Job Order and Process Costing Chapter 17 1

Learning Objectives Distinguish between job order costing and process costing Record materials and labor in a job order costing system Track overhead in a job order costing system 2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Learning Objectives Adjustment for under- or overallocated overhead Calculate unit costs for a service company Allocate costs using a process costing system—weighted-average method (see Appendix 17 A) 3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

1 Distinguish between job order costing and process costing 4 Copyright © 2012 Pearson

Cost Accounting Systems Help management determine: cost of goods sold cost of good sold for each product profitability of each business segment With that information the company can Prepare COGS and inventory valuations for the financial statements set selling prices that lead to profits cut or improve lagging product categories Companies track product costs using: Job order costing Process costing 5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order vs. Process Costing Job Order Costing For manufactured batches of unique products or specialized services Accounting firms Music studios Building contractors Health-care providers Accumulates cost per batch or job More prevalent with servicebased companies and with ERP systems 6 Process Costing For companies that produce identical units through a series of processes Coca-Cola Surfboards Medical equipment Used by large producers of similar goods Accumulates cost of each process needed to complete the product Assigns costs to products Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order vs. Process Costing Cost tracing is used to assign directly traceable costs Direct materials Direct labor Cost allocation Assigns indirect costs to the product Overhead costs Less precise technique 7 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Would the following companies use job order costing or process costing? a. A manufacturer of luxury yachts _________ Job order costing b. A law firm _________ Job order costing c. A non-dairy whipped toping maker _________ Process costing d. A custom home builder _________ Job order costing e. A soft drink producer _________ Process costing f. A saddle manufacture _________ It depends 8 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2 Record materials and labor in a job order costing system Emphasis: tracking each

Purchasing Materials Debit asset Materials inventory Subsidiary ledgers Ø Direct, indirect Ø Individual sku records Materials inventory 5, 000 Direct Materials inventory 3, 000 Indirect Materials Inventory 2, 000 10 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Using Materials Direct materials debited to Work in process Indirect materials debited to Manufacturing overhead Materials inventory 5, 000 140 110 Work in process DM 140 Manufacturing overhead 110 11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Materials Requisition Used to request the transfer of materials to Work in process Assigns the cost of the direct material to a job (Job 16) Shows the company cost of the material requested 12 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Cost Record 13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Labor Debit Work in process inventory (for direct labor) Debit Manufacturing overhead (for indirect labor) Credit Wages payable (or cash) in both cases Wages payable 200 12, 000 Work in process DM 140 DL 200 Manufacturing overhead 12, 000 14 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Cost Record with Labor Added 15 Copyright © 2012 Pearson Education, Inc. Publishing

Rite Packs manufactures backpacks. Its plant records include the following transactions: Purchases of canvas (on account). . . . . Materials requisitions: Canvas for job # 119. . . . Sewing machine oil, needles, thread, and bobbins. . . Labor costs recorded for job #119……………. . Shop Supervisor salary recorded, payable 1 st of next month $71, 000 64, 000 950 1, 300 3, 500 1. Journalize the entries to record these transactions. 2. Post these transactions to the appropriate accounts. 3. If the company had $34, 000 of Materials inventory at the beginning of the period, what is the ending balance of Materials inventory? 16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Track overhead in a job order costing system 17 Copyright © 2012 Pearson

Account for using Manufacturing Overhead 18 Copyright © 2012 Pearson Education, Inc. Publishing as

MOH Application: Predetermined overhead rates MOH is applied to individual jobs using Predetermined overhead rates (POHR). What are these? Why do we use them? How do you do it? When do we use them? Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

What is a predetermined overhead rate? A rate designed to apply expected overhead spending to production jobs according to their use of a specified input. How much overhead do we expect to use? $500, 000 What inputs cause us to use those MOH resources? Labor, Materials, machine use, or… Let’s apply overhead costs to jobs based on their use of the selected input. The tool that let’s us do this is the predetermined overhead rate (POHR) Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Why use a predetermined manufacturing overhead rate? Ø We do not know precisely how many overhead resources each product or job uses. Ø Actual overhead used during the period is not known until spending stops @ end of period. Ø POHR’s apply it to the product NOW. Ø So, you can know right away if you are making, or losing, money on a particular job. $ Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order Costing System: Costing Specific Jobs WIP Direct Materials Job No. 1 Direct Labor Manufacturing Overhead Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as resources are used. $12, 000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order Costing System: Manufacturing Overhead Application WIP Direct Materials Job No. 1 Direct Labor Manufacturing Overhead $12, 000 Job No. 2 Job No. 3 Option: Apply MOH equally to each product. $4, 000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order Costing System: Manufacturing Overhead Application WIP Direct Materials Job No. 1 Direct Labor Manufacturing Overhead $12, 000 Job No. 2 Job No. 3 Option: Apply MOH to each job based on MOH caused by the job. $2, 000 $4, 000 $6, 000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Assigning Manufacturing Overhead to Jobs Step 1 – Calculate overhead allocation rate Step 2 – The application rate is multiplied by the actual quantity of allocation base used on the job If the rate is based on direct labor hours Rate is multiplied by the direct labor hours used on each job Predetermined overhead rate (from Step 1) 25 x Actual quantity of the overhead allocation base used by each job Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Assigning Manufacturing Overhead Debit Work in process inventory (for direct labor) