Unit 3

CHAPTER THREE
JOB ORDER COSTING SYSTEM AND PROCESS COSTING SYSTEM

3.1 Job Order Costing Systems
Manufacturers can use two basic accounting systems; general accounting system, and cost accounting
system. A general accounting system is the logical extension of accounting for merchandising firms, and
uses the periodic inventory system. However, since managers require frequent accounting reports on
manufacturing costs for decision making purpose, the use of the general accounting system is very
limited. Cost accounting system uses the perpetual inventory system and it is most widely used, because it
helps to gather information that are needed in order to prepare periodic reports without physical counting
and related cumbersome tasks.
The cost accounting system uses the perpetual inventory system, and achieves greater accuracy in the
determination of product cost than is possible with the general accounting system. It also permits far more
effective control by supplying data on costs incurred by each manufacturing department or process and it
provides a fairly accurate unit cost of manufacturing each type of product that helps managers make good
decisions timely.
There are two extremes of cost accounting systems for manufacturing operation-Job order costing system
and Process costing system.
A job order costing system provides a separate record of the cost of each particular batch of product that
passes through the factory. The system accumulates costs for a particular batch of production, commonly
referred to as a job. A job has a definite starting and completion time as would, for example, the
production of 10 pieces of windows, or 50 coffee tables. As the name implies, job order means, the units
are produced as per the order of a customer, each customer order is different in terms of specification. A
difference in specification means a difference in quantity of inputs used. An individual job does not mean
a single output; rather it means a single order which can be just for stock that can be sold later to ready-
made buyers. Whatever, whether for customer or stock, jobs are not similar, and their costs are also
different. In job order costing system, costs are accumulated by job. For each job, the firm maintains a
separate job cost sheet, which is a record on which manufacturing costs of the job are accumulated.
In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that, the work is
done to the customer's specifications. As a result, each job tends to be different. For example, job order
costing is used for construction projects, government contracts, shipbuilding, automobile repair, printing
jobs, wood furniture, office machines, machine tools, and luggage. Accumulating the cost of professional
services such as lawyers, doctors and CPA's also falls into this category.
Process costing system is a costing system used for manufacturing processes which produce a single
product or single mix of products continuously for an extended period of time. In process costing, costs
are accumulated by departments, operations, or processes. The work performed on each unit is
standardized or uniform where a continuous mass production or assembly operation is involved. For
example, process costing is used by companies that produce appliances, alcoholic beverages, tires, sugar,
breakfast cereals, leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes,
typewriters, cement, gasoline, steel, baby foods, flour, glass, men's suits, pharmaceuticals and
automobiles. Process costing is also used in meat packing and for public utility services such as water, gas
and electricity.
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Source Documents in Job order Costing System
1. Measuring Direct Materials Cost in Job Order Costing System:
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 material requirements from the blueprints submitted by the customer.
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. 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. The following is a sample material requisition form for job 2B47.
Sample Materials Requisition Form:

Materials Requisition Number14873 Date March 2 ,2009
Job Number to Be Charged 2B47
Department Milling
Description Quantity Unit Cost Total Cost
M46 Housing 2 Br.124 Br.248
G7 Connector 4 103 412
Br.660
Authorized Signature __________________
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 add up to the balance in the work in process (WIP). The raw material cost Br.660 for job 2B47 is
accumulated on a job cost sheet as follows:
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JOB COST SHEET
Job Number 2B47 Date Initiated March 2 ,2009
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 Br.660
2. Measuring Direct Labor Cost under Job Order Costing System:
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 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 employees’ time ticket.
Time Ticket No. 843 Date March 3 ,2009

Employee : Jaleta Bulli Station 4
Started Ended Time Rate Amount Job Number

Completed
7:00 12:00 5.0 Br.9 Br.45 2B47
12:30 2:30 2.0 9 18 2B50
2:30 3:30 1.0 9 9 Maintenance
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. The following is how to do that for job 2B47.
JOB COST SHEET

Department Milling Date Completed
Item Units Completed
For Stock

14873 Br.660 843 5 Br.45
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3. Application of Manufacturing Overhead Cost in Job Order Costing:
Manufacturing overhead must be included with direct labor on the job cost sheet since manufacturing
overhead is also a product cost. However, assigning manufacturing overhead to units of products can be a
difficult task. There are two 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.
Given these problems, 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, direct labor cost, machine hours and even units of product can also
be used to some extent. The allocation base is used to compute "predetermined overhead rate" in the
following formula or equation.
Predetermined Overhead Rate = Estimated total MOH cost
Estimated total allocation base
For example, if a company has estimated that its total manufacturing overhead cost will be Br.320, 000
for the year and its total direct labor hour will be Br.40, 000, its predetermined overhead rate (POR) for
the year will be Br.8 per direct labor hour, calculated as follows:
Br. 320,000 / 40,000 = Br.8 per direct labor hour
Predetermined overhead rate is based on estimates rather than actual result. 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 costs 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 particular job = POR × Amount of allocation base
Note that the job cost sheet in the example below indicates that 27 labor hours have been worked.
Therefore a total of Br.216 of manufacturing overhead cost would be applied to the job.
Overhead applied to Job 2B47 = Predetermined overhead rate × Actual direct labor hours
= Br.8 per DLH × 27 DLHrs
= Br.216
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JOB COST SHEET

Department Milling Date Completed March 8 ,2009

14873 Br.660 843 5 Br.45 27 Br.8/DLH Br.216
14875 506 846 8 60
14912 238 850 4 21
--------- 851 10 54
Br.1,404 -------- --------
===== 27 Br.180
===== =====
Cost Summary Units Shipped
Direct Materials Br.1,404 Date Number Balance
Direct Labor 180 March 8 -- 2
Manufacturing Overhead 216
Total Cost Br.1800
Unit Product Cost 900
In addition to direct material and direct labor cost, the applied manufacturing overhead cost will
beentered in the job cost sheet and the total estimated cost to complete the job will be summarized as
shown below.
The amount of overhead cost entered in the job cost sheet 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. When a company applies overhead cost to jobs as we
have done, it is called normal costing 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.
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 the following two reasons for using
predetermined over head 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 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.
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2. 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.
The job cost

Materials
sheet is used
A requisition
These to compute
production form
production unit product
A sales order
costs are costs that in
order is initiates Job
Sales prepared Production work on a Direct labor accumulated turn are
→ → → cost
Order as a basis Order job, time ticket on a form, used to
prepared by sheet value ending
for issuing whereby
the accounting inventories
a..... costs are
department and to
charged Predetermined known as... determine
through... overhead rates cost of
goods sold
The Flow of Documents in a Job Order Costing System
Accounting Procedures for Job order Costing System
To understand the flow of costs in job order costing system, we shall consider a single month's activity
for Gibe Furniture Company, a producer of product A and product B. The company has two jobs in
process during April, the first month of its fiscal year. Job 1 (1000 units of product A) was started in
March. By the end of March, Br. 30,000 in manufacturing costs had been recorded for job 1. Job 2, an
order for 10,000 units of product B was started in April.
1. The Purchase and Issue of Materials:
On April 1, the company had Br.7,000 in raw materials on hand. During the month, the company
purchased an additional Br.60,000 in raw materials. The purchase is recorded in journal entry (1) below:
Raw Materials 60,000
(1)
Accounts Payable 60,000
A raw material is an asset account. Thus, when raw materials are purchased, they are initially recorded as
an asset--not as an expense.
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2. Issue of Direct and Indirect Materials:
During April, Br.52,000 in raw materials was requisitioned from the storeroom for use in production.
These raw materials include Br. 2,000 indirect materials. Entry (2) records issuing the materials to the
production department.
(2)
Work in Process 50,000
Manufacturing Overhead 2,000
The materials charged to work in process (WIP) represent 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. The Br.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 as they are incurred during a period. 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.
3. Labor Cost:
As work is performed each day in various departments of the company, employee time tickets are filled
out by workers, collected, and forwarded 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 a total labor cost Br.75, 000 of which Br.15, 000 is indirect
material. The journal entry to record this is given as follows
(3) Work in process 60,000

Manufacturing overhead 15,000
Salaries and wages payable 75,000
Only direct labor is added to the work in process account. At the same time the direct labor costs are
added to work in process, they are also added to the individual job cost sheets. During April, Br.40, 000
of direct labor cost was charged to job 1 and the remaining Br.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 for the two jobs in common.
4. Manufacturing Overhead Costs:
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) Br.21,000

Rent on factory equipment 16,000
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Miscellaneous factory costs 3,000
Total Br.40,000
The following entry records the incurrence of these costs:
(4a)
In addition, let us assume that during April, the company recognized Br.13, 000 in accrued property taxes
and that Br.7, 000 in prepaid insurance expired on factory buildings and equipment. The following entry
records these items:
(4b) Property taxes payable 13,000
Prepaid insurance 7,000
Finally let us assume that the company recognizes Br.18, 000 in depreciation on factory equipment during
April. The following entry records the accrual of this depreciation:
(4c) Manufacturing overhead 18,000

Accumulated Depreciation 18,000
In short, all manufacturing overhead costs are recorded directly into the manufacturing overhead account
as they are incurred day by day through 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.
5. 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 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 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 Br.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,
Br.90, 000 in overhead cost (15,000 machine hours times Br.6 per machine hour = Br.90, 000) would be
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applied to work in process. The following entry records the application of manufacturing overhead to
work in process:
(5) Work in process 90,000

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 through 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.
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, the company's actual overhead costs for the period in the above example are
Br.5,000 greater than the overhead cost that has been applied to work in process (WIP), resulting in a
Br.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.
The accounting for MOH over/under applied is discussed in the next section. For the moment, we can
conclude that the cost of a completed job consists of the actual material cost of the job, the actual labor
cost of the job, and the overhead cost applied to the job. This is called Normal costing. Pay particular
attention to the following 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, appear on the job cost sheet and in the
work in process account.
6. Non-Manufacturing Costs:
In addition to manufacturing costs, companies also incur marketing and selling costs. These costs should
be treated as periodic 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 the company (in this example) incurred Br.30,000 in selling and administrative salary costs
during a months, the following entry records these salaries.
(6a) Salaries expense 30,000

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 manufacturing overhead. Assume
that depreciation of office equipment during the month was Br.7, 000. The entry is as follows.
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(6b) Depreciation expense 7,000
Accumulated depreciation 7,000
Finally, assume that advertising was Br.42, 000 and that other selling and administrative expenses during
the month were Br.8, 000. The following journal entry records these items:
(6c) Advertising expenses 42,000

Other selling and admin. Expense 8,000
Accounts payable 50,000
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.
7. 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 job 1 was completed at a total cost of Br.158,000 during the period. The following
entry transfers the cost of job 1 from work in process (WIP) to finished goods.
(7)
Finished goods 158,000
Work in process 158,000
Since Job 1 was the only Job completed during April, the Br.158,000 also represents the cost of goods
manufactured for the month. 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 thus far on the job 2 will appear as "work in process inventory" in the assets
section.
8. 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
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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 Br.225,000. The unit product cost is Br.158. The Following journal entries would
record the sales (all sales are on account).
(8a) Accounts receivable 225,000

Sales 225,000
(8b)
Cost of goods sold 118,5000
(Br.158 × 750units = Br.118, 500)
With entry (8), the flow of cost through our job order costing system is completed. To pull the entire
example together, journal entries (1) through (8), T-accounts, and schedules of cost of goods
manufactured and cost of goods sold are presented below:
(1)
(2)
Raw materials 52,000
(3)
(4a)
(4b)
Property taxes payable 13,000
Prepaid insurance 7,000
(4c)
(5)
(6a)
Salaries expenses 30,000
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(6b)
Depreciation expense 7,000 .
(6c)
Advertising expense 42,000
Other selling and administrative expense 8,000
(7)
(8a)
Accounts receivable 225,000
Sales 225,000
(8b)
The above journal entries can be summarized using T-account as follows
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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
(4b) 7,000 (6a) 30,000
Raw Materials Property Taxes Payable Sales
Bal. 7,000 (2) 52,000 xx (12) 225,000
(1) 60,000 (4b) 13,000
Bal. 15,000
Cost of Goods Sold
Work in Process Salaries expenses (8b)118500
Bal. 30,000 (7 158,000 (6a)30,000
(2) 50,000 Depreciation expenses
(3) 60,000 (6b) 7,000
(5 90,000
Bal. 72,000
Finished Goods Advertising Expenses

Bal. 10,000 (8b)118,500 (6c)42,000
(7) 158,000
Bal. 49,000
Accumulated Depreciation Other Selling and
Administrative expenses
xx (6c) 8,000
(4c) 18,000
(6b) 7,000
Manufacturing Overhead
(2) 2000 (5) 90,000
(3) 15,000
(4a) 40,000
(4b) 20,000
(4c) 18,000
Bal. 5,000
After accounts are summarized in a T-account, cost of goods manufactured, cost of goods sold and
Income statement for the job completed (Job1) is presented as follows.
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1. Cost of Goods Manufactured:
Direct materials Br.50,000
Direct labor 60,000
Manufacturing overhead applied to work in process 90,000
Total Manufacturing cost Br.200,000
Add: Beginning work in process 30,000
Total cost incurred to date Br.230,000
Deduct: Ending work in process inventory (Job-2) 72,000
Cost of goods manufactured Br.158,000
2. Cost of Goods Sold:

Finished goods inventory beginning Br.10,000
Add: cost of Goods manufactured 158,000
Goods available for sale Br.168,000
Deduct: Finished goods inventory ending 49,500
Unadjusted cost of goods sold Br.118,500
Add: Under applied overhead 5,000
Adjusted cost of goods sold Br.123,500
3. Income Statement:
Sales Br.225,000
Less cost of goods sold (Br. 118,500 + Br.5,000) 123,500
Gross margin Br.101,500
Less selling and administrative expenses:
Salaries Br.30,000
Depreciation 7,000
Advertising expenses 42,000
Other expense 8,000 87,000
Net operating income Br.14,500
Accounting for Under/Over-Applied MOH cost
Since 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
Br.6 per machine hour. 15,000 machine hours are actually worked and overhead applied to production is
therefore Br.90, 000 (15,000 hours × Br.6). If actual factory overhead is Br.95, 000 then under applied
overhead is Br.5, 000 (Br.95, 000 – Br.90, 000). If the situation is reversed and the company applies
Br.95, 000 and actual overhead is Br.90, 000, the over applied overhead would be Br.5, 000.
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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 Br.6 per machine hour, then it is assumed that actual
overhead cost incurred will be Br.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. For example, suppose that two companies A and B have prepared the following
estimated data for the coming year:
Company
A B
Predetermined overhead rate based on Machine-hours Direct materials cost
Estimated manufacturing overhead Br.300,000 Br.120,000
Estimated machine-hours 75,000 --
Estimated direct materials cost Br.80,000
150% of direct materials
Predetermined overhead rate, (a) ÷ (b) Br.4 per machine hour
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:
Company
A B
Actual manufacturing overhead costs Br.290,000 Br.130,000
Actual machine-hours 68,000 --
Actual direct materials costs -- Br.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 Br.290,000 Br.130,000
Manufacturing overhead cost applied to work in process during
the year:
68,000 actual machine hours × Br.4 per machine hour 272,000
Br.90,000 actual direct materials cost × 150% of direct
135,000
materials cost
Under applied (over applied) overhead Br. 18,000 Br. (5,000)
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For company A, notice that the amount of overhead cost that has been applied to work in process
(Br.272, 000) is less than the actual overhead cost for the year (Br.290, 000). Therefore the overhead is
under applied. Also notice that original estimate of overhead in company A (Br.300, 000) is not
directly involved in this computation. Its impact is felt only through the Br.4 predetermined overhead
rate that is used. For B company the amount of overhead cost that has been applied to work in process
(WIP) (Br.135, 000) is greater than the actual overhead cost for the year (Br.130, 000), and so
overhead is over applied.
There are three main approaches to accounting for the under/over applied manufacturing overhead.
1. Adjusted Allocation Rate Approach: The adjusted allocation rate approach restates all overhead
entries in the general ledger and subsidiary ledger using actual cost rates than budget cost rates. First, the
actual manufacturing overhead rate is computed at the end of the fiscal year. Then, the manufacturing
overhead costs allocated to every job during the year are recomputed using the actual manufacturing
overhead rate rather than the budgeted manufacturing overhead rate. The result is that at year end, every
job cost record and finished goods record accurately represent actual manufacturing overhead costs
incurred.
2. Closed Out to Cost of Goods Sold: Closing out the balance in manufacturing overhead account to cost
of goods sold is simpler than the adjusted allocation rate approach. Where the overhead is under applied,
the following journal entry is made:
Cost of goods sold XX

Manufacturing overhead XX
Where the overhead is over applied, the following journal entry is made:
Manufacturing Overhead XX
Cost of goods sold XX
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. For
Gibe furniture factory, the under applied amount is Br.5, 000 and is closed to cost of goods sold as
follows
This is the reason why we have added the under applied manufacturing overhead to the unadjusted cost of
goods sold amount and arrive at the adjusted amount of Br.123, 500
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3.Proration Approach: Allocation of under or over applied overhead between work in process (WIP),
finished goods and cost of goods sold (COGS) 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.
Accounts End balance Percentage

Work In process 72,000 30%
Cost of Goods Sold 118,500 50%
Finished Goods 49,000 20%
Total 239,500
The followings are end balance of the three accounts for Gibe Furniture Company
The under applied manufacturing overhead can be prorated based on the end balance percentage
computed above as follows
Accounts Percentage Prorated amount
Work In process 30% 30%×5000 = 1,500
Cost of Goods Sold 50% 50%×5000 = 2,500
Finished Goods 20% 20%×5000 = 1000
Total 5,000
After peroration the under applied amount will be closed to the three accounts as shown below
Work in Process 1,500
Finished Goods 1000
17
3.2 PROCESS COSTING SYSTEM
Similarities and Difference between Process and Job order Costing
As discussed in the previous unit, the production process influences the choices of cost
accounting system. Firms producing distinct and unique products use job order costing system
where as firms producing similar or identical units use process-costing system. Process costing
system accumulate costs by departments for a period of time, just as a job order costing system
accumulate costs by jobs, and the total cost will be assigned to the units produced in that period.
Process costing system is product costing system which is applied when identical units are
produced in mass. Identical units are assumed to take the same amount of direct material, direct
labor & manufacturing overhead. These costs are accumulated over a period of time and the total
cost is assigned to units produced in the period the cost is accumulated
In process costing system, each unit is assumed to take equal amount of direct material, direct
labor and manufacturing overhead. The difference between job order and process costing system
is, thus, the extent of the averaging used to compute unit cost. In job order costing each job
differs in terms of material used, labor incurred, and manufacturing overhead. Hence, it is
impossible to assign the same cost for different jobs. On the contrary, identical units produced in
mass take equal amount of direct material, direct labor, and manufacturing overhead. Thus, the
unit cost can be found by dividing total cost by the number of units produced.
When a firm produces identical lots of goods repetitively, maintaining a separate job cost sheet
would be unnecessarily expensive. The aggregate cost and the unit cost can be computed with
out a job cost sheet, thus saving the cost associated with producing such records. Costs are
accumulated by departments over a certain period and the unit cost can be found by dividing the
total cost to the units produced during that period. Process costing system fit among others to,
paint manufacturers; oil refineries, sugar refineries, and salt producers.
The difference between job order and process costing arise from two factors. The first is that, the
flow of units in process costing system is more or less continuous, and the second is that these
units are indistinguishable from one another. Under process costing, it makes no sense to try to
identify material, labor and overhead costs with a particular order from customers as we did in
18
job order costing system, since each order is just one of the many that are filled from a
continuous flow of virtually identical units from the production line. Under process costing, we
accumulate costs by department, rather than by order, and assign these costs equally to all units
that pass through the department during the period.
A further difference between the two costing system is that the job order cost sheet has no use in
process costing, since the focal point of that method is on department. Instead of using job order
cost sheets, a document known as cost of production report is prepared for each department in
which work is done on products. The production report serves several functions. It provides a
summary of the number of units moving through a department during a period, and it also
provides a computation of unit costs. In addition, it shows what costs were charged to the
department and what disposition was made of these costs. The department production report is a
key document in process costing system. The major difference between job order and process
costing systems is summarized in the table below.
Base of comparison Job order costing Process costing
Type of product Diversified, heterogeneous and Homogeneous products produced
unique products continuously
Cost accumulation By job for a specified number By department or cost center for a
of units specified period of time
Work in process One for each job One for each department
Basic document Job cost sheet for each job Cost of production report for each
department or cost centers
Cost per unit Cost accumulated by job Cost accumulated by cost centers
divided by units in job divided by equivalent unit of
production during a period of time
Reporting By job By cost center or department
Nature of costs for Each job may use different Each units produced uses the same
each cost object amount of material, labor and slandered amount of materials, labor
overhead cost and overhead cost
It is important to recognize that much of what was learned in the preceding unit about costing
and about cost flows equally applies well to process costing in this chapter. That is, we are not
throwing out all that we have learned about costing and starting from scratch with a whole new
system. The similarities that exist between job orders costing and process costing can be
summarized as follows:
19
 The same basic purposes exist in both systems, which are to assign material, Labor, and
overhead cost to products and to provide a mechanism for computing unit cost.
 Both systems maintain and use the same basic manufacturing account including
manufacturing overhead, raw material, work in process and finished goods.
 The flow of costs through the manufacturing accounts is basically the same in both
systems. As can be seen from these comparisons, much of the knowledge that we have
already acquired about costing is applicable to process costing system. our task is simply
to refine and extend this knowledge to process costing
In process costing system, direct material, labor, and manufacturing overhead costs are
accumulated in the same way as job order costing system. However, the costs are accumulated
by department over some period of time than by individual jobs. The time period over which the
cost is to be accumulated depends on the information needs of the company. It can be a week,
two weeks, but no longer than a month most often. Cost accumulation is much simpler in process
costing system than in job order costing.
Hybrid Costing System: Product-costing systems must often be designed to fit the particular
characteristics of different production systems. Many production systems are a hybrid- they have
some features of customer-order manufacturing and other features of mass-production
manufacturing. Manufacturers of relatively wide variety of closely related standardized products
(for example televisions, dishwashers and washing machines) tend to use a hybrid-costing
system. A hybrid-costing system blends characteristics from both job-costing and process costing
systems. Job-costing and process-costing systems are best viewed as the ends of a continuum.
Process Costing System – Different Cases

