POMA-Chapter 3 Job-Order Costing Cost Flows

POMA-Chapter 3:Job-Order
Costing:
Cost Flows and External
Reporting
LO3–1 Understand the flow of costs in a job order costing system and prepare
appropriate journal entries to record costs.
LO3–2 Use T-accounts to show the flow of costs in a job-order costing system.
LO3–3 Prepare schedules of cost of goods manufactured and cost of goods sold
and an income statement.
LO3–4 Compute underapplied or overapplied overhead cost and prepare the journal
entry to close the balance in Manufacturing Overhead to the appropriate accounts.
POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 1

Job-Order Costing—The Flow of Costs
LO3–1: Understand the flow of costs in a job-order costing system and prepare
appropriate
journal entries to record costs.

Exhibit 3–2 shows that in job-order costing a company’s product costs flow through
three inventory accounts on the balance sheet and then on to cost of goods sold in
the
income statement.
More specifically, raw materials purchases are recorded in the Raw Materials
inventory account.
Raw materials include any materials that go into the final product.
When raw materials are used in production as direct materials, their costs are
transferred to Work in Process inventory.
Work in process consists of units of product that are only partially complete and will
require further work before they are ready for sale to the customer.
To transform direct materials into completed jobs, direct labor cost is added to Work in
Process and manufacturing overhead cost is applied to Work in Process by
multiplying the predetermined overhead rate by the actual quantity of the
allocation base consumed by each job.

When jobs are completed, their costs are transferred from Work in Process to
Finished Goods inventory.
Finished goods consist of completed units of product that have not yet been sold to
customers.
The amount transferred from Work in Process to Finished Goods is referred to as the
cost of goods manufactured.
The cost of goods manufactured includes the manufacturing costs associated with
units of product that were finished during the period.
As jobs are sold, their costs are transferred from Finished Goods to Cost of Goods
Sold.
At this point, the various costs attached to each job are finally recorded as an expense
on the income statement.
Until that point, these costs are in inventory accounts on the balance sheet.
Period costs (or selling and administrative expenses) do not flow through
inventories on the balance sheet. They are recorded as expenses on the income
statement in the period incurred.
The materials charged to Work in Process represent direct materials for specific jobs.
The $2,000 charged to Manufacturing Overhead in entry (2) represents indirect
materials.
The debit side of the Manufacturing Overhead account is always used to record the
actual manufacturing overhead costs, such as indirect materials, that are incurred
during the period.
The credit side of this account, as you will see in transaction (7), is always used to
record the manufacturing overhead applied to work in process.
Before leaving Exhibit 3–3, we need to provide one additional comment. Notice from the
exhibit that the job cost sheet for Job A 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 the Work in Process account contains the same $30,000 balance. Thus,
the Work in Process account summarizes all of the costs appearing on the job cost
sheets of the jobs that are in process. Job A was the only job in process at the
beginning of April, so the beginning balance in the Work in Process account equals Job
A’s beginning balance of $30,000.

Labor Cost

Manufacturing Overhead Costs

Recall that all manufacturing costs other than direct materials and direct labor are
classified as manufacturing overhead costs.
In short, all actual manufacturing overhead costs are debited to the Manufacturing
Overhead account as they are incurred.

Applying Manufacturing Overhead
Because actual manufacturing overhead costs are charged to the Manufacturing
Overhead account rather than to Work in Process, it begs the question how are
manufacturing overhead costs assigned to Work in Process? The answer is, they are
assigned by
using the predetermined overhead rate—which is calculated by dividing the estimated

total manufacturing overhead cost for the period by the estimated total amount of the
allocation base. For example, if we assume that machine-hours is the allocation base,
then overhead cost would be applied to jobs by multiplying the predetermined overhead
rate by the number of machine-hours charged to each job.
The flow of costs through the Manufacturing Overhead account is shown in Exhibit 3–5.
The actual overhead costs on the debit side in the Manufacturing Overhead account in
Exhibit 3–5 are the costs that were added to the account in entries (2)–(6).
Observe that recording these actual overhead costs [entries (2)–(6)] and the application
of overhead to Work in Process [entry (7)] represent two separate and entirely distinct
processes.
The Concept of a Clearing Account The Manufacturing Overhead account operates as a

clearing account.

As we have noted, actual manufacturing overhead costs are debited to the account as
they are incurred throughout the year.
When jobs are completed (or at the end of an accounting period), overhead cost is
applied to the jobs using the predetermined overhead rate—Work in Process is debited
and Manufacturing Overhead is credited. This sequence of events is illustrated below
As we emphasized earlier, the predetermined overhead rate is based entirely on

estimates of what the level of activity and 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 actual overhead cost incurred.
For example, notice from Exhibit 3–5 that Ruger Corporation’s actual overhead costs
for the period are $5,000 greater than the overhead cost that has been applied to Work
in Process, resulting in a $5,000 debit balance in the Manufacturing Overhead account.

For the moment, we can conclude from Exhibit 3–5 that the cost of a completed job
consists of the actual direct materials cost of the job, the actual direct labor cost of the
job, and the manufacturing 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 cost, based on the predetermined overhead rate, appears on the job cost
sheet and in the Work in Process account
Nonmanufacturing Costs
In addition to manufacturing costs, companies also incur selling and administrative
costs.
These costs should be treated as period expenses and charged directly to the income
statement. Nonmanufacturing costs should not go into the Manufacturing Overhead
account.

