Chapter 2

‘’…….Come to learn; Go to Serve…..
’’
Chapter Two
Job Order Costing System
Chapter Learning Objectives:

After studying this chapter students should be able to:
1. Define a product costing system.

2. Define a product costing approaches.
3. Distinguish between process costing and job order costing and identify companies that would
use each costing method.
4. Identify the documents used in job order costing system.
5. Compute predetermined overhead rates and explain why estimated overhead costs (rather
than actual overhead costs) are used in the costing process.
6. Understand the flow of costs in a job order costing system and prepare appropriate journal
entries to record costs.
7. Apply overhead cost to work in process (WIP) using a predetermined overhead rate.
8. Prepare T-accounts to show the flow of costs in a job order costing system.
9. Explain the implications of basing the predetermined overhead rate on activity at capacity
rather than on estimated activity for the period.
10. Explain normal, actual and extended normal costing methods
Targeted group: 2nd year students of Accounting and Finance (Weekend program)
Complied by: Sitota.G!(Course instructor
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‘’…….Come to learn; Go to Serve…..’’
Introduction to Product Costing
Product Costing: is the process of assigning costs to the products and services provided by a
firm. i.e. it is the process of determining the true worth (cost) of a finished good. There are
different approaches to product costing.
1. Absorption costing
2. Variable costing
The absorption costing (also called as full cost approach) assigns all manufacturing costs to
products regardless of considering their behavioral patterns: Variable or Fixed.
To illustrate the distinction between the two assume a company having a cost structure as
follows to manufacture a 1,000 units of a product:
Direct Materials $ 5,400

Direct Labor 3,500
Fixed Manufacturing Overheads 4,000
Variable Manufacturing Overheads 4,600
Fixed Selling and Administrative Costs 6,500
Variable Selling and Administrative Costs 7,500
Determine the per-unit cost of the product using Absorption Costing and variable costing.
a. Absorption Costing:
Product cost = Total manufacturing cost = DMs + DL + VMOH + FMOH
= 5,400 + 3,500 + 4,600 + 4,000 = $ 17,500
= $ 17,500 ÷ 1,000 = $17.50
b. Variable Costing
Product cost = Total variable manufacturing cost = DMs + DL + VMOH
= 5,400 + 3,500 + 4,600 = $ 13,500
= $ 13,500 ÷ 1,000 = $13.50
Product costing became a difficult task to mangers for the following reasons. First, the difference
in production level from period to period while many costs remain unchanged for a long period
of time causes the unit cost of products to fluctuate (though the quality and feature of products
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being produced is kept constant). Second, the production of many kinds of products in the same
facility makes the accurate allocation of the costs in the facility difficult.
In practice, two costing systems are widely used in many manufacturing and service enterprises: Job-
order Costing and Process costing. The choice among the two heavily depends up on the nature of
production process used to manufacture the goods and deliver the services of the company. In the
subsequent chapters, a brief discussion of the two popular costing systems is presented.
Another popular approach to product costing is the Activity Based Costing (ABC) System. This is not a
replacement to the above systems; rather it enhances the efficient allocation of indirect costs to products
by accumulating overheads on the basis of the different activities in the organization from which
overheads arise.
Costing systems in general serve three basic functions:
1. Determination of cost of products that aid in planning decisions such as pricing and product mix;
2. Valuing inventory and cost of goods sold for external reporting; and,
3. Managing costs and evaluating performance
The following subsequent topics deal with discussions of different alternative costing systems.
A) Job Order Costing System:
A job order costing system is used in situations where many different products are produced each
period using flexible Production facilities. In a job order costing system, costs are traced to the
jobs and then the costs of the job are divided by the number of units in the job to arrive at an
average cost per unit.
Job-order costing system is used in situations where many different kinds of products are
produced in each period. It is more appropriate to firms producing goods and services that are
characterized by unique and distinct from one another, custom made I.e. based on customers’
specifications and are one of a kind.
In this system, the cost object is a unit or multiple units of distinct goods or services called a
batch or a Job. Job is a task for which resources are extended in bringing a distinct product to
market.
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E.g. Magazines and newspapers by printing houses, houses by a real estate contractor,
entertainment boats by Ship building company, commercial jets by aircraft building company,
furniture produced by furniture manufacturing company and etc.
In this system cost assignment is done in such a way that direct costs are traced directly to each
job and indirect costs are allocated to jobs using one or more allocation bases and the total cost
of each job is determined.
 General approaches to job costing

There are seven steps to assign costs to an individual job.
Step 1: Identify the job that is chosen as a cost object.
Step 2: Identify the direct costs of the job.
Step 3: Select cost allocation base(s) to allocate indirect costs
Step 4: Identify the indirect costs associated with each allocation base.
Step 5: compute the rate per unit of each cost allocation base used to allocate indirect costs
to the job.
Step 6: Compute the indirect costs allocated to the job.
Step 7: Determine the total cost of the job by adding all direct and indirect costs assigned to
the job.
Job order costing system is also extensively used in service industries. Hospitals, law firms,
movie studios, accounting firms, advertising agencies and repair shops all use a variety of job
order costing system to accumulate costs for accounting and billing purposes. The details here
deal with a manufacturing firm, the same concept and procedures are used by many service
organizations.
The record keeping and cost assignment problems are more complex in a job order costing
system when a company sells many different products and services than when it has only a single
product or service. Since the products are different, the costs are typically different.
Consequently, cost records must be maintained for each distinct product or job.
For example, an attorney in a large criminal law practice would ordinarily keep separate records
of the costs of advising and defending each of his/her clients. A clothing factory would keep
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separate track of the costs of filling orders for particular styles, sizes, and colors of jeans. A job
order costing system requires more effort than a process costing system. Companies classify
manufacturing costs into three broad categories: (1) direct materials, (2) direct labor, (3)
manufacturing overhead.
As we study the operation of a job costing system, we will see how each of these three types of costs is
recorded and accumulated.
 Measuring Direct Materials Cost in Job Order Costing System:
o Bill of Materials:
At the beginning of production process a document known as bill of materials is used for standard
products. "A bill of materials is a document that lists the type and quantity of each item of materials
needed to complete a unit of standard product". In case where it is not possible to use a bill of materials,
the production staff determines the materials requirements from the blueprints submitted by the customer.
o Materials Requisition Form:
When an agreement is reached with the customer concerning the quantities, price and shipment date for
the order, a production order is issued. The production department then prepares a materials requisition
form. "The materials requisition form is a detailed source document that specifies the type and quantity of
materials to be drawn from the storeroom, and identifies the job to which the costs of the materials are to
be charged". The form is used to control the flow of materials into production and also for making entries
in the accounting records. The completed form is presented to the storeroom clerk who then issues the
necessary raw materials. The storeroom clerk is not allowed to release materials without such a form
bearing an authorized signature. Following is an example of a materials requisition form.
Figure 1: Sample materials requisition form:
Materials Requisition Number14873 Date March 2