A processing department is any location in organizations where work is performed on a product
and where materials, labor or overhead costs are added to the product. For example, a potato chip
factory might have three processing department-one for preparing potatoes, one for cooking, and
one for inspecting and packaging. A company can have as many or as few processing
departments as are needed to complete a product or service. Some products and service may go
through several processing departments, while others may go through only one or two.
Regardless of the number of departments involved, all processing departments have essential
features. First, the activity performed in the processing department must be performed uniformly
20
on all of the units passing through it, second; the output of the processing department must be
homogenous. The discussion on process costing will be clear when we use examples. Hence, we
use the case of SNAP computers to illustrate three cases under process costing.
Illustration 1: SNAP computers imports component parts of a computer and its accessories from
abroad and assemble computers here in Ethiopia. The components parts are first assembled in the
assembly department. Up on completion, units are transferred to finishing department for testing,
loading the different office software and packaging. Since all computers assembled are the same,
the company uses process costing system for cost accumulation. The process costing system for
the computer has two cost categories (Direct material and Conversion cost). Each unit of
computers passes through two departments, the assembly department and Finishing department.
Every effort is made to ensure that all computers are identical and meet assets of demanding
performance specification. Direct material is added at the beginning of the process in assembly
department. Additional direct material is added at the end of the process in finishing department
when each computer is completed. Conversion cost is added evenly during both processes. When
the finishing department finishes work on each computer, it is immediately transferred to
finished goods and taken to warehouse until it is sold. The following diagram presents these
facts.
Conversion cost added
evenly during the process
Assembly Finishing
Department Transfer Department
Direct material
added at the beginning
Process costing system separates costs in two categories according to when costs are
introduced in to the process. Often, as in our SNAP computer example, only two cost
classifications, direct material and conversion costs are necessary to assign costs to products.
Because all direct materials are added to the process at one time and all conversion costs are
generally added to the process evenly through time. If, however two different direct materials
were added to the process at different times, two different direct material cost categories
would be needed to assign these costs to products. Similarly, if manufacturing labor costs
21
were added to the process at a different time than when the other conversion costs were
added, an additional cost category-direct manufacturing cost - would be needed to separately
assign these costs to products. We will use the assembling of each computer in the assembly
department to illustrate three cases, starting with the simplest case and introducing additional
complexities in subsequent cases.
Case 1: Process Costing with No Beginning or Ending Work In Process Inventory. That
is, all units are started and fully completed by the end of the accounting period. This case
illustrates the basic averaging of cost data, which is a key feature of process costing. On
January 1, 2008, there were no beginnings WIP of computers in the assembly department.
During January 2008, SNAP computers started and completed assembly of computers and
transferred out to finishing department 400 units. Additional information for assembly
department is given below:
Physical unit for January, 2008:
 WIP beginning------------- 0 unit
 Started during January ------- 400 unit
 Completed and transferred --- 400 unit
 WIP ending ------------------ 0 unit
Total cost for January, 2008:
 DM cost added during January --Br. 640,000
 Conversion cost added -------------- 480,000
 Total assembly department cost -Br.1,120,000
SNAP computer should record direct materials and conversions in the assembly department as
these costs are incurred as follows:
Work In process – Assembly 640,000
Raw material control 640,000
(To record the use of direct materials in the production process)
Various accounts 480,000
(To record the use of conversion costs in the production process)
In the above journal entry, various accounts consists of many accounts that can be credited when
conversion cost is incurred such as cash, accounts payable, accumulated depreciation, prepaid
insurance etc. In this case, average cost can be calculated easily by dividing the total cost
incurred to units assembled and completed in the assembly department as follows
22
Average cost = Total cost = Br.640, 000 + Br.480, 000
Total units completed 400 units
= Br 2,800
When the 400 units completed in assembly department are transferred to the finishing
department, the following journal entries will be recorded:
Work In process – Finishing 1,120,000
Work In process- Assembly 1,120,000
In the real manufacturing process, the above case is a very simplified case, because, usually all
units started in a given period will not be completed and transferred to the next department.
There might be some units which are started but not completed. That is, there might be some
ending work in process. This leads us to the 2nd case of process costing.
Case 2: Process costing with Zero Beginning but Some Ending WIP inventory
Assume that in February, 2008, SNAP computer place another 400 unit in to the assembly
process. Because all units placed in production in January were completely assembled, there is
no beginning WIP on February 1. Because of different reasons, not all units started in February
were completed by the end of the month. Only 175 units are completed and transferred to the
finishing department. Data for the assembly department for the month of February 2008 are:
 Physical unit for february2008:
 WIP beginning(February 1) ------------------ 0 unit
 Units Started during February --------------- 400 unit
 Completed and transferred out ------------- 175 unit
 WIP ending ( February 29) ---------------- 225 unit
 Direct material (100% complete)
 Conversion cost (60% complete)
 Total cost for February:
 DM cost added during February ------------Br.640,000
 CC cost added during February -------------- 372,000
 Total assembly department cost------------Br.1,012,000
The 225 partially assembled units as of February 29, 2008, are fully processed with respect to
direct materials. This is because; all direct materials in the assembly department are added at the
beginning of the assembly process. Conversion costs however are added evenly during assembly
process. Based on work completed relative to the total work required to complete each computer
units still in process at the end of February, an assembly department supervisor estimates that the
partially assembled units are on average 60% complete with respect to conversion costs.
23
The accuracy of the completion estimates of conversion costs depends on the care, skill and
experience of the estimator and the nature of conversion process. Estimating conversion is
usually easier for direct material cost than for conversion costs. That is because, the quantity of
direct material needed for completed units and the quantity of direct materials in partially
completed units can be measured more accurately. In contrast, the conversion cost sequence
usually consists of a number of basic operations specified for a specified number of hours, days,
or weeks for various steps in the production process. The point to understand here is that, a
partially assembled unit is not the same as fully assembled unit, faced with some fully assembled
units and some partially assembled units, SNAP Computers calculates in five steps:
1. the cost of fully assembled units and
2. the cost of partially assembled units still in process at the end of that month
Step 1: Summarize the Flow of Physical Units
Physical unit’s express the physical flow of production. It is a measure of the units of production
that have been started and that may or may not be completed. The physical units’ summary,
tracks where the physical units came from and where they went. It does not consider the degree
of completion. The physical flow can be summarized as shown in the schedule below:
Physical flow
Beginning WIP -------------------------XX
Units started ----------------------------- XX
Units to account for------------------ XX
Units completed ------------------------ XX
Ending WIP-------------------------------XX
Units accounted for ------------------ -- XX
Step 2: Compute Output in Terms of Equivalent Units (EU)

Equivalent units measure output in terms of the physical quantity of each of the input (factor
of production) that has been consumed when producing the units. Equivalent units are
computed using physical units. It disregard birr amount. Equivalent unit of each major
category of production inputs is calculated using the following formula:
Equivalent unit = Physical unit x Percentage of completion
For instance, the 225 partially assembled units in the above case are 100% complete with
respect to direct material. This means that the equivalent units in terms of direct material are
24
225 units but with respect to conversion cost, they are 60% complete, which means, the 225
partially completed units are equivalent to 135 fully completed units (225x60%= 135 units)
Step 3: Compute Equivalent Unite Cost
After computing equivalent units of partially completed units in terms of each cost category,
cost per equivalent unit can be computed using the following formula. This cost per
equivalent unit can be used to assign total cost incurred in the period to units completed and
units in work in process ending.
Cost per EU = Production cost
Equivalent units
Step 4: Summarize Total Cost to Account For
In this step, we add up all costs incurred in the period. For SNAP computer, the cost to
account for the month of February, 2008 is Br. 1,012,000 (Br.640, 000 + Br. 372,000 = Br.
1,012,000)
Step 5: Assign Total Cost to Units Completed and Units in Ending WIP
In this step, we assign the total cost to account for to units completed and transferred out and
to units in ending working process at the end of the month. The idea is to attach the Birr
amounts to the equivalent output units for direct material and conversion costs of units
completed and ending working process. Equivalent output units for each inputs are
multiplied by cost per equivalent unit both for units completed and ending work in process.
After costs have been assigned to units completed and units in work in process ending, the
total cost assigned should agree with the amount we have to account for. The following cost
of production report for SNAP computer summarizes the five steps discussed above for the
month of February, 2008.
(Step 1)
Flow of production Physical flow
Work in process beginning 0 (Step 2)
Units started in current period 400 Equivalent Units
Direct Conversion
Units to account for 400 Materials Costs
Units completed and transferred out 175 175 175
Work in process ending 225 225 135
Units accounted for 400
Work done in current period only
(Equivalent units) 400 310
(Step 3): Cost Summary
Costs added during February Br. 1,012,000 Br 640,000 Br 372,000
Divide by equivalent units ÷ 400 ÷ 310
Cost per equivalent units Br. 1,600 Br. 1,200
25
(Step 4):
Total cost to account for Br. 1,012,000
(Step 5) Assignment of cost:
To completed and transferred units
(175 units) Br. 490,000 Br. 1,600×175 + Br. 1,200×175
To work in process ending (225 units) 522,000 Br. 1,600×225 + Br. 1,200×135
Total cost accounted for Br. 1,012,000
The cost of production per unit for the month of February is the sum of the cost per equivalent
unit for both direct material and conversion cost which is Br. 2,800 (Br. 1600 + Br. 1200). The
journal entries for SNAP computer for the month of February, 2008 are given below:
(To record the use of conversion costs in the production process)
Work In process – Finishing 490,000
Work in process - Assembly 490,000
(To record the transfer of completed products from assembly department to finishing)
Case 3: Process costing with some beginning and some ending work in process inventory.
In a production process, in addition to work in process ending, their might be some work in
process available at the beginning of the period. When this is the case, the five steps in the
preparation of cost of production report involve two additional inventory costing systems
(Weighted Average and FIFO methods).
Weighted Average Method: The weighted average process costing method calculates cost per
equivalent unit of all work done to date( regardless of the accounting period in which it was
done) and assigns this cost to equivalent units completed and transferred out of the process and
to equivalent units in ending work in process inventory. The weighted average cost is the total of
all costs entering the work in process account (whether they are from beginning work in process
or from work started during the current period) divided by the total equivalent units of work done
to date.
Illustration 3: At the beginning of March, 2008, SNAP computers had 225 units of partially
assembled computers in the assembly department. It started production of another 275 units in
March, 2008; data for assembly department for the month of March are:
Physical units for March 2008
 WIP beginning------------------------------------ 225 unit
26
Direct material (100% complete)
Conversion cost (60% complete)
 Started during March ---------------------------- 275 unit
 Completed and transferred out -------------------- 400 unit
 WIP ending ----------------------------------------- 100 units
Conversion cost (50% complete)
Total cost for March:
WIP beginning:
DM -------------------------Br.360, 000
CC-------------------------- 162,000 - Br.522, 000
DM added during March ---------------------------- 396,000
CC added during March ------------------------------ 327,600
Total cost to account for --------------------------Br.1, 245,600
The cost of production report for Assembly department for the month of March using the five
steps is presented below under weighted Average method.
(Step 1)
Direct Conversion
Units to account for 500 materials costs
Units completed and transferred out 400 400 400
Work done to date (Equivalent units) 500 450
(Step 3) ; Cost summary
Work in process beginning Br. 522, 000 Br. 360, 000 Br. 162,000
Costs added during February 723,600 396,000 327,600
Total cost incurred to date Br. 756,000 Br. 489,600
Cost per equivalent units Br 1,512 Br 1,088
(Step 4)
To completed and transferred units
(400 units) Br. 1,040,000 Br. 1,512×400 + Br. 1,088×400
To work in process ending (100units) 205,600 Br. 1,512×100 + Br. 1,088×50
In the equivalent unit column of work done to date, there are 500 equivalent units of direct
materials and 450 units of conversion costs. All completed and transferred out units are 100%
complete as to both direct material and conversion cost because direct material is added at the
beginning of the assembly process and they are 100% complete with respect to conversion cost.
But units in WIP ending are 50% complete as to conversion cost, hence the equivalent unit of
27
WIP ending are 50 units (100x50%) with respect to conversion cost. In step 3, the cost per
equivalent unit is calculated by merging together the cost of beginning inventory and the
manufacturing cost of the period and dividing by equivalent units of work done to date. The
journal entry to recognize the consumption of raw material, conversion cost and transfer of
assembled computers from assembling to finishing department using weighted average costing
method is given below:
(To record the use of conversion cost in the production process)