Schedules of Cost of Goods Manufactured
and Cost of Goods Sold

LO3–3 Prepare schedules of cost of goods manufactured and cost of goods sold
and an income
statement.
This section uses the Ruger Corporation example to explain how to prepare schedules
of cost of goods manufactured and cost of goods sold as well as an income statement.
The schedule of cost of goods manufactured contains three elements of product costs—
direct materials, direct labor, and manufacturing overhead—and it summarizes the
portions
of those costs that remain in ending Work in Process inventory and that are transferred
out
of Work in Process into Finished Goods.
The schedule of cost of goods sold also contains three elements of product costs—
direct materials, direct labor, and manufacturing overhead—and it summarizes the
portions of those costs that remain in ending Finished Goods inventory and that are
transferred out of Finished Goods into Cost of Goods Sold.
Schedule of Cost of Goods Manufactured

Exhibit 3–8 presents Ruger Corporation’s schedule of cost of goods manufactured.
We want to draw your attention to three equations that are embedded within this
schedule. First, as shown in the left-hand column of numbers, the raw materials used in
production are computed using the following equation:
Keep in mind that indirect material costs attach to inventory by way of the manufacturing
overhead application process; hence, they must be removed from the calculation of
direct materials used in production.
Subtract indirect cost

Underapplied and Overapplied Overhead—A
Closer Look
Compute underapplied or overapplied overhead cost and prepare the journal
entry to close the balance in Manufacturing Overhead to the appropriate
accounts.
Computing Underapplied and Overapplied Overhead

The difference between the overhead cost applied to Work in Process and the actual
overhead costs of a period is called either underapplied overhead or overapplied
overhead
What is the cause of underapplied or overapplied overhead?
Basically, 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.
There are at least two reasons why this may not be true.
First, much of the overhead often consists of fixed costs that do not change as the

number
of machine-hours incurred goes up or down.
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.

Disposition of Underapplied or Overapplied Overhead
Balances
if there is a debit balance in the Manufacturing Overhead account of X dollars, then the
overhead is underapplied by X dollars. On the other hand, if there is a credit balance
in the Manufacturing Overhead account of Y dollars, then the overhead is overapplied
by Y dollars.

Once we have quantified the amount of underapplied or overapplied overhead, the
corresponding amount remaining in the Manufacturing Overhead account at the end of
a
period must be disposed of in one of two ways:
1. It can be closed to Cost of Goods Sold.
2. It can be closed proportionally to Work in Process, Finished Goods, and Cost of

Goods Sold.
Keep in mind that unadjusted cost of goods sold is based on the amount of
manufacturing overhead cost applied to jobs, not the amount of actual manufacturing
overhead cost incurred.
So, when overhead is underapplied it means two things—not enough overhead cost
was applied to jobs and the cost of goods sold is understated. Adding the underapplied
overhead to the cost of goods sold corrects this understatement.
Closed Proportionally to Work in Process, Finished Goods, and Cost of Goods Sold

Closing underapplied or overapplied overhead proportionally to Work in Process,
Finished Goods, and Cost of Goods Sold is more accurate than closing the entire
balance into Cost of Goods Sold; however, it is also more complex.
We’ll explain the proportional allocation of underapplied or overapplied overhead using
a
three-step process
The first step is to take the total overhead cost applied to production during the period
and break it into three pieces—the portion included in Work in Process at the end of the
period, the portion included in Finished Goods at the end of the period, and the portion
applied to Cost of Goods Sold during the period.
The second step is to state each of these three amounts as a percent of the total
overhead cost applied to production during the period.
The third step is to derive the amounts needed for the journal entry by multiplying the
percentages from step two by the amount of underapplied or overapplied overhead.

Comparing the Two Methods for Disposing of Underapplied or Overapplied Overhead
Closing the underapplied or overapplied overhead to Work in Process, Finished Goods,

and Cost of Goods Sold is more accurate than the simpler approach of closing it out to
Cost of Goods Sold.

A General Model of Product Cost Flows
Exhibit 3–13 presents a T-account model of the flow of manufacturing costs in a job-
order costing system.
This model can be very helpful in understanding how manufacturing costs flow through
a normal costing system and finally end up as Cost of Goods Sold on the income
statement.

Overhead application may be made slowly as a job is worked on.
II. Overhead application may be made in a single application at the time of
completion of the job.
III. Overhead application should be made to any job not completed at year-end in
order to properly value the work in process inventory.
If a company applies overhead to production on the basis of a predetermined rate, a
debit balance in the Manufacturing Overhead account at the end of the period means
that:
A) actual overhead cost was greater than the amount charged to production.

Prime and Coversion
Prime: direct labour and material
conversion: direct labour and manufacturing overhead

product cost: all manufacturing cost
period: non-manufacturing
property tax are period costs
Insurance, factory is manufacturing overhead
utilities…variable cost

POMA-Chapter 3 Job-Order Costing Cost Flows

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POMA-Chapter 3:Job-Order

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 1

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 2

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 3

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POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 5

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POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 7

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 8

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 11

The Concept of a Clearing Account The Manufacturing Overhead account operates as a

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 12

As we emphasized earlier, the predetermined overhead rate is based entirely on

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 13

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 14

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 20

Schedule of Cost of Goods Manufactured

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POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 22

Computing Underapplied and Overapplied Overhead

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1. It can be closed to Cost of Goods Sold.

2. It can be closed proportionally to Work in Process, Finished Goods, and Cost of

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 32

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 33

Closing the underapplied or overapplied overhead to Work in Process, Finished Goods,

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 35

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 39

POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 41

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POMA-Chapter 3:Job-Order Costing: Cost Flows and External Reporting 43

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