Job Number to Be Charged 2B47
Department Milling
Description Quantity Unit Cost Total Cost
M46 Housing 2 $124 $248
G7 Connector 4 103 412
$660
Authorized Signature Bill White
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o Job Cost Sheet:
After being notified that the production order has been issued, the Accounting Department
prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that records
the materials, labor and overhead costs charged to the job. After direct materials are issued, the
Accounting department records their costs directly on the job cost sheet.
In addition to serving as a means for charging costs to jobs, the job cost sheet also serves as a
key part of a firm's accounting records. The job cost sheets form a subsidiary ledger to the work
in process (WIP) account. They are detailed records for the jobs in process that adds up to the
balance in the work in process (WIP). Following is an example of a job cost sheet.
Figure 2: Example of Job Cost Sheet

JOB COST SHEET
Job Number 2B47 Date Initiated March 2

Department Milling Date Completed
Item Units Completed
For Stock
Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 $660
Cost Summary Units Shipped

Direct Materials $ Date Number Balance
Direct Labor $
Manufacturing Overhead $
Total Cost $
Unit Product Cost $
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 Measuring Direct Labor Cost under Job Order Costing System:
o Labor Time Ticket:
Direct labor cost is handled in much the same way as direct materials cost. Direct labor consists
of labor charges that are easily traced to a particular job. Labor charges that cannot be easily
traced directly to any job are treated as part of manufacturing overhead. The later category of
labor cost is known as indirect labor and includes tasks such as maintenance, supervision, and
cleanup.
Workers use time tickets to record the time they spend on each job and task. A completed labor
time ticket is an hour by hour summary of the employees activities throughout on a specific job,
the employee enters the job number on the time ticket and notes the amount of time spent on that
job. When not assigned to a particular job, the employee records the nature of the indirect labor
task (such as cleanup and maintenance) and the amount of time spent on the task. The daily time
tickets are also used as the basis for labor cost entries into the accounting records. Following is
an example of employee’s time ticket.
Figure 3: Sample Employee Time Ticket

Time Ticket No. 843 Date March 3
Employee Mary Holden Station 4
Started Ended Time Rate Amount Job Number
Completed
7:00 12:00 5.0 $9 $45 2B47
12:30 2:30 2.0 9 18 2B50
2:30 3:30 1.0 9 9 Maintenance
o Job Cost Sheet:
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At the end of the day, the time tickets are gathered and accounting department enters the direct
labor hours and costs on individual job cost sheets. Following is an example of a job cost sheet.

JOB COST SHEET

Department Milling Date Completed
Item Units Completed
For Stock

14873 $660 843 5 $45

Direct Materials $ Date Number Balance
Direct Labor $
Manufacturing Overhead $
Total Cost $
Unit Product Cost $
The system we have just described is a manual method for recording and posting labor costs.
Many companies now rely on computerized system and no longer record labor time by hand on
sheet of paper.
One computerized approach uses bar codes to enter the basic data into the computer. Each
employee and each job has a unique bar code. When an employee begins work on a job, s/he
scans three bar codes using a hand-held device much like the bar code readers at grocery store
check-out stands. The first bar code indicates that a job is being started; the second is the unique
bar code on his or her identity badge; and the third is the unique bar code of the job itself.
This information is fed automatically via an electronic network to a computer that notes the time
and then records all of the data. When the employee completes the task, he or she scans a bar
code attached to the job. This information is relayed to the computer that again notes the time,
and a time ticket is automatically prepared. Since the entire source data is already in computer
files, the labor costs can be automatically posted to job cost sheets (or their electronic
equivalents). Computers, coupled with technology such as bar codes, can eliminate much of the
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drudgery involved in routine bookkeeping activities while at the same time increasing timeliness
and accuracy.
 Application of Manufacturing Overhead Cost in Job Order Costing:
o Predetermined Overhead Rate:
Manufacturing overhead must be included on the job cost sheet since it is also a product cost
together with direct material and direct labor. However, assigning manufacturing overhead to
units of product can be a difficult task. There are three reasons for this:
1. Manufacturing overhead is an indirect cost. This means that it is either impossible or

difficult to trace these costs to a particular product or job.
2. Manufacturing overhead consists of many different items ranging from the grease used in
machines to the annual salary of production manager.
3. Even though output may fluctuate due to seasonal or other factors, manufacturing
overhead costs tend to remain relatively constant due to the presence of fixed costs.
Given these problems, about the only way to assign overhead costs to production is to use an
allocation process. This allocation of overhead cost is accomplished by selecting an allocation
base that is common to all of the company's products and services. An allocation base is a
measure such as direct labor hours or machine hours that is used to assign overhead costs to
products and services. The most widely used allocation bases are direct labor hours, and direct
labor cost, with machine hours and even units of product (where a company has only a single
product) also used to some extent. The allocation base is used to compute "predetermined
overhead rate" in the following formula or equation.
Formula and Calculation of Predetermined Overhead Rate:
Estimated total manufacturing overhead cost

Predetermined Overhead Rate =
Estimated total units∈the allocationbase
Example:
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If a company has estimated that its total manufacturing overhead cost will be $320,000 for the
year and its total direct labor hour will be 40,000. Its predetermined overhead rate for the year
will be $8 per direct labor hour, as calculated below:
$320,000 / 40,000
= $8 per direct labor hour
Predetermined overhead rate is based on estimates rather than actual results. This is because the
predetermined overhead rate is computed before the period begins and is used to apply overhead
cost throughout the period. The process of assigning overhead cost to jobs is called overhead
application. The formula for determining the amount of overhead cost to apply to a particular job
is:
[Overhead applied to a job = Predetermined overhead rate × Amount of allocation incurred by

the job]
Note that the job cost sheet in the example below indicates that 27 labor hours have been
worked. Therefore a total of $216 of manufacturing overhead cost would be applied to the job.
According to the following calculation:
Overhead applied to job 2B47 = Predetermined overhead rate × Actual direct labor hours
charged to job 2B47
= $8 per DLH × 27 DLHs
= $216 of overhead applied to job 2B47
In the subsequent section the complete feature of a job cost sheet that shows the summary of the
points discussed in the above sections is displayed.

