JOB ORDER COSTING

Is the accumulation of costs by specific jobs. This costing method is appropriate if a

product can be produced separately, distinct from the other jobs which require
different amount of materials, labor and overhead.

Procedure

1. Costing each product

a. Direct materials and direct labor are traced to a particular job

b. Cost not directly traceable (i.e. manufacturing overhead) are applied to
individual jobs using a predetermined overhead application rate.
c. Since applied overhead is used as a basis for costing the products instead
of the actual factory overhead, the difference between the two, which may
either be over-applied or under-applied may be disposed as a period cost
or allocation between cost of goods sold and appropriate inventory account
(work-in-process and finished goods)

2. Service cost allocation – all manufacturing costs, whether originating in production

department or in service departments, must be assigned to the goods produced
for proper inventory valuation and cost of goods sold determination:

a. Direct Method allocates costs of each of the service departments to each

operating department based on each department’s share of the allocation
base. Services used by other service departments are ignored.
b. Step Method allocates service costs to the operating departments and
other service departments in a sequential process. The sequence of
allocation generally starts with the service department that has incurred the
greatest costs. After this department’s costs have been allocated, the
service department with the next highest costs will then be allocated, and
so forth until the service department with the lowest costs has had its costs
allocated. Costs are not allocated back to a department that has already
had all of its costs allocated.
c. Reciprocal Method allocates service department costs to operating
departments and other service departments. Under the reciprocal cost, the
relationship between service departments is recognized and cost is
allocated to and from each service department for services provided

3. Overhead allocation – allocation is usually based on predetermined rate

determined by dividing budgeted overhead by budgeted volume (in hours or
labor cost etc.)
Scrap, Waste, Spoilage, and Rework

1. Scrap materials
a. Additional revenue
b. Reduction of cost of goods sold
c. Reduction of factory overhead control
d. Reduction in the cost of materials traceable to the particular job

Generally, scrap is regarded as an offset to manufacturing overhead

2. Waste – not usually salable at any price and must be discarded

3. Spoilage or Spoiled goods – partially or fully completed units that cannot be

corrected
a. Charged to a particular job
b. Charged to all production / factory overhead

4. Rework – process of correcting defective units in order to bring them into salable
condition
a. Charged to a particular job
b. Charged to all production / factory overhead

PROCESS COSTING

Process costing accumulates all the costs of operating a process for a period of time
and then divides the costs by the number of units of product that passed through
that process during the period, the result is a unit cost. If the product of one process
becomes the material of the next process, a unit cost is computed for each process.

Procedures

1. Costing each product

a. Materials, labor and overhead are debited to work-in-process when they

are committed to the manufacturing process
b. As goods are completed, their cost is transferred to finished goods
c. Production are accumulated for a process or department rather than a job
d. Unit costs are established

2. Equivalent units of production – measures the amount of work done in each

production phase in terms of fully processed units during a given period.
Incomplete units are also computed in terms of equivalent completed units. The
 calculation is made separately for cost from preceding departments, materials, and
conversion costs.

a. FIFO Method – only the costs incurred this period are allocated between
finished goods and ending work-in-process. Beginning inventory costs are
maintained separately from current period costs

Finished goods this period are costed separately as either started last
period and completed this period or started this period and completed
this period

b. Weighted Average Method – averages all materials, labor, and overhead

both incurred in the beginning work-in-process and those incurred this
period. No differentiation is made between goods started in the preceding
and the current periods

Lost Units

1. Normal loss units – are treated as product costs. The cost of the lost units is
included as part of all units finished or still in process. The good units absorb the
cost of the units lost.

2. Abnormal loss units – are not necessary to the production of good units and the
cost is avoidable in the future. Any cost of abnormal loss is regarded as a period
costs or to a current period expense account

BY-PRODUCTS AND JOINT PRODUCTS

By-products and joint products are delivered from processing a single input or common
set of inputs. By-products and joint products both start their manufacturing process from
the same raw material until a certain point that distinction can be made between the
products. The point in a production process at which individual products can be identified
for the first time and thereafter separate production process can be applied to the
individual products is called SPLIT-OFF POINT. At the split-off point, by-products or joint
products may be saleable or would require further processing to be saleable.

BY-PRODUCTS are outputs that are relatively minor in quantity and/or value when
compared to the main products. The objective of by-product accounting is to reflect
the economic relationship between the by-products and the main products with
minimum bookkeeping for inventory valuation purposes. The common methods used
for accounting for by-products are as follows:
 a. As CONTRA COST – The net realizable value from sale of the by-products is
deducted from cost of the main product.
b. As INCOME – The net realizable value from sale of the by-product is treated
as other income.

JOINT PRODUCTS are products from the same manufacturing process that have
relatively substantial value. Joint costs or costs incurred before split-off point are
allocated among the joint products and separable costs or additional costs incurred
after split-off point that can be identified directly are charged accordingly to individual
products.

Joint costs are allocated to joint products using the following:

1. Physical measurement
2. Sales value
3. Net realizable value

Net realizable value of a product is the product’s sales value at the split-off point
which is computed by subtracting the additional processing and selling costs beyond
split-off point from the sales value of the product.

