Chapter 2:

JOB-ORDER COSTING
Lecture 3
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LEARNING OBJECTIVES

1 Compute a predetermined overhead rate

2 Apply overhead cost to jobs using a predetermined overhead rate

3 Compute the total cost and average cost per unit of a job

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to
4 record costs
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RECALL FROM PREVIOUS CHAPTER

Manufacturing costs consists of:

• Direct materials
• Direct labour
• Manufacturing overhead
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THE NEED FOR JOB-ORDER COSTING:

• Costs do not change from month to month (e.g., factory rent,
insurance and council fees) -> cannot be directly traced to any
particular product
• Many different products are produced each period
• E.g., A is a clothing factory, making different types of jeans
for men and women during a month.
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JOB-ORDER COSTING - AN OVERVIEW

In this charper, we use absorption costing to determine costs
=> All manufacturing costs (fixed and variable) are assigned to units of product
(fully absorb manufacturing costs)
In a job-order costing system
Costs are traced and allocated to jobs and then the costs of the job are divided by the
number of units in the job to arrive at an average cost per unit
• Jobs: A particular order of 1,000 boot-cut men’s blue denim jeans, style
number A312. -> A Job
A specific tour that includes international airfare, use of a bycicle, meals
and so on -> A job

The production activities necessary to complete the customized product are called a job.
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THE USE OF JOB-ORDER COSTING

• Large scale construction projects (Bechtel International),
commercial aircraft (Boeing) and air-line meals (LSG
SkyChefs)
• In service industries: hospitals, law firms, movie studios,
accounting firms, advertising agencies, and repair shop
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JOB-ORDER COSTING – DIRECT MATERIALS

A custom product is made, if that was one of the company’s standard products
-> A bill of materials will be established
• A bill of materials is a document that lists the type and quantity of each type of
direct material needed to complete a unit of product
Once, an agreement has been reached with the customer concerning the
quantities, prices and shipment date -> a production order is issued
The Production Department then prepares a materials requisition form
• The materials requisition form is a document that specifies the type and quantity
of materials to be drawn from the storeroom and identifies the job that will be
charged for the cost of the materials.
DIRECT MATERIALS 8

(CONT.)

Materials
Requisition
Form
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a production DIRECT MATERIALS

order (CONT.)

issued

A Job cost Accounting

deparment
sheet

A job cost sheet records the materials, labor, and manufacturing overhead costs charged to that job
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DIRECT MATERIALS
(CONT.)
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JOB-ORDER COSTING – DIRECT LABOR

Direct labor consists of labor charges:

Direct: Easily traced to a particular job
Indirect: Cannot be traced to a particular job (maintenance,
supervision, and cleanup) -> treated as part of
manufacturing overhead
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DIRECT LABOR
(CONT.)
Most company uses computerized systems to maintain employee
time tickets
A complete time ticket is an hour-by-hour summary of the
employee’s activities throughout the day
Employees scan 3-bar codes using the bar code reader to start
working
• 1st bar: Indicates a job being started
• 2nd bar: Employee’s identity
• 3rd bar: Unique bar code for the job itself
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DIRECT LABOR
(CONT.)

Employee
Time Ticket
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JOB-ORDER COSTING – MANUFACTURING

OVERHEAD – LO1
Assigning manufacturing overhead to a specific job meets difficulties
due to 3 reasons:
It’s an indirect cost
It consists of many different items (from grease used in machine to
annual salary of the production manager)
It has fixed costs (factory rent, insurance, depreciation)
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MANUFACTURING OVERHEAD
(CONT.)
Resolving difficulties
Use predetermined overhead rate (POR)
o Allocation is used to assign overhead costs to products
o Allocation is accomplished by selecting an allocation base that is common to all of
the company’s products and services
o Allocation base is a measure such as direct labor-hours (DLH) or machine-hours
(MH) that is used to assign overhead costs to products and services
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MANUFACTURING OVERHEAD
(CONT.)
Predetermined overhead rate (POR) is computed before the period begins using a four-
step process:

1 Estimate the total amount of the allocation base required for

next period’s estimated level of production

2
Estimate the total fixed manufacturing overhead cost for the
coming period and the variable manufacturing overhead
cost per unit of the allocation base
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MANUFACTURING OVERHEAD
(CONT.)

