Department, to finished-goods inventory. The Machining Department is heavily automated;
in contrast, the Assembly Department performs a number of manual-assembly activities.

The company uses machine hours to apply manufacturing overhead to products in the Machining
Department, and direct labor cost to apply manufacturing overhead to products in the Assembly
Department.
The following information relates to the Machining Department for the year just ended:

The Machining Department adopts a job costing system and the data that follow pertain to job no. 775,
the only job in production at year-end.

Required:
A. Assuming the use of job costing, calculate the predetermined overhead rate that is used in the
Machining Department.
B. Compute the cost of the Machining Department's year-end work-in-process inventory.
C.Determine the amount that overhead was under- or overapplied during the year in the Machining
Department. Indicate whether it is overapplied or underapplied.
D.If Dodger disposes of the Machining Department's under- or overapplied overhead as an adjustment
to Cost of Goods Sold, would the company's Cost-of-Goods-Sold account increase or decrease?
Explain.
 Lecture Suppl. Question 3

Daget Corporation uses direct labour-hours in its

predetermined overhead rate. At the beginning of the year,
the total estimated manufacturing overhead was $364,140. At
the end of the year, actual direct labour-hours for the year
were 24,000 hours, manufacturing overhead for the year was
overapplied by $8,060, and the actual manufacturing
overhead was $359,140. The predetermined overhead rate
for the year would be:

A $15.43 per direct labour-hour

B $15.30 per direct labour-hour
C $15.17 per direct labour-hour
D $14.96 per direct labour-hour
E $14.50 per direct labour-hour

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