STANDARD COSTING

Standard cost system is using information from historical data, inputs from factory
personnel and data relevant to the industry and technology that relates to the
manufacturing process to determine the amount that the manufacturing activity should
cost and compares it to the amount that it actually costs.

Advantages:

1. Establishing budget
2. Cost control
3. Price setting
4. Cost awareness

Direct Materials

1. Material price variance – is the actual price less standard price multiplied by actual
quantity. It is usually the purchasing department that is responsible for material
price variance

(Actual price – Standard price) x Actual quantity

2. Material quantity (or efficiency) variance – is the actual quantity less the standard
quantity multiplied by standard price. The production department or cost center
that controls the direct materials into the production process

(Actual quantity – Standard quantity) x Standard price

Direct Labor

1. Labor rate variance – is the actual rate less standard rate multiplied by actual hours
used. It is usually the supervisor of the department or cost center where the work
is performed is responsible for the direct labor rate variance

(Actual rate – Standard rate) x Actual hours

2. Labor efficiency (or usage) variance – is the actual hours less the standard hours
multiplied by standard rate. It is usually the supervisor of the department or cost
center where the work is performed is responsible for the direct labor efficiency
variance

(Actual hours – Standard hours) x Standard rate

Factory Overhead (2-way variance analysis)

1. Controllable variance – will occur if a company actually spends more or less on

factory overhead than expected and/or uses more or less than the number of direct
labor hours allowed. It assumes a manager or supervisor can control these
factors.

Actual factory overhead ………………………………………. Pxxxx

Less Budgeted allowed based on standard hours
Fixed as budgeted Pxxxx
Variable xxxx xxxx
Variance Pxxxx

2. Volume variance – might indicate the unutilized portion expressed in hours that
were not effectively applied or over applied during the period.

Budgeted allowed based on standard hours ……………………………. Pxxxx

Less: Standard factory overhead or Applied factory overhead xxxx
Variance Pxxxx
 Disposition

1. Immaterial variances are customarily treated as period cost as an adjustment to

cost of goods sold account or income summary
2. Variances that are material may be prorated. A simple approach to allocate the
total net variance (materials, labor and overhead) to work-in-process, finished
goods, and cost of goods sold based on balances.

JUST-IN-TIME (JIT) SYSTEM is an important and significant innovation in production

system. JIT is designed to produce goods as needed by customers, using minimal
inventories. The holding of minimal inventories is achieved by physical sequencing of
purchasing, production and sales to occur in quick succession. The goal is to have little
or no raw material, work-in-process, or finished goods inventory in the plant. This saves
costs that arrives from holding inventory, including the risk of damage, theft, loss or failure
to find a customer for the finished product. Emphasis are placed on the following:
1. Careful selection of suppliers
2. Multiskilled workers capable of performing variety of tasks
3. Organized manufacturing set-up for an efficient product flow lines that reduces
setup time and consequently reduce manufacturing lead time.

JIT requires that raw materials are received just in time to go into production,
manufactured parts are completed just in time to be assembled into products, and
products are completed just in time to be shipped to customers.

Just-in-time purchasing is the purchase of materials so that they are delivered just
as needed for production. Suppliers may be required to make frequent deliveries in
small orders directly to the production floor, based on the production schedules.
Aside from quality, proximity to the production site or delivery system of the supplier
is considered in the selecting the suppliers.

Just-in-time production or lean production is a demand-pull approach that

focuses on eliminating waste and non-value-added activities from production
process. Demand drives the procurement to production of any needed materials and
immediate delivery eliminates waiting time and the need for inventory. Demand
pulls the manufacturing process, starting with customer demand for a finished
product then working all the way back the demand of direct materials. Close
coordination between workstations is needed for a smooth flow of goods in the
production process.

BACKFLUSHING is a simplified approach to determining product cost that is used when

there is little or no work-in-process and finished goods inventory. This approach charges
current production costs directly to cost of goods sold. Backflush costing avoids the costly
and complicated reporting of costs as they occur, and instead flushes all costs in a single
entry once the production process is completed. Backflush costing is common among
companies using Just-In-Time inventory management system. For this reason, backflush
costing is often referred to as JIT costing.

Backflush costing differs from traditional costing with regards to the accounts used and
the time of recording cost as follows:
1. Instead of using separate accounts for materials and work-in-process, this is
combines into a Raw and In-Process Account.
2. Direct labor and manufacturing overhead are charged to a Conversion Cost
Account
3. Overhead is not applied to production until they are completed.
4. At the end of the period, the cost associated with unsold or uncompleted items,
if any, are backflushed to either finished goods or in-process account.

Pro-forma entries are as follows:

1. Purchased raw materials:

Raw and In Process xxxxx
Accounts Payable xxxxx
#

2. Direct labor and overhead incurred:

Conversion Cost xxxxx
Accrued Payroll/Other Accounts xxxxx
#

3. Cost of goods completed

(Materials and applied conversion cost):
Cost of Goods Sold xxxxx
Raw and In Process xxxxx
Conversion Cost xxxxx
#

4. Backflushed cost of unsold and in-process items: (if any)

Raw and In Process xxxxx
Finished Goods xxxxx
Cost of Goods Sold xxxxx
#