Work in process - Assembly 1,040,000
(To record the transfer of completed products from assembly department to finishing
department)
2. First In First Out (FIFO) Method: the first in first out process costing method assigns the
cost of the previous accounting period’s equivalent units in beginning work in process inventory
to the first units completed and transferred out of the process and assigns the cost of equivalent
units worked on during the current period first to completed beginning inventory, next to started
and completed new units, and finally to units in ending work in process inventory. The FIFO
method assumes that the earliest equivalent units in work in process are completed first. A
distinctive feature of the FIFO process costing method is the work done on beginning inventory
before the current period is kept separate from work done in the current period. Costs incurred
and units produced in the current period are used to calculate cost per equivalent units of work
done in the current period. In contrast, equivalent unit and cost per equivalent unit calculation
under the weighted average method merges units and costs in beginning inventory with units and
costs of work done in the current period. For SNAP computers, Under the FIFO method,
equivalent units of work done in March on the beginning work in process inventory equals 225
physical units times the percentage of work remaining to be done in march to complete these
units: 0% for direct materials, because beginning work in process is 100% complete with respect
to directs material last month and 40% (100%- 60%) for conversion costs, because beginning
work in process is 60% complete with respect to conversion costs last month. The results are
28
0(0%×225) equivalent units of work for direct materials and 90(40%×225) equivalent units of
work for conversion cost. The following is the cost of production report under FIFO method.
(Step 1)
Direct Conversion
Units to account for 500 Materials Costs
Units completed and transferred out:
From beginning work in process 225 0 90
Started and completed 175 175 175
Work done in current period only 275 315
(Step 3): Cost summary
Work in process beginning Br. 522, 000 Incurred Last Month
Costs added during March 723,600 Br. 396,000 Br. 327,600
Cost per equivalent units Br. 1,440 Br. 1,040
(Step 4)
To completed units (400 units)
Work In process beginning (225 units) Br. 522, 000 -------------------------------------
Cost added to beginning WIP in the
current month 93600 0×Br. 1,440 + 90×Br. 1,040
Total from beginning Inventory Br. 615,600
Started and completed 434000 175×Br. 1,440 + 175×Br. 1,040
Total cost of units completed Br. 1,049,600
To work in process ending (100units) 196,000 Br. 1,440×100 + Br. 1,040×50
The equivalent unit of work done on the 175 physical unit started and completed equals 175 units
times 100% for both direct material and conversion cost, because all works on these units is done
in the current period. The equivalent units of work done on the 100 units of ending work in
process equals 100 physical units times 100% for direct materials(because all direct materials for
these units are added in the current period) and 50% for conversion costs because only 50% of
conversion cost work on these units is done in the current period.
Computation of cost per equivalent units for work done in the current period is only based on
direct material and conversion costs of the current period. Under FIFO method, cost of work
done in the current period is assigned, First to the additional work done to complete the
beginning work in process, then to work done on units started and completed during the current
period, and finally to ending work in process. The journal entry to recognize the consumption of
29
raw material, conversion cost and transfer of assembled computers from assembling to finishing
department using FIFO costing method is given below
To record the use of conversion cost in the production process)
(To record the transfer of completed products from assembly department to finishing
department)
Managers use information from process costing system to aid them in pricing and product mix
decision and to provide them with feedback about their performance. The weighted average
method merges units’ costs from different accounting periods obscuring period to period
comparison. Advantages of the weighted method however, are its relative computational
simplicity and its reporting of a more-representative average unit cost when inputs prices
fluctuate markedly from month to month. FIFO provides managers with information about
changes in cost per unit from one period to the next. Managers can use this information to adjust
selling price and evaluate performance in the current period. By focusing on work done and cost
of work done during the current period, the FIFO method provides useful information for
planning and control purpose.
Transferred in Cost
Up to now, we have seen how to prepare cost of production report for the first department in
SNAP computer, how do we accumulate cost in the second department?
Many process-costing systems have two or more departments or processes in the production
cycle. As units move from department to department, the related cost is also transferred by
monthly journal entries. If standard costs are used, accounting for such transfers is simple.
However, if the weighted-average or FIFO method is used, the accounting can become more
complex. We now extend our SNAP computer example to the finishing department. As the
assembly process is completed, the assembly department of SNAP computer immediately
transfers each unit to its finishing department. Here, each unit will be loaded with appropriate
office and application soft wares and the units receive additional direct material such as crating
and other packing materials at the end of the process, to prepare the units for shipment.
30
Conversion cost is added evenly during the finishing department’s process. As units are
completed in finishing department, they are immediately transferred to finished goods and taken
to warehouse. The following diagram shows this fact diagrammatically.
Conversion cost added
evenly during the process
WIP
Assembly Finishing
Department Transfer Department
Direct material
added at the end
Transferred-in costs (also called previous departments’ cost) are the cost incurred in the previous
process in the production cycle. That is, as the units move from one department to the next, their
costs are transferred with them. Computations of finishing department costs consist of
transferred-in costs as well as the direct materials and conversion costs added in finishing
department. Transferred-in cost is treated as if it is a separate type of direct material added at the
beginning of the process. When successive departments are involved, transferred units from one
department become all or part of the direct materials of the next department; however, they are
called transferred-in costs not direct materials costs.
Transferred-In costs and the Weighted-Average Method
To examine the weighted-average process-costing method with transferred-in costs, we use the
five-step procedure described earlier to assign costs of the finishing department to units
completed and transferred out and to units in ending work in process. Let us assume the
following data for SNAP computer for the month of April, 2008.
Illustration 4: The assembly department of SNAP computer transfers assembled units to its
finishing department. Here, the units receive additional direct material such as crating and other
packing material to prepare the units for sell at the end of the process. Conversion costs are
added evenly during the process. As units are completed in finishing department, they are
immediately transferred to finished goods.
Physical units
WIP beginning ----------------------------- 240 units
Transferred in Cost (100% complete)
Conversion cost (62.5% complete)
31
Transferred in during April -------------- 400 unit
Completed during April ------------------------- 440 unit
WIP ending ---------------------------------------200 units
Transferred in Cost (100% complete)
Conversion cost (80% complete
Cost for finishing department in April:
WIP beginning
Transferred In cost --------------------------Br.672, 000
Direct materials ---------------------------------- 0
Conversion cost ---------------------------- 360,000
Transferred in during April:
Under WA method -------------------------------Br.1, 040,000
Under FIFO method ----------------------------- 1, 049,600
Direct material cost added during April --------- -- -- 13,200
Conversion cost during April ----------------------- --- 48,600
The production report for the month of April for finishing department can be prepared under
weighted average method as follow:
(Step 1)
Physical
Flow of production flow
Transferred in Direct Conversion
Units to account for 640 cost material costs
Units completed and transferred
out: 440 440 440 440
Work in process ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period only 640 440 600
Work in process beginning Br. 1,032,000 Br. 672,000 0 Br. 360,000
Costs added during March 1,101,800 1, 040,000 13,200 48,600
Total cost Br. 1,712,000 Br. 13,200 408,600
Divide by equivalent units ÷ 640 ÷ 440 ÷ 600
Cost per equivalent units Br. 2,675 Br. 30 Br. 681
(Step 4)
Total cost to account for Br.2,133,800
To completed units (440 units) Br.1,489,840 (440×2,675) + (440×30) + (440×681)
To work in process ending (200
units) 643,960 (200×2675) + (0×30) + (160×681)
The computations are the same as the calculations of equivalent units under the weighted-
average method for the assembly department, but here we also have transferred-in costs as
another input. The units, of course are fully completed as to transferred-in costs carried forward
32
from the previous process. Direct material costs have a zero degree of completion in both the
beginning and ending work-in process inventories because, in finishing department direct
materials are introduced at the end of the process. Beginning work in process and work done in
the current period are combined for purposes of computing equivalent-unit costs for transferred-
in costs, direct material costs and conversion costs. The necessary journal entries for the month
of April in the finishing department are given as follows:
Finished Goods 1,489,840
(To record the transfer of completed products from finishing department to warehouse)
2. Transferred-In Costs and the FIFO Method:
The cost of production report for finishing department for the month of April can be prepared
using FIFO method as follows:
(Step 1)
Physical
Flow of production flow
Transferred in Direct Conversio
Units to account for 640 cost material n costs
Units completed
From WIP Beginning 240 0 240 90
Started and completed 200 200 200 200
WIP Ending 200 200 0 160
Units accounted for 640 - - -
Work done in current period only 400 440 450
Work in process beginning Br. 1,032,000 Incurred last month
Costs added during March 1,111,400 Br. 1, 049,600 Br. 13,200 48,600
Divide by equivalent units ÷ 400 ÷ 440 ÷ 450
Cost per equivalent units Br. 2,624 Br. 30 Br. 108
(Step 4)
Total cost to account for 2,143,400
To completed units (440 units)
From WIP Beginning (240 units) Br.1,032,000
Cost added to WIP Beginning 16,920 (0×2,624) + (240×30) + (90×108)
Total from beginning Inventory Br. 1,048,920
33
Started and completed 552,400 (200×2,624)+(200×30)+ (200×108)
Total cost of units completed Br. 1,601,320
To WIP ending (200 units) 542,080 (200×2,624) + (0×30) + (160×108)
Total cost accounted for Br.2,143,400
To examine the FIFO process-costing method with transferred-in costs, we again use the five
step procedure. Other than considering transferred-in costs in the computations of equivalent
units, the remaining are the same as under the weighted average method for the assembly
department. The necessary journal entries for the month of April in the finishing department are
given as follows:
Finished Goods 1,601,320
(To record the transfer of completed products from finishing department to warehouse)
Process Costing System and Spoilage
Spoilage is units of production – whether fully or partially completed – that do not meet the
specifications required by customers for good units and that are discarded or sold at reduced
price. Some examples of spoilage are defective shirts, jeans, shoes, and carpeting sold as
“second hand,” or defective aluminum cans sold to aluminum manufacturers for remolding to
produce other aluminum products. Accounting for spoilage aims to determine the magnitude of
spoilage costs and to distinguish between costs of normal and abnormal spoilage
Normal spoilage is spoilage inherent in a particular production process that arises even under
efficient operating conditions. Management decides the spoilage rate it considers normal
depending on the production process. Costs of normal spoilage are typically included as a
component of the costs of good units manufactured because good units cannot be made without
also making some units that are spoiled.
Abnormal spoilage is spoilage that is not inherent in a particular production process and would
not arise under efficient operating conditions. Abnormal spoilage is usually regarded as
avoidable and controllable. Line operators and other plant personnel generally can decrease or
eliminate abnormal spoilage by identifying the reasons for machine breakdowns, operator errors,
and the like, and by taking steps to prevent their recurrence. To highlight the effect of abnormal
34
spoilage costs, companies calculate the units of abnormal spoilage and record the cost in the loss
from abnormal spoilage account, which appears as a separate line time in the income statement.
Issues about accounting for spoilage arise in both process – costing and job – costing systems.
We first present the accounting for spoilage in process – costing systems using illustrative
example
Illustration 5: ABC Company manufactures a recycling container in its forming department.
Direct materials are added at the beginning of the production process. Some units of this product
are spoiled as a result of defects, which are detectable only upon inspection of finished units.
Normally, spoiled units are 10% of the finished output of good units. That is, for every 10 good
units produced, there is 1 unit of normal spoilage. Summary data for July 2009 are:
Physical Direct Conversion Total
Units (1) Materials Costs (3) Costs
Work in process, beginning inventory (July 1) 1,500 Br.12,000 Br.9,000 Br.21,000
Degree of completion of beginning work in process 100% 60%
Started during July 8,500
Good units completed and transferred out in July 7,000
Work in process, ending inventory (July 31) 2,000
Degree of completion of ending work in process 100% 50%
Total costs added during July Br.76,500 Br.89,100 Br.165,600
Normal spoilage as a percentage of good units 10%
Degree of completion of normal spoilage 100% 100%
Degree of completion of abnormal spoilage 100% 100%
The five – step procedure for process costing used in the previous sub section need only slight
modification to accommodate spoilage.
Step 1: Summarize the flow of Physical units of Output. Identify units of both normal and
abnormal spoilage.
Total spoilage = (WIP Beginning + Units started) _ (Good units completed + WIP End)
= (1,500 + 8,500) – (7, 000 + 2,000)
= 10,000 – 9,000
= 1,000 units
Recall that normal spoilage is 10% of good output at ABC Corporation. Therefore, normal
spoilage = 10% of the 7,000 units of good output = 700 units.
35
Abnormal Spoilage = Total spoilage – Normal spoilage
= 1,000 units – 700 units
= 300 units
Step 2: Compute output in terms of equivalent units. Compute equivalent unit for spoilage in
the same way we compute equivalent units for good units. All spoiled units are included in the
computation of output units. Because ABC’s inspection point is at the completion of production,
the same amount of work will have been done on each spoiled and each completed good unit.
Step 3: Compute cost per Equivalent unit.
Step 4: Summarize Total costs to Account for. The total costs to account for are all the costs
debited to work in process.
Step 5: Assign total Costs to units Completed, to Spoiled Units, and to units in ending work in
process. This step now includes computation of the cost of spoiled units and the cost of good
units. We will illustrate these five steps of process costing for the weighted – average and FIFO
methods using the example of ABC corporation.
1. Weighted – Average Method and Spoilage
(Step 1)
Work in process beginning 1,500 (Step 2)
Units started in current period 8,500 Equivalent Units
Direct Conversion
Units to account for 10,000 materials costs
Good units completed 7,000 7000 7000
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Units accounted for 10,000
Work done to date (Equivalent units) 10,000 9,000
Work in process beginning Br.21,000 Br.12,000 Br. 9,000
Total cost incurred to date Br.88,500 Br.98,100
Divide by equivalent units ÷ 10,000 ÷ 9,000
Cost per equivalent units Br. 8.85 Br. 10.90
(Step 4)
Total cost to account for Br. 186,600
To Good units completed (7000 units) Br. 138,250 Br 8.85×7000 + Br 10.90×7000
Normal spoilage 13,825 Br 8.85×700 + Br 10.90×700
36
Total cost of good units Br. 152,075
Abnormal spoilage 5,925 Br 8.85×300 + Br 10.90×300
To work in process ending (2000 units) 28,600 Br 8.85×2000 + Br 10.90×1000
Total cost accounted for Br. 186,600
The journal entry to be recorded are given below:
Work In process – Forming 76,500
Work In process – Forming 89,100
Finished Goods 152,075
Work in process - forming 152,075
(To record the transfer of completed products from finishing
department to warehouse)
Loss from abnormal spoilage 5,925
(To record the loss from abnormal spoilage)
2. FIFO Method & Spoilage
(Step 1)
Work in process beginning 1,500 (Step 2)
Units started in current period 8,500 Equivalent Units
Direct Conversion
Units to account for 10,000 materials costs
Good units completed :
From WIP Beg. 1,500 0 600
Started and completed 5,500 5,500 5,500
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Units accounted for 10,000
Work done in the current period 8,500 8,100
Work in process beginning Br.21,000 ----------------- --------------------
Divide by equivalent units ÷ 8,500 ÷ 8,100
Cost per equivalent units Br. 9 Br. 11
(Step 4)
Total cost to account for Br.186,600
Good units completed (7000 units)
WIP Beginning (1,500 units) 21,000
Cost added during the period 6,600 Br. 9×0+ Br. 11×600
Total from beginning inventory 27,600
Started and completed (5,500 units) 110,000 Br. 9×5,500+ Br. 11×5,500
37
Normal spoilage (700 units) 14,000 Br. 9×700+ Br. 11×700
Total cost of good units completed Br.151,600
Abnormal spoilage 6,000 Br. 9×300 + Br. 11×300
To work in process ending (2000 units) 29,000 Br. 9×2000 + Br. 11×1000
Total cost accounted for Br.186,600
The journal entry for recording consumption of raw material and conversion cost is the same as
in the weighted average method but the remaining journal entries are slightly different & are
given as follows:
Finished Goods 151,160
(To record the transfer of completed products from finishing
department to warehouse)
Loss from abnormal spoilage 6,000

