1

MANAGEMENT ACCOUNTING AND CONTROL

(MNAC)

Session 9

Job Costing

Chapter 4 of Prescribed Text-Book : Horngren

 Flow of Costs in Job Costing
Flow of Cost in Job Costing

Sales Profit or Loss Cost of Sales

 Contrasting Actual Costing

• All product or inventoriable costs are

accumulated in the work-in-process control
account.
– Direct materials used
– Direct labor incurred
– Factory overhead allocated (or applied)
• Actual indirect costs (overhead) are
accumulated in the manufacturing overhead
control account.
 Accounting for Overhead

Two different overhead accounts used :

Manufacturing overhead control was debited for

the actual overhead costs incurred.
Manufacturing overhead allocated was credited
for estimated (budgeted) overhead applied to
production through the work-in-process account.
 Accounting for Overhead

Actual costs will almost never equal budgeted costs.

Accordingly, an imbalance situation exists between the

two overhead accounts.

If Overhead Control > Overhead Allocated, this is

called UNDERALLOCATED overhead
If Overhead Control < Overhead Allocated, this is
called OVERALLOCATED overhead.
 Accounting for Overhead

The difference between the overhead accounts will

be eliminated in the end-of-period adjusting entry
process, using one of three possible methods.

1. Adjusted allocation rate approach

2. Proration approach
3. Write-off approach
1. Adjusted allocation rate approach

Adjusted allocation rate approach – all allocations are

recalculated with the actual, exact allocation rate.
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.
Finally, end of the year every job-cost record and finished
goods record as well as WIP control, FGs control and
COGs accounts represent the actual manufacturing
overhead costs incurred.
 Adjusted allocation rate approach

Example : Manufacturing firm

Actual manufacturing overhead : Rs. 1,21,50,000
Manufacturing overhead allocated : Rs. 1,08,00,000
Difference = 1,21,50,000 -1,08,00,000 = 13,50,000
(under-allocated)

Difference = (1,21,50,000 -1,08,00,000)/1,08,00,000

= 12.5%

At the end of the year firm could increase the manufacturing

overhead allocated to each job by 12.5%.
 Adjusted allocation rate approach
Example : Job WPP 298

Under normal costing, the manufacturing overhead allocated to this job was
Rs. 35,200 (budgeted rate of Rs. 400 per direct manufacturing labor-hours* 88
hours).
Increasing the manufacturing overhead allocated by 12.5% (35200*12.5% = Rs.
4400) means the adjusted amount of manufacturing overhead allocated to Job
WPP 298 equals Rs. 39,600 (Rs. 35,200 + Rs. 4400).
Making this adjustment under normal costing for each job ensures that all Rs.
1,21,50,000 of manufacturing overhead is allocated to jobs.
Each individual job-cost record are adjusted to actual costs at the end of the year.
The Adjusted allocation rate approach yields the benefits of both the timeliness
and convenience of normal costing during the year and the allocation of actual
manufacturing overhead costs at year end.
Knowing the actual profitability of individual jobs after they are completed
provides managers with accurate and useful insights for future decisions about
which jobs to undertake, how to price them and how to manage their costs.
 2. Proration approach

Proration approach – spreads the under-allocated or

overallocated overhead between cost of goods sold, work-
in-process, and finished goods based on their relative sizes.
Example : How should firm prorate the under-allocated Rs
13,50,000 of manufacturing O/H at the end of the year?
Data :
Actual manufacturing overhead : Rs. 1,21,50,000
Manufacturing overhead allocated : Rs. 1,08,00,000
Difference = 1,21,50,000 -1,08,00,000 = 13,50,000 (under-
allocated)
 2. Proration approach

Firm prorates the under-allocated amounts on the basis of the total

amount of manufacturing O/H allocated in the year (before proration) in
the ending balances of WIP control, FGs control and COGs.
Result is the ending balance after proration at actual costs (last column
in the next slide)

If the manufacturing O/H is overallocated, it would be decrease the balances

of WIP control, FGs control and COGs.
 2. Proration approach

The increase in COGs expense by Rs. 12,90,600 as a result of proration causes firm’s
reported Op. Income to decrease by the same amount.
 2. Proration approach
Some companies uses the proration approach but base it on the ending
balances of WIP control, FGs control and COGs prior to proration.
Ending account balances are not the same as the more accurate proration
calculated earlier because the proportions of manufacturing overhead costs
to total costs in these accounts is not the same.
 3. Write-off to COGS approach

Write-off approach – the difference (under-allocated

or overallocated manufacturing overhead) is simply
written-off to cost of goods sold.
Example : Firm’s two Manufacturing overhead control
and Manufacturing overhead allocated – are closed
with the difference by writing off to COGs.

COGS after the write-off = 2,37,50,000 + 13,50,000 = Rs. 2,51,00,000

This results in decrease in Op. Income by Rs. 13,50,000
 Choosing Among Approaches

When management is deciding among approaches,

they should consider the following:
1. The purpose of the adjustment
2. The total amount of under-allocation or overallocation
3. Whether the variance was over- or under-allocated

The choice of method should be based on such

issues as materiality, consistency, and industry
practice.
Choosing Among Approaches
 Choosing Among Approaches
The method managers choose affect the operating income a
company reports.
In case of under-allocated overhead – the method of writing-off to
COGs result in lower Op. income compared to proration method.
In case of over-allocated overhead – the proration method result in
lower Op. income compared to writing-off to COGs.

Do managers prefer to report lower or higher operating income?

 Reporting lower operating income lowers the company’s taxes,
saving the company cash and increasing the company value.
 Managers are often compensated based on Op. income and so
they favor reporting higher operating income even if it results in
higher taxes. Compensation plans should include metrics such
as after-tax cash flow in addition to operating income.
 Practice Questions:

4.18; 4.21; 4.23; 4.24 & 4.26