3 Use the cost formula below

Where,
: The estimated total manufacturing overhead cost
: The estimated total fixed manufacturing overhead cost
b:
X: The estimated total amount of the allocation base
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MANUFACTURING OVERHEAD
(CONT.)

4 Compute the POR.

Predetermined 𝑬𝒔𝒕𝒊𝒎𝒂𝒕𝒆𝒅 𝒕𝒐𝒕𝒂𝒍 𝒎𝒂𝒏𝒖𝒇𝒂𝒄𝒕𝒖𝒓𝒊𝒏𝒈 𝒐𝒗𝒆𝒓𝒉𝒆𝒂𝒅 𝒄𝒐𝒔𝒕

overhead rate (POR)= 𝑬𝒔𝒕𝒊𝒎𝒂𝒕𝒆𝒅 𝒕𝒐𝒕𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒕𝒉𝒆 𝒂𝒍𝒍𝒐𝒄𝒂𝒕𝒊𝒐𝒏 𝒃𝒂𝒔𝒆

Note: Total manufacturing overhead cost includes variable overhead costs that depend on the amount of the
allocation base -> Step 1 must be done first
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MANUFACTURING OVERHEAD – LO 2
(CONT.)
Overhead applied to a particular job = Predetermined overhead rate (POR) x Amount of
the allocation base incurred by the job
E.g., POR = $8 per direct labor-hour
Overhead applied to a particular job = POR x Actual direct labor-hourS charged to the
job
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MANUFACTURING OVERHEAD -
EXCERCISE
Company Yost Precision Machining
 The company estimated that 40,000 direct labor-hours would be required to support the
production planned for the year
 The company also estimated $220,000 of total fixed manufacturing overhead cost for the
coming year and $2.50 of variable manufacturing overhead cost per direct labor-hour
a) Calculate POR
b) 27 direct labor-hours (DLHs) were charged to Job 2B47, calculate the Overhead applied to
Job 2B47
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MANUFACTURING OVERHEAD –
EXERCISE (CONT.)
a)
• Step 1 Total amount of the allocation base (for next period) = 40,000 direct labor-hours
• Step 2 Total fixed and variable manufacturing overhead cost per unit of the allocation base (for the
coming period): Fixed amount = $220,000, Variable amount per unit = $2.50 per direct labor-hour
(DLH)
• Step 3
• Y = a + bX
= $220,000 + ($2.50 per direct labor-hour x 40,000 direct labor-hourS)
= $320,000
• Step 4
• POR = Estimated total manufacturing overhead cost/ Estimated total amount of the allocation base =
$320,000/40,000 direct labor-hours = $8 per direct labor-hour
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MANUFACTURING OVERHEAD –
EXERCISE (CONT.)
b)
Overhead applied to Job 2B47 = POR x Actual direct labor-hours charged to Job 2B47
= $8 per DLH x 27 DLHs
= $216 of overhead applied to Job 2B47
Note: This is not Actual amount of overhead caused by the job -> Actual overhead costs are
not asigned to jobs and it should be direct costs, not overhead
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THE NEED OF A PREDETERMINED RATE

Why not base the overhead rate on the actual total manufacturing overhead cost and the
actual total amount of the allocation base on a monthly, quarterly, or annual basis?
• An actual rate can produce fluctuations in the overhead rate
• E.g., the costs of heating and cooling a factory will be highest in the winter and summer months and
lowest in the spring and fall -> the overhead rate will go up in the winter and summer and down in the
spring and fall -> two identical jobs completed in different seasons would be assigned to different
manufacturing overhead costs
• If computed annually to reduce fluctuations (less-frequent basis) -> manufacturing overhead
assigned to a particular job would be known until the end of the year
• E.g., the cost of Job 2B47 would be unknown until the end of the year, even though the job will be
completed and shipped to the customers in March
=> Most companies use POR rather than actual overhead rates
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CHOICE OF AN ALLOCATION BASE FOR

OVERHEAD COST
A cost driver is a factor, such as machine-hours, beds occupied, computer time, or
flight-hours, that causes overhead costs
• if the base in POR does not “drive” overhead costs - > product costs will be
distorted
• E.g., direct labor-hours is used to allocate overhead, but in reality overhead has
little to do with direct labor-hours -> the products could be overcosted or
undercosted
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CHOICE OF AN ALLOCATION BASE FOR

OVERHEAD COST (CONT.)
• In the past, direct labor accounted for up to 60% of the cost
• Recently, the porpotions have been changed due to 2 reasons
• Sophisticated automated equipment has taken over functions used to be
performed by direct labor workers
• -> increase overhead while decreasing direct labor
• Products become more sophisticated and complex and are changed more
frequently -> increase the need for highly skilled indirect workers (Engineers)
=> Direct labor has decreased overtime
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CHOICE OF AN ALLOCATION BASE FOR

OVERHEAD COST – LO3 (CONT.)
 After having the totals for direct materials, direct labor and manufacturing overhead, these
amount will be transferred to Cost Summary section of the job cost sheet -> add up to the
total cost for the job
 The total product cost is then divided by the number of units to obtain the Unit product cost
-> used for valuing unsold units in the ending inventory and for determining cost of goods
sold
=> This is not the cost that would actually be incurred if another unit were produced
CHOICE OF AN ALLOCATION BASE FOR
27

OVERHEAD COST (CONT.)

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CONCEPT CHECK
1) Which of the following statements is false? (You may select more than one answer)
a) Absorption costing assigns fixed and variable manufacturing overhead costs to products
b) Job-order costing systems are used when companies produce many different types of products
c) A normal costing system assigns overhead costs to products by multiplying the actual overhead
rate by the actual amount of the allocation base
d) An unit product cost represents the additional cost that would be incurred if another unit were
produced
Þc and d
Þc: A predetermined overhead rate rather than an actual overhead rate is used in a normal costing
system
Þd: A unit product cost does not represent an incremental cost
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CONCEPT CHECK (CONT.)

2) Assume that a company’s total estimated fixed overhead cost for the coming year is
$100,000 and its estimated variable overhead cost is $3.00 per direct labor-hour. If the
company estimates that it will work 50,000 direct labor-hours in the coming year, what is
its predetermined overhead rate per direct labor-hour?
a) $2.00
b) $3.00
c) $4.00
d) $5.00
=> d. At an activity level of 50,000 direct labor-hours, Y= $100,000
+ ($3 per direct labor-hour x 50,000 direct labor-hours) = $250,000. POR = $250,000/ 50,000
= $5 per direct labor-hour
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DECISION POINT
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DECISION POINT (CONT.)

 JOB-ORDER COSTING –
32

THE FLOW OF COSTS – LO4

Manufacturing
Balance Income
costs
sheet statement
Unused Materials
Direct inventory
material

Unfinished Work in
Used Manufacturing process
Direct process inventory
labour
Finished Finished Sold Cost of
Manufacturing goods goods sold
overhead inventory

POR
 JOB-ORDER COSTING –
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THE FLOW OF COSTS (CONT.)

Income statement
Balance Sales revenue
sheet
less
Sold
Work in Finished Cost of goods sold
Materials
process goods
inventory
inventory inventory Equals
Gross profit
less
Period costs Selling and admin expenses

Equals Net profit

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SUMMARY
• Computed a predetermined overhead rate
• Applied overhead cost to jobs using a predetermined overhead rate
• Computed the total cost and average cost per unit of a job
• Understand the flow of costs in a job-order costing system and prepare appropriate journal
entries to record costs
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PRACTICE EXERCISES FOR NEXT

WEEK
• Exercises 2.1->2.3, 2.9, 2.10
• Extra exercises on LO1-LO4 content
• Pre reading work