(To record the loss from abnormal spoilage)
Note that Costs of abnormal spoilage are separately accounted for as losses of the accounting
period in which they are detected. However, the cost of normal spoilage is added to the costs of
good units completed in the period.
Job Costing System and Spoilage, Rework & Scrap
The concepts of normal and abnormal spoilage can also apply to job order costing systems.
Abnormal spoilage is separately identified so companies can work to eliminate it altogether.
Costs of abnormal spoilage are not considered to be inventor able cost and are written of as costs
of the accounting period in which the abnormal spoilage is detected. Normal spoilage costs in
job – costing systems – as in process – costing systems – are inventor able costs, although
increasingly companies are tolerating only small amounts of spoilage as normal. When
assigning costs, job costing systems generally distinguish normal spoilage attributable to a
specific job from normal spoilage common to all jobs. We describe accounting for spoilage in
job costing using the following example.
Illustration 6: In the BOING Machine Shop, 5 aircraft parts out of a job lot of 50 aircraft parts
are spoiled. Costs assigned prior to the inspection point are Br. 2, 000 per part. Our presentation
here and in subsequent sections focuses on how the Br. 2, 000 cost per part is accounted for.
When the spoilage is detected, the spoiled goods are inventoried at Br. 600 per part which is the
net disposal value.
38
Normal Spoilage attributable to a specific job: when normal spoilage occurs because of the
specifications of a particular job, that job bears the cost of the spoilage minus the disposal value
of the spoilage. The journal entry to recognize disposal value is:
Materials Control - spoiled goods (5  Br. 600) 3,000
Work-in-Process Control (specific job) 3,000
Note, the Work – in – process Control (specific job) has already been debited (charged) Br.10,
000 for the spoiled parts (5 spoiled parts  Br.2, 000 per part). The net cost of normal spoilage =
Br. 7, 000 (Br.10, 000 - Br.3, 000), which is an additional cost of the 45(50 – 5) good units
produced. Therefore, total cost of the 45 good units is Br.97, 000: Br.90, 000 (45 units  Br.2,
000 per unit) incurred to produce the good units plus the Br.7, 000 net cost of normal spoilage.
Cost per good unit is Br.2, 155.56 (97,000  45 good units).
Normal spoilage common to all jobs: In some cases, spoilage may be considered a normal
characteristic of the production process. The spoilage inherent in production will of course,
occur when a specific job is being worked on. But the spoilage is not attributable to, and hence
is not charged directly to, the specific job. Instead, the spoilage is allocated indirectly to the job
as manufacturing overhead because the spoilage is common to all jobs. The journal entry is:
Materials Control -spoiled goods (5 Br. 600) 3,000
MOH control - normal spoilage (Br.10, 000 - Br. 3, 000) 7,000
Work-in-Process control (specific job): 5 unit  Br.2, 000 10,000
When normal spoilage is common to all jobs, the budgeted manufacturing overhead rate includes
a provision for normal spoilage cost. Normal spoilage cost is spread, through overhead
allocation, over all jobs rather than allocated to a specific job.
Abnormal Spoilage: If the spoilage is abnormal, the net loss is charged to the loss from
abnormal spoilage account. Unlike normal spoilage costs, abnormal spoilage costs are not
included as a part of the cost of good units produced. Total cost of the 45 good units is
Br.90,000 (45 units  Br.2,000 per unit). Cost per good unit is Br.2,000 (Br.90,000  45 good
units).
Materials Control - spoiled goods (5  Br.600) 3,000
Loss from Abnormal Spoilage: (Br.10,000 - Br.3,000) 7,000
Work – in- process control (specific job): 5 units  Br.2,000 10,000
39
Job costing and Rework: Rework is units of production that are inspected, determined to be
unacceptable, repaired, and sold as acceptable finished goods. We again distinguish (1) normal
rework attributable to a specific job, (2) normal rework common to all jobs, and (3) abnormal
rework.
1. Normal Rework attributable to specific job: Consider the BOING Machine shop data in
illustration above; assume the five spoiled parts are reworked. The journal entry for the
Br.10,000 of total costs (the details of these costs are assumed) assigned to the five spoiled units
before considering rework costs is:
Work-in-Process Control (specific job) 10,000
Materials Control 4,000
Wages payable control 4,000
Manufacturing Overhead Allocated 2,000
2. Normal rework common to all jobs: When rework is normal and not attributable to a
specific job, the costs of rework are charged to manufacturing overhead and are spread, through
overhead allocation, over all jobs.
Manufacturing overhead control (rework costs) 10,000
Wage Payable Control 4,000
Manufacturing overhead allocated 2,000
3. Abnormal rework: If the rework is abnormal, it is recorded by charging abnormal rework to a
loss account.
Loss from Abnormal Rework 10,000
Wages Payable Control 4,000
Manufacturing Overhead Allocated 2,000
Accounting for rework in a process – costing system also requires abnormal rework to be
distinguished from normal rework. Process costing system accounts for abnormal rework in the
same way as job order costing. Accounting for normal rework follows the accounting described
for normal rework common to all jobs (units) because masses of identical or similar units are
being manufactured.
40
Accounting for Scrap: Scrap is residual material that results from manufacturing a product; it
has low total sales value compared with the total sales value of the product. No distinction is
made between normal and abnormal scrap because no cost is assigned to scrap. The only
distinction made is between scrap attributable to a specific job and scrap common to all jobs.
When should the value of scrap be recognized in the accounting records – at the time scrap is
produced or at the time scrap is sold? How should revenues from scrap be accounted for? To
illustrate this, we extend the case of BOING machine shop. Assume the manufacture of aircraft
parts generates scrap and that the scrap from a job has a net sales value of Br.900.
1. Recognizing Scrap at the Time of Its Sale

When the Birr amount of the scrap is immaterial, the simplest accounting is to record the
physical quantity of scrap returned to the storeroom and to regard scrap sales as a separate line
item in the income statement. In this case, the only journal entry is:
Sales of Scrap: Cash or Accounts Receivable 900
Scrap Revenues 900
When the Birr amount of scrap is material and the scrap is sold quickly after it is produced, the
accounting depends on whether the scrap is attributable to a specific job or is common to all jobs.
Scrap Attributable to a Specific Job: Job-costing systems sometimes trace scrap revenues to
the jobs that yielded the scrap. This method is used only when the tracing can be done in an
economically feasible way. For example, BOING Machine Shop and its customers may reach an
agreement that provides for charging specific jobs with all rework or spoilage costs and then
crediting these jobs with all scrap revenues that arise from the jobs. The journal entry is:
Scrap returned to storeroom: No journal entry.
Sale of scrap: Cash or Accounts Receivable 900
Work-in-Process Control 900
Unlike spoilage and rework, there is not cost assigned to the scrap, so no distinction is made
between normal and abnormal scrap. All scrap revenues, whatever the amount, are credited to
the specific job. Scrap revenues reduce the costs of the job. The journal entry for Scrap common
to all jobs is given as follows
Scrap returned to storeroom: No journal entry.
Sale of Scrap: Cash or accounts receivable 900
41
MOH control 900
2. Recognizing Scrap at the Time of its Production
Our Preceding illustrations assume that scrap returned to the storeroom is sold quickly, is not
assigned an inventory cost figure. Sometimes, as in the case with edges of molded plastic parts,
the value of scrap is not immaterial, and the time between storing it and selling reusing it can be
long. In these situations, the company assigns an inventory cost to scrap at a conservative
estimate of its net realizable value so that production costs and related scrap revenues are
recognized in the same accounting period. Some companies tend to delay sales scrap until its
market price is considered attractive. Volatile price fluctuations are typical for scrap metal. In
these cases, it’s not easy to determine some “reasonable inventory value.”
Scrap attributable to a specific job: The journal entry in the BOING example is:
Scrap retuned to storeroom: Materials Control 900
Work-in-process control 900
Scrap common to all jobs: The journal entry in this case is:
Scrap returned to storeroom: Materials Control 900
Manufacturing Overhead Control 900
Observe that the materials control account is debited in place of cash or account receivable.
When the scrap is sold, the journal entry is:
Sale of Scrap: Cash or Accounts Receivable 900
Materials Control 900
Scrap is sometimes reused as direct material rather than sold as scrap. In this case, materials
control is debited at its estimated net realizable value when the scrap is reused. For example, the
entries when the scrap is common to all jobs are:
Scrap returned to storeroom: Materials Control 900
Manufacturing overhead control 900
Reuse of scrap: Work-in-process control 900
Materials Control 900
Accounting for scrap under process costing is like the accounting under job costing when scrap
is common to all jobs. That is because; the scrap in process costing is common to the
manufacture of mass of identical or similar units.
42

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CHAPTER THREE

JOB ORDER COSTING SYSTEM AND PROCESS COSTING SYSTEM

1. Measuring Direct Materials Cost in Job Order Costing System:

Sample Materials Requisition Form:

Direct Materials Direct Labor Manufacturing Overhead

2. Measuring Direct Labor Cost under Job Order Costing System:

Time Ticket No. 843 Date March 3 ,2009

Started Ended Time Rate Amount Job Number

JOB COST SHEET

Direct Materials Direct Labor Manufacturing Overhead

Predetermined Overhead Rate = Estimated total MOH cost

Estimated total allocation base

Br. 320,000 / 40,000 = Br.8 per direct labor hour

Overhead applied to a particular job = POR × Amount of allocation base

= Br.8 per DLH × 27 DLHrs

Job Number 2B47 Date Initiated March 2 ,2009

Direct Materials Direct Labor Manufacturing Overhead

The job cost

The Flow of Documents in a Job Order Costing System

Accounting Procedures for Job order Costing System

1. The Purchase and Issue of Materials:

(3) Work in process 60,000

4. Manufacturing Overhead Costs:

Utilities (heat, water, and power) Br.21,000

The following entry records the incurrence of these costs:

(4c) Manufacturing overhead 18,000

5. Calculation of Predetermined Overhead Rate and Application of Manufacturing Overhead to

(5) Work in process 90,000

(6a) Salaries expense 30,000

(6c) Advertising expenses 42,000

7. Cost of Goods Manufactured (COGM):

8. Cost of Goods Sold (COGS):

(8a) Accounts receivable 225,000

(Br.158 × 750units = Br.118, 500)

The above journal entries can be summarized using T-account as follows

Prepaid Insurance Salaries and Wages Payable Retained Earnings

Finished Goods Advertising Expenses

2. Cost of Goods Sold:

Accounting for Under/Over-Applied MOH cost

Cost of goods sold XX

Accounts End balance Percentage

Process Costing System – Different Cases

Step 2: Compute Output in Terms of Equivalent Units (EU)

Work In process – Finishing 1,040,000

1. Weighted – Average Method and Spoilage

Loss from abnormal spoilage 6,000

1. Recognizing Scrap at the Time of Its Sale

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