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JOB COST SHEET

Department Milling Date Completed March 8
14873 $660 843 5 $45 27 $8/DLH $216
14875 506 846 8 60
14912 238 850 4 21
$1,404 851 10 54
27 $180
Direct Materials $1,404 Date Number Balance
Direct Labor 180 March 8 -- 2
Manufacturing Overhead 216
Total Cost $ 1800
Unit Product Cost $ 900
The amount of overhead has been entered on the job cost sheet above. Note that this is not the
actual amount of overhead caused by the job. There is no attempt to trace actual overhead costs
to jobs-if that could be done, the costs would be direct costs, not overhead costs. Overhead
assigned to the job is simply a share of the total overhead that was estimated at the beginning of
the year. Applying overheads to jobs as we have done it is called normal cost system. The
overhead may be applied as direct labor-hours are charged to jobs, or all of the overhead can be
applied at once when the job is completed. The choice is up to the company. If a job is not
completed at the year-end, however, overhead should be applied to value the work-in-process
inventory.
o The Need for/Advantages of Predetermined Overhead Rate:
Instead of using a predetermined overhead rate, a company could wait until the end of the
accounting period to compute an actual overhead rate based on actual total manufacturing costs
and the actual total units in the allocation base for the period. However, managers cite several
reasons for using predetermined overhead rates instead of actual overhead rates:
1. Managers would like to know the accounting system's valuation of completed jobs before
the end of the accounting period. Suppose, for example a company waits until the end of
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the year to compute its overhead rate. Then there would be no way for managers to know
the cost of goods sold for a job until the close of the year. The job may be completed and
shipped before the end of the year. The seriousness of this problem can be reduced to
some extent by computing the actual overhead more frequently, but that immediately
leads to another problem as discussed below.
2. If actual overhead rates are computed frequently, seasonal factors in overhead costs or in
the allocation base can produce fluctuations in the overhead rates. For example, the cost
of heating and cooling a production facility will be highest in the winter and summer
months and lowest in the spring and fall. If an overhead rate were computed each month
or each quarter, the predetermined overhead rate would go up in the winter and summer
and down in the spring and fall. Two identical jobs, one completed in winter and one
completed in spring, would be assigned different costs if the overhead rate were
computed on a monthly or quarterly basis. Managers generally feel that such fluctuations
in overhead rates and costs serve no useful purpose and are misleading.
3. The use of predetermined overhead rate simplifies the record keeping. To determine the
overhead cost to apply to a job, the accounting staff simply multiplies the direct labor hours
recorded for the job by the predetermined overhead rate.
 Comprehensive illustration of job-order costing system in a manufacturing

enterprise
Assume an imaginary firm-Sunrise Enterprise, manufacturer of office and household furniture in Addis
Ababa. The manufacturing plant has two departments within which all finished goods should pass:
Machining and Finishing departments. The company receives orders from a client, Bahir Dar University,
which requires the manufacture of 200 different kinds of furniture to it’s newly inaugurated
administrative & research center building in Bahir Dar town. The following paragraphs explain the detail
steps taken in completing the product costing using the popular system of costing, Job-Order Costing.
Step 1: Identify the job that is chosen as a cost object.
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The cost object in the Sunrise Enterprise example is Job Number ‘BDU-200’, manufacturing
200 office furniture to Bahir Dar University.
Step 2: Identify the direct costs of the job.
Sunrise identifies two direct manufacturing cost categories: direct materials and direct labor.
It is estimated that each unit of finished product requires two types of raw materials: steel and
wood
BDU-200 requires 1,500 pounds of steel, 1,000 metric tons of wood and 120 direct labor
hours.
Steel per pound, wood per metric ton and direct labor per hour are given as $60, $40 and
$200 respectively.
Direct Materials (that need 4,000 machine hours):

Steel ($ 60 X 1,500pd) $ 90,000
Wood ($40 X 1,000mt) 40,000 $ 130,000
Direct Labor: (120hr X $ 200) 24,000
Total Direct Costs of BDU-200 $ 154,000
Step 3: Select the cost allocation base(s) to use for allocating indirect costs to the job
Indirect costs are necessary costs to do a job that cannot be traced to a specific job that they must be
allocated to all jobs in a systematic way as different jobs require different quantities of indirect
resources. The allocation base(s) should be selected by considering cause-effect relationship. In other
words the selected allocation base should be the driver of the overhead costs accumulated in the cost
pool.
Sunrise Enterprise selected two allocation bases to allocate the indirect costs of manufacturing plant:
machine hours in machining department and direct labor hours for finishing department.
Total annual machine hours to be consumed 25,000MHrs
Total annual labor hours to be consumed 1,500DLHrs
Step 4: Identify the indirect costs associated with each allocation base.
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Sunrise Enterprise creates two indirect cost pools to accumulate indirect costs in its two departments:
Manufacturing Overhead-Machining
Manufacturing Overhead-Finishing
The estimated overhead costs in these two departments are determined to be $ 675,000 and $
525,000, respectively.
Step 5: compute the rate per unit of each cost allocation base used to allocate indirect costs to
the job.
For each cost pool, the indirect cost rate is calculated by dividing total overheads in the pool
(determined in step 4 above) by the total quantity of the cost allocation base (determined in step
3).
Total Costs in the Indirect Cost Pool

Indirect Cost Rate =
i.e., Total Quantity of the Cost Allocation Base
Sunrise calculated the allocation rate to its two cost pools as follows:
Manufacturing Overhead-Machining
Indirect Cost Rate in Machining dep't= =
1. Total Machine Hours
Or
$ 675,000
=$ 27 Per Machine Hours
25,000 Machine Hours
Manufacturing Overhead-Finishing
Indirect Cost Rate in Finishing dep't= =
2. Total Direct Labor Hours
Or
$ 525,000
=$ 350 Per Direct labor Hours
1,500 Direct Labor Hours
Step 6: Compute the indirect costs allocated to the job.
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The indirect costs of a job are computed by multiplying the actual quantities of each
different cost allocation base associated with the job by the predetermined cost allocation
rate of each cost allocation base (computed in step 5).
Sunrise Enterprise, as can be referred above, actually used 4,000 machine hours in
machining department and 120 direct labor hours in finishing department. Hence, the
indirect costs allocated to job BDU-200 from the two departments are as follows.
From Machining Department:= $108,000

(4,000 Actual MHrs. X $27 Per Machine Hours)
From Finishing Department:= 42,000
(120 Actual DLHrs X $350 Per Direct Labor Hours)
Total Indirect Costs Allocated $150,000
Step 7: Determine the total cost of the job by adding all direct and indirect costs assigned to
the job.
The cost of job to Bahir Dar University i.e. BDU-200 is determined as shown below.
Direct Manufacturing Costs:

Direct Materials $ 130,000
Direct Labor 24,000 $ 154,000
Indirect Manufacturing Costs:
Machining Department $ 108,000
Finishing Department 42,000 150,000
Total Mfg Costs Job BDU-200 $304,000
How much should Sunrise charge Bahir Dar University to Job BDU-200, given that the firm
requires a 30% profit margin from each order, and selling and administrative costs related
to the job are given as 116,000? How much is the gross profit margin?
1. Sales revenue determination:

Total Cost + Profit = Sales Revenue
Total Cost + 30% X Sales Revenue = Sales Revenue
Total Cost = Sales Revenue - 30% X Sales Revenue
Total Cost = 70% X Sales Revenue
70% X Sales Revenue = Manufacturing costs + Selling & Administrative Expenses
70% X Sales Revenue = $ 304,000 + 116,000 = 420,000
Sales Revenue = $ 420,000 ÷ 70% = $ 600,000
2. Computation of gross profit margin
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[ Sales Revenue - Cost of Goods Sold ]

Gross Profit Margin=
Sales Revenue
or
[ 600,000 - 304,000 ]
Gross Profit Margin= =49 . 33 %
600,000
The Flow of Documents in a Job Order Costing System
Materials
requisition The job cost
A These
form sheet is used to
production production
compute unit
order costs are
A sales product costs
initiates accumulated
order is that in turn are
Sales work on a on a form, Job
prepared as → Production → Direct labor time used to value
Order Order job, ticket prepared by → cost
a basis for sheet ending
whereby the
issuing a..... inventories and
costs are accounting
to determine
charged department
cost of goods
through... Predetermined known as...
sold
overhead rates
 Job Order Costing - The Flow of Cost:
To understand the flow of costs in job order costing system, consider a single month's activity for
an imaginary company, a producer of two products: product A and product B. The company has
two jobs in process during April, the first month of its fiscal year. Job 1, of 1000 units of product
A was started in March. By the end of March, $30,000 in manufacturing costs had been recorded
for the job 1. On the other hand, Job 2 an order for 10,000 units of product B, was started in
April.
o The Purchase and Issue of Materials:
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On April 1, the company had $7,000 in raw materials on hand. During the month, the company
purchased an additional $60,000 in raw materials. The purchase is recorded in journal entry (1)
below:
(1)
Raw Materials 60,000 Dr.
Accounts Payable 60,000 Cr.
‘Raw materials’ is an asset account. Thus, when raw materials are purchased, they are initially
recorded as an asset-not as an expense.
o Issue of Direct and Indirect Materials:
During April, $52,000 valued raw materials were requisitioned from the storeroom for use in
production. These raw materials include both direct ($50,000) and indirect materials ($2,000).
Entry (2) shows issuing the materials to the production department.
(2)
Work in Process 50,000 Dr.
Manufacturing Overhead 2,000 Dr.
Raw Materials 52,000 Cr.
The ‘materials charged to work in process (WIP)’ represents direct materials for specific jobs. As
these materials are entered into the work in process account, they are also recorded on the
appropriate job cost sheets. This point is illustrated in Chart-2 where $28,000 of the $50,000 in
direct materials is charged to Job 1 cost sheet and the remaining $22,000 is charged to job 2 cost
sheet.
The $2,000 charged to manufacturing overhead in entry (2) represents indirect materials used in
production during April. Observe that the manufacturing overhead account is separate from work
in process account. The purpose of the manufacturing overhead account is to accumulate all
manufacturing overhead costs they are as they are incurred during a period.
Before leaving Chart-2 we need to point out one additional thing. Notice from the chart that the
job cost sheet for job 1 contains a beginning balance of $30,000. We stated earlier that this
balance represents the cost of work done during March that has been carried forward to April.
Also note that work in process account contains the same $30,000 balance.
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The reason the $30,000 appears in both places is that the work in process account is a control
account and the job cost sheets form a subsidiary ledger. Thus, the work in process account
contains a summarized total of all costs appearing on the individual job cost sheet for all jobs in
process at any given point in time. Since the company had only Job-1 in process at the beginning
of April, Job-1's $30,000 balance on that date is equal to the balance in the work in process
account.
Chart 2
 Issue of Direct Materials Only:
Sometimes the materials drawn from the raw materials inventory account are all direct materials.
In this case, the entry to record the issue of the materials into production would be as follows:
Work in process XXX Dr.

Raw materials XXX Cr.
o Labor Cost:
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As work is performed each day in various departments of the company, employee time tickets
are filled out by workers, collected, and forward to the accounting department. In the accounting
department, wages are computed and the resulting costs are classified as either direct or indirect
labor. This costing and classification for April resulted in the following summary entry for
incurrence of $60,000 direct and $15,000 indirect labor costs:
(3)
Work in process 60,000 Dr.
Manufacturing overhead 15,000 Dr.
Salaries and wages payable 75,000 Cr.
Only direct labor is added to the work in process account. In this example, direct labor is $60,000 for
April.
At the same time the direct labor costs are added to work in process, they are also added to the
individual job cost sheets, as shown in the Chart-3. During April, $40,000 of direct labor cost
was charged to job 1 and the remaining $20,000 was charged to job 2. The labor cost charged to
manufacturing overhead represent the indirect costs of the period, such as supervision, janitorial
work, and maintenance.
Chart-3
o Manufacturing Overhead Costs:
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All costs of operating the factory other than direct materials and direct labor are classified as
manufacturing overhead costs. These costs are entered directly into the manufacturing overhead
account as they are incurred. To illustrate, assume that the company incurred the following
general factory costs during April:
Utilities (heat, water, and power) $21,000

Rent on factory equipment 16,000
Miscellaneous factory costs 3,000
Total $40,000
The following entry records the incurrence of these costs:
(4)
In addition, let us assume that during April, the company recognized $13,000 in accrued property
taxes and that $7,000 in prepaid insurance expired on factory buildings and equipment. The
following entry records these items:
(5)
Property taxes payable 13,000 Cr.
Prepaid insurance 7,000 Cr.
Finally let us assume that the company recognizes $18,000 in depreciation on factory equipment
during April. The following entry records the accrual of this depreciation:
(6)
Accumulated Depreciation-
Equipments 18,000 Cr.
In short, all manufacturing overhead costs are recorded directly into the manufacturing overhead
account as they are incurred day by day throughout a period. It is important to understand that
manufacturing overhead is a control account for many-perhaps thousands-of subsidiary accounts
such as indirect materials, indirect labor, factory utilities, and so forth. As the manufacturing
overhead account is debited for costs during a period the various subsidiary accounts are also
debited. In this example we omit the entries to the subsidiary accounts for the sake of
brevity/simplicity.
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 Calculation of Predetermined Overhead Rate and Application of Manufacturing

Overhead to Work in Process (WIP):
Since actual manufacturing costs are charged to the manufacturing overhead control account rather than
work in process account. How are indirect manufacturing costs assigned to work in process? The answer
is, by means of the predetermined overhead rate.
A predetermined overhead rate is established at the beginning of each year. The predetermined overhead
rate is calculated by dividing the estimated total manufacturing overhead cost for the year by the
estimated total units in the allocation base (measured in machine hours, direct labor hours, or some other
allocation base). This rate is then used to apply overhead costs to jobs.
To illustrate assume that the company has used machine hours to compute predetermined overhead rate
and that this rate is $6 per machine hour. Also assume that during April, 10,000 machine hours were
worked on Job 1 and 5,000 machine hours were worked on Job 2 (a total of 15,000 machine hours).
Thus, $90,000 in overhead cost (15,000 machine hours X $6 per machine hour = $90,000) would be
applied to work in process.
The following entry records the application of manufacturing overhead to work in process:
(7)
Manufacturing overhead 90,000 Cr.
The flow of cost through the manufacturing overhead account in Chart-4
Chart-4
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The actual overhead costs in the debit side of manufacturing overhead account in Chart-4 are the
costs that were added to the account in entries (2) to (6).
Observe that the incurrence of these actual overhead costs and the application of overhead to
work in process represent two separate and entirely distinct processes.
 The Concept of Clearing Account:
The manufacturing overhead account operates as a clearing account. As we have noted, actual
factory overhead costs are debited to the accounts as they are incurred day by day throughout the
year. A certain intervals during the year, usually when a job is completed, overhead cost is
applied to the job by means of the predetermined overhead rate, and work in process is debited
and manufacturing overhead is credited. This sequence of events is illustrated below:
Manufacturing Overhead
(a clearing account)
Actual overhead costs are charged to this account as Overhead is applied to work in process using the
they are incurred throughout the period. predetermined overhead rate.
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As we emphasized earlier, the predetermined overhead rate is based on estimates of what

overhead costs are expected to be, and it is established before the year begins. As a result, the
overhead cost applied during a year will almost certainly turn out to be more or less than the
overhead cost that is actually incurred.
For example, notice from Chart-4 that the company's actual overhead costs for the period are
$5,000 greater than the overhead cost that has been applied to work in process (WIP), resulting
in a $5,000 debit balance in the manufacturing overhead account. This debit balance in
manufacturing overhead account is called under-applied overhead. Any credit balance in
manufacturing overhead account is called over-applied overhead.
For the moment, we can conclude by nothing from Chart-4 that the cost of a completed job
consists of the actual materials cost of the job, the actual labor cost of the job, and the overhead
cost applied to the job. Pay particular attention to the following subtle but important point:
‘Actual overhead costs are not charged to jobs; actual overhead costs do not appear on the job
cost sheet nor do they appear in the work in process account. Only the applied overhead costs,
based on the predetermined overhead rate, appear on the job cost sheet and in the work in
process account.’ Note this point carefully.
 Non-manufacturing Costs:
In addition to manufacturing costs, companies also incur marketing and selling costs. These costs
should be treated as period expenses and charged directly to the income statement and therefore
should not go into the manufacturing overhead account.
To illustrate the correct treatment of non-manufacturing costs, assume that our example company
incurred $30,000 in selling and administrative salary costs during a month, the following entry
records these salaries.
(8)
Salaries expense 30,000 Dr
Salaries and wages payable 30,000 Cr
Depreciation on factory equipment is debited to manufacturing overhead account but
depreciation on office equipment is considered a period expense and is not included in
40
manufacturing overhead. Assume that depreciation of office equipment during the month was
$7,000. The entry is as follows.
(9)
Depreciation expense 7,000 Dr
Accumulated depreciation 7,000 Cr
Finally assume that advertising was $42,000 and that other selling and administrative expenses
during the month were $8,000. The following journal entry records these items:
(10)
Advertising expenses 42,000 Dr.
Other selling and administrative expense 8,000 Dr.
Accounts payable 50,000 Cr.
Since the amounts in entries above all go directly into expense accounts, they will have no effect
on the costing of the company's production for the month. The same will be true of any other
selling and administrative expenses incurred during the month including sales commission,
depreciation on sales equipment, rent on office facilities, insurance on office facilities, and
related costs.
o Cost of Goods Manufactured (COGM):
When a job has been completed, the finished output is transferred from the production
department to the finished goods warehouse. By this time, the accounting department will have
charged the job with direct materials and direct labor cost and manufacturing overhead will have
been applied using the predetermined overhead rate. A transfer of costs is made within the
costing system that parallels the physical transfer of the goods to the finished goods warehouse.
The costs of the completed jobs are transferred out of the work in process (WIP) account and
into the finished goods account. The sum of all amounts transferred between these two accounts
represents the cost of goods manufactured for the period.
Let us assume that the job 1 was completed during the period. The following entry transfers the
cost of job 1 from work in process (WIP) to finished goods.
(11)
Finished goods 158,000 Dr.
Work in process 158,000 Cr
40
The $158,000 represents the completed cost of job 1, as shown on the job cost sheet in Chart-4.
Since job 1 was the only job completed during April, the $158,000 also represents the cost of
goods manufactured for the month.
The job 2 was not completed by month-end, so its cost will remain in the work in process (WIP)
account and carry over to the next month. If a balance sheet is prepared at the end of April, the
cost accumulated so far on the job 2 will appear as "work in process inventory" in the asset
section.
o Cost of Goods Sold (COGS):
As units in the finished goods are shipped to the customers, their costs are transferred from the
finished goods account into the cost of goods sold account. If complete job is shipped, as in the
case where a job has been done to a customer's specification then it is a simple matter to transfer
the entire cost appearing on the job cost sheet into the cost of goods sold account. In most cases,
only a portion of the units involved in a particular job will be immediately sold. In these
situations the unit cost must be used to determine how much product cost should be removed
from finished goods and charged to cost of goods sold.
Assume that the company has completed 1000 units and 750 out of 1000 units have been shipped
to customers for a price of $225,000. The unit product cost is $158. Following journal entries
would record the sales (all sales are on account).
(12)
Accounts receivable 225,000 Dr.
Sales 225,000 Cr.
(13)
Cost of goods sold 118,5000* Dr.
Finished goods 118,5000 Cr.
($158 × 750units = $118,500*)
With entry (13), the flow of cost through our job order costing system is completed.
Summary of Cost Flow:

To pull the entire example together, journal entries (1) through (13), T accounts, and schedules
of cost of goods manufactured and cost of goods sold are presented below:
Journal Entries:
40
(1)
Raw Materials 60,000 Dr.
(2)
Raw materials 52,000 Cr.
(3)
Salaries and wages 75,000 Cr.
(4)
(5)
Property taxes payable 13,000 Cr.
Prepaid insurance 7,000 Cr.

(6)
Work in process 18,000
Manufacturing overhead 18,000

(7)
Manufacturing overhead 90,000 Cr.
(8)
Salaries expenses 30,000 Dr.
Salaries and wages payable 30,000 Cr.
(9)
Depreciation expense 7,000 Dr.
Accumulated depreciation 7,000 Cr.
(10)
Advertising expense 42,000 Dr
Other selling and administrative expense 8,000 Dr.
(11)
Finished goods 158,000 Dr.
Work in process 158,000 Cr.
(12)
Accounts receivable 225,000
Sales 225,000
40
(13)
Cost of goods sold 118,500
Finished goods 118,500

T Accounts:
Accounts Receivable Accounts Payable Capital Stock
xx xx Xx

(12) 225,000 (1) 60,000
(4) 40,000
(10) 50,000
Prepaid Insurance
Salaries and Wages Payable Retained Earnings
xx xx Xx
(3) 75,000
(5) 7,000 (8) 30,000
Raw Materials Property Taxes Payable Sales

Bal. 7,000 (20) 52,000 xx (12) 225,000
(1) 60,000 (5) 13,000
Bal. 15,000
Cost of Goods Sold
Work in Process Salaries expenses (13) 118500
Bal. 30,000 (11) 158,000 (8) 30,000
(2) 50,000 Depreciation expenses
(3) 60,000 (9) 7,000
(7) 90,000
Bal. 72,000
Finished Goods Advertising Expenses

Bal. 10,000 (13) 118,500 (10) 42,000
(11) 158,000
Bal. 49,000
Accumulated Depreciation Other Selling and
Administrative expenses
xx (10) 8,000
(6) 18,000
(9) 7,000
Manufacturing Overhead
(2) 2000 (7) 90,000
40
(3) 15,000
(4) 40,000
(5) 20,000
(6) 18,000
Bal. 5,000
Explanation of entries:
(1) Raw materials purchased.

(2) Direct and indirect materials issued into (8) Administrative salaries expenses
production. incurred.
(3) Direct and indirect factory labor cost (9) Depreciation recorded on office
incurred. equipment.
(4) Utilities and other factory costs incurred.(10) Advertising and other expenses
incurred
(5) Property taxes and insurance incurred (11) COGM transferred into finished goods.
on the factory.
(6) Depreciation recorded on the factory (12) Sale of job 1 recorded.
assets.
(7) Overhead cost applied to work in (13) Cost of goods sold recorded for job 1.
process.
XX = Normal balance in the account (for example accounts receivable normally carries
a debit balance).
40
 Cost of Goods Manufactured:
Direct materials $50,000

Direct labor $60,000
Manufacturing overhead applied to work in process $90,000*
Total Manufacturing cost $200,000
Add: Beginning work in process 30,000
$230,000
Deduct: Ending work in process inventory 72,000
Cost of goods manufactured $158,000
o Cost of Goods Sold:
Finished goods inventory beginning $10,000

Cost of goods manufactured 158,000
Goods available for sale $168,000
Deduct: Finished goods inventory ending 49,500
Unadjusted cost of goods sold $118,500
Add: Under applied overhead $5,000*
Adjusted cost of goods sold $123,500
*Overhead applied = $90,000 (15,000 Direct labor hours × $6.00

Predetermined overhead rate)
Actual overhead = $95,000
Under applied overhead = $95,000 (actual) - $90,000 (applied) =
$5,000
Entry to close the $5,000 of under applied to cost of goods sold

would be as follows:
Cost of goods sold--------------------------------- 5,000 Dr

Manufacturing overhead-------------------------------- 5,000
Cr
Note that the under applied overhead is added to cost of goods

sold. If overhead were over applied, it would be deducted from
cost of goods sold. nd
Targeted group: 2 year students of Accounting and Finance (Weekend program)
40
 Income Statement:
Sales $225,000
Les cost of goods sold ($ 118,500 + $5,000) 123,500
Gross margin $101,500

Less selling and administrative expenses:
Salaries $30,000
Depreciation 7,000
Advertising expenses 42,000
Other expense 8,000 87,000
$14,500
Net operating income
 Multiple Predetermined Overhead Rates:

In a multiple predetermined overhead rate system, each production department may have its own
predetermined overhead rate. Such a system, though more complex, is considered to be more
accurate. Since it can reflect differences across departments in how overhead costs are incurred.
For example, overhead might be allocated based on machine-hours in departments that are
relatively machine intensive. When multiple predetermined overhead rates are used, overhead is
applied in each department according to its own overhead rate as a job proceeds through the
department.
o Under-applied and Over-applied Overhead
Since the predetermined overhead rate is established before a period begins and is based entirely
on estimated data, the overhead cost applied to work in process (WIP) will generally differ from
the amount of overhead cost actually incurred during a period. The difference between the
overhead cost applied to work in process (WIP) and the actual overhead costs of a period is
termed as either under applied overhead or over applied overhead.
For example if a company calculates it’s predetermined overhead rate $6 per machine hour.
15,000 machine hours are actually worked and overhead applied to production, therefore, is
$90,000 (15,000 hours × $6). If actual factory overhead is $95,000 then under applied overhead
40
is $5,000 ($95,000 – $90,000). If the situation is reverse and the company applies $95,000 and
actual overhead is $90,000 the over applied overhead would be $5,000.
o Causes / Reasons of under applied or over applied overhead:
The causes / reasons of under or over-applied overhead can be complex. Nevertheless the basic
problem is that the method of applying overhead to jobs using a predetermined overhead rate
assumes that actual overhead costs will be proportional to the actual amount of the allocation
base incurred during the period. If, for example, the predetermined overhead rate is $6 per
machine hour, then it is assumed that actual overhead cost incurred will be $6 for every machine
hour that is actually worked.
There are actually two reasons why this may not be true. First, much of the overhead often
consists of fixed costs that do not grow as the number of machine hours incurred increases.
Second, spending on overhead items may or may not be under control. If individuals who are
responsible for overhead costs do a good job, those costs should be less than were expected at the
beginning of the period. If they do a poor job, those costs will be more than expected.
Example:
Suppose that two companies A and B have prepared the following estimated data for the coming year:
Company
A B
Machine-
Direct materials
Predetermined overhead rate based on
hours cost
Estimated manufacturing overhead $300,000
$120,000
Estimated machine-hours 75,000 --
Estimated direct materials cost $80,000
$4 per 150% of direct
Predetermined overhead rate, (a) ÷ (b)
machine hour materials cost
Now assume that because of unexpected changes in overhead spending and changes in
demand for the companies' products, the actual overhead cost and the actual activity
recorded during the year in each company are as follows:
40
Company
A B
Actual manufacturing overhead costs $290,000 $130,000
Actual machine-hours 68,000 --
Actual direct materials costs -- $90,000
For each company, note that the actual data for both cost and activity differ from the
estimates used in computing the predetermined overhead rate. This results in under applied
overhead and over applied overhead as follows:
Company
A B
Actual manufacturing overhead costs $290,000 $130,000
Manufacturing overhead cost applied to work in process
during the year:
68,000 actual machine hours × $4 per machine hour 272,000
$90,000 actual direct materials cost × 150% of direct
135,000
materials cost
------------- -------------
Under applied (over applied) overhead $ 18,000 $ (5,000)
At the beginning of the period

Estimated total
Estimated total units in Predetermined
manufacturing overhead ÷ =
the allocation base overhead rate
cost
During the period

Actual total units of the
Predetermined overhead Total manufacturing
× allocation base incurred =
rate overhead applied
during the period
40
At the end of the period

Total manufacturing Under applied (over
Actual total manufacturing
– overhead = applied)
overhead cost
applied overhead
For company A, notice that the amount of overhead cost that has been applied to work in
process ($272,000) is less than the actual overhead cost for the year ($290,000). Therefore
the overhead is under applied. Also notice that original estimate of overhead in company A
($300,000) is not directly involved in this computation. Its impact is felt only through the $4
predetermined overhead rate that is used.
For B company the amount of overhead cost that has been applied to work in process (WIP)
($135,000) is greater than the actual overhead cost for the year ($130,000), and so overhead
is over applied. A summary of the concepts discussed so for is presented below:
 Disposition of Under-applied or Over-applied Overhead Balances:
What disposition should be made of an under applied overhead or over applied overhead balance
remaining in the manufacturing overhead account at the end of a period?
Generally any balance in the account is treated in one of the two ways.
1. Closed out to cost of goods sold.
40
2. Prorating based on the total ending balances in WIP, finished goods and cost of goods
sold.
3. Prorating based on the total amounts of indirect costs allocated in the ending balances of
work-in-process (WIP), finished goods and cost of goods sold.
The third method, Prorating based on the total amounts of indirect costs allocated in the ending balances
of work-in-process (WIP), finished goods and cost of goods sold, is equivalent to using an "actual"
overhead rate and is for that reason considered by many accountants to be more accurate than the first
method. Consequently, if the amount of under applied or over applied overhead is material, many
accountants would insist that the third method be used.
 Closed Out to Cost of Goods Sold:
Closing out the balance in manufacturing overhead account to cost of goods sold is simpler than the
allocation method.
Where the overhead is under applied following journal entry is made:
Cost of goods sold Dr
Manufacturing overhead Cr
Where the overhead is over applied the following journal entry is made:
Manufacturing overhead Dr
Cost of goods sold Cr
After passing one of these journal entries, cost of goods sold is adjusted. Consequently cost of goods sold
is increased by the amount of under applied and decreased by the amount of over applied overhead .
Example:
Cost of Goods Manufactured:

Direct materials $50,000
Direct labor $60,000
Manufacturing overhead applied to work in process $90,000*
---------
Total Manufacturing cost $200,000
Add: Beginning work in process $30,000
----------
$230,000
Deduct: Ending work in process inventory $72,000
----------
40
Cost of goods manufactured $158,000
Cost of Goods Sold:

Finished goods inventory beginning $10,000
$158,000
-----------
Goods available for sale $168,000
Deduct: Finished goods inventory ending $49,500
----------
Unadjusted cost of goods sold $118,500
Add: Under applied overhead $5,000*
----------
Adjusted cost of goods sold $123,500
Overhead applied = $90,000 (15,000 Direct labor hours × $6.00 Predetermined overhead rate)
Actual overhead = $95,000
Under applied overhead = $95,000 - $90,000 = $5,000
Entry to close the $5,000 of under applied to cost of goods sold would be as follows:
Cost of goods sold-------------------------- 5,000 Dr

Manufacturing overhead------------------------- 5,000 Cr
 Allocated between Accounts based on ending balances of WIP, FGs & CGS:
Allocation of under or over applied overhead between work in process (WIP), finished goods
and cost of goods sold (CGS) is more accurate than closing the entire balance into cost of goods
sold. The reason is that allocation assigns overhead costs to where they would have gone in the
first place had it not been for the errors in the estimates going into the predetermined overhead
rate.
40
Example:
40
If the amount of under-applied or over-applied overhead is significant, it should be allocated

among the accounts containing applied overhead: Work in Process Inventory, Finished Goods
Inventory, and Cost of Goods Sold.
Significant amount of “under-applied” or “over-applied” overhead reflects that the balances in

these accounts are quite different from what they would have been if actual overhead costs had
been assigned to products.
Allocation restates the account balances to conform more closely to actual historical cost as
required for external reporting by generally accepted accounting principles. The above
figure uses assumed data for the Cutting and Mounting Department to illustrate the proration of
40
over-applied overhead among the necessary accounts; had the amount been under-applied, the
accounts debited and credited in the journal entry would be the reverse of that presented for over-
applied overhead. A single overhead account is used in this illustration.
Theoretically, under-applied or over-applied overhead should be allocated based on the amounts

of applied overhead contained in each account rather than on total account balances. Use of total
account balances could cause distortion because they contain direct material and direct labor
costs that are not related to actual or applied overhead.
Percentage
Balance of
of
Unadjusted Allocated Adjusted
Allocated
Account Account overhead Adjustment Amount Account
overhead in
balance in the Balance
the Account
balance
balance
Work-in-
$45,640 $15,000 0.05 ($40,000x.05)=$2,000 $43,640
process
Finished
78,240 90,000 0.30 ($40,000x.30)=$12,000 66,240
Goods
Cost of
528,120 195,000 0.65 ($40,000x.65)=$26,000 502,120
Goods Sold
Total $652,000 $300,000 1.00 $612,000
In spite of this potential distortion, use of total balances is more common in practice for two
reasons: First, the theoretical method is complex and requires detailed account analysis. Second,
overhead tends to lose its identity after leaving Work in Process Inventory, thus making more
difficult the determination of the amount of overhead in Finished Goods Inventory and Cost of
Goods Sold account balances
 Job Order Costing in Service Companies:
40
Job order costing is also used in service organizations such as law firms, movie studios,
hospitals, and repair shops. In a law firm, for example, each client represents a "job," and the
costs of that job are accumulated day by day on a job cost sheet as the client's case is handled by
the firm. Legal forms and similar inputs represent the direct materials for the job; the time
expended by attorneys represents the direct labor; and the costs secretaries, clerks, rent,
depreciation, and so forth, represent the overhead.
In a movie studio, each film produced is a "job", and costs for direct materials (costumes, props,
film, etc.) and direct labor (actors, directors and extras) are accounted for and charged to each
film's job cost sheet. A share of the studio's overhead costs, such as utilities, depreciation of
equipment, wages of maintenance workers, and so forth, is also charged to each film. However,
the method used by some studios, to distribute overhead costs among movies, are controversial
and sometimes result in lawsuits.
In sum, one should be aware that Job order costing is a versatile and widely used costing method, and
may be encountered in virtually any organization that provides diverse products or services.
o Advantages and Disadvantages of Job Order Costing System:

The pros and cons of job order costing system are presented in this section as follows:
A. Advantages of Job Order Costing System:
i. One of the primary advantages of is that the management team has ready access to all the
costs incurred for each job being completed. This allows the team to examine each cost
incurred, finding out why it happened, and determine how it can be controlled better in
the future, thereby contributing to better ongoing levels of profitability.
For example, a proper job record contains any special reworking costs, which a manager
can then use to trace back to the specific reason why the rework was needed. Similarly,
overhead allocations based on machine usage reveal problems with excess use, which
might be the result of lengthy machine setups or break downs as well as longer than
expected machine cycle times.
40
ii. Another reason for using job order costing system is that it yields ongoing results for
each job. In today's world of fully computerized production tracking data bases, one can
use a job order costing system to track costs as they are added rather than waiting until
the job has been completed.
This gives a company several advantages. One is that the accounting staff can monitor
job accounts to see if costs are being posted to the wrong accounts and corrects them
right away, rather than waiting until the job closes and having to frantically review
records to see why the results are different from expectations.
Another advantage is that a company can monitor the costs incurred for longer jobs and
have enough time to make changes before they close, based on the costing information
revealed by the job costing system.
For example, a lengthy new product development project might be over budget after just
25% of the work has been completed; if the management team is made aware of this
costing problem early in the project, it will still have 75% of the project in which to make
corrections and bring costs back down to budgeted levels.
Yet a third advantages is that changes in the cost of a job can result in negotiations with
cost-plus customers who are paying for all the costs incurred, so that they are fully aware
of cost overruns well in advance and are prepared to pay the additional amounts. All
these factors are the main advantages of using job order costing system in a computerized
environment.
B. Disadvantages of Job Order Costing System:
There are also several problems with job order costing system. One is that it focuses attention
primarily on products rather than on departments or activities. This is not an issue if there are
supplemental systems in place that record information about these other cost categories, but it
leaves management with inadequate information if this is not the case.
40
The other difficulty is that overhead is generally allocated based on rates that are changed only
about once in a year. Considerable fluctuation in overhead costs over the course of a year can
result both in over and under allocation of overhead costs to jobs during that period.
Another problem is specific to the use of normal costing. This practice involves the use of
standards overhead rate rather than one that is based on actual costs and requires adjustment
from time to time. If it is management's intention to charge individual jobs for the variance
between standard and actual overhead rates, this may not be possible if some jobs have already
been closed by the time the variance allocation takes place. This is not just a technical
accounting issue, for some jobs are fully reimbursed by customers who pay on a cost plus basis;
if the overhead variance is a positive one, a company may not be able to charge its customers for
the added costs if the related job have already been closed and sold out.
Job costing has little relevance in some environments. For example, software industries have
high development costs but almost zero direct costs associated with the sale of its products. The
use of a job order costing system to records these costs makes little sense if the associated costs
represent only a few percent of the total revenue gained from each one.
The same problem arises in service industries, such as retailing, where there is no discernible/
visible product. These situations limit the most effective use of job order costing system to two
areas-production and professional services. The first case, production is an obvious use for the
concept since there are high material costs that can be specifically identified with a job. The
same is true of professional services, but here the main cost is direct labor rather than direct
materials. In most other cases job costing does not provide management with sufficient quantity
of information to be useful.
The most important problem with job order costing is that it requires a major amount of data
entry and data accuracy in order to yield effective results. Data related to materials, labor, and
overhead, indirect labor, scrap, spoilage, and supplies must be entered into system capable of
accurately assigning these costs to the correct jobs every time.
40
In reality such systems are filled with mistakes due to the large volume of data transactions,
keying errors, misidentification of jobs, and the like. Problems can be resolved with a sufficient
amount of error tracing by the accounting staff, but there may be so many that there are not
enough staff members to keep up with them. Though these issues can to some degree be resolved
through the use of computerized data entry system outweighs the benefits to be gained from it.
A final issue is that a large proportion of the costs assigned to a job, frequently more 50%, come
from allocated overhead. When there is no fully proven method for accurately allocating
overhead, such as through an activity based costing system, the results of the allocation yield
meaningless information. This has been a particular problems for the companies that persist in
allocating overhead costs based on the direct labor used by each job, Since a small amount of
labor is generally being used to allocate a much larger amount of overhead, resulting in large
shifts in overhead allocations based on small changes in labor costs. Some companies avoid this
problem by ignoring overhead for job order costing purposes or by reducing overhead cost pools
to include only overhead directly traceable at the job level. In this way, many costs are not
allocated to jobs at all, but those that are allocated are fully justifiable.
Clearly, one must weigh the pros and cons of using a job order costing system to see if the
benefits outweigh the costs. This system is a complex one that is prone to error, but it does yield
good information about production-specific costs.
…….Thank you for your committed effort…
40

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‘’…….Come to learn; Go to Serve…..

Job Order Costing System

Chapter Learning Objectives:

1. Define a product costing system.

Complied by: Sitota.G!(Course instructor

Introduction to Product Costing

Direct Materials $ 5,400

Complied by: Sitota.G!(Course instructor

Costing systems in general serve three basic functions:

A) Job Order Costing System:

Complied by: Sitota.G!(Course instructor

 General approaches to job costing

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 Measuring Direct Materials Cost in Job Order Costing System:

o Materials Requisition Form:

Figure 1: Sample materials requisition form:

Materials Requisition Number14873 Date March 2

Complied by: Sitota.G!(Course instructor

o Job Cost Sheet:

Figure 2: Example of Job Cost Sheet

Job Number 2B47 Date Initiated March 2

Direct Materials Direct Labor Manufacturing Overhead

Cost Summary Units Shipped

Complied by: Sitota.G!(Course instructor

 Measuring Direct Labor Cost under Job Order Costing System:

o Labor Time Ticket:

Figure 3: Sample Employee Time Ticket

o Job Cost Sheet:

Complied by: Sitota.G!(Course instructor

Figure 4: Example of Job Cost Sheet

Job Number 2B47 Date Initiated March 2

Direct Materials Direct Labor Manufacturing Overhead

Cost Summary Units Shipped

Complied by: Sitota.G!(Course instructor

 Application of Manufacturing Overhead Cost in Job Order Costing:

o Predetermined Overhead Rate:

1. Manufacturing overhead is an indirect cost. This means that it is either impossible or

Formula and Calculation of Predetermined Overhead Rate:

Estimated total manufacturing overhead cost

Complied by: Sitota.G!(Course instructor

[Overhead applied to a job = Predetermined overhead rate × Amount of allocation incurred by

Figure 5: Example of Job Cost Sheet

Complied by: Sitota.G!(Course instructor

JOB COST SHEET

o The Need for/Advantages of Predetermined Overhead Rate:

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 Comprehensive illustration of job-order costing system in a manufacturing

Step 1: Identify the job that is chosen as a cost object.

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Step 2: Identify the direct costs of the job.

Direct Materials (that need 4,000 machine hours):

Total annual machine hours to be consumed 25,000MHrs

Total annual labor hours to be consumed 1,500DLHrs

Complied by: Sitota.G!(Course instructor

Total Costs in the Indirect Cost Pool

Step 6: Compute the indirect costs allocated to the job.

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From Machining Department:= $108,000

Direct Manufacturing Costs:

1. Sales revenue determination:

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[ Sales Revenue - Cost of Goods Sold ]

The Flow of Documents in a Job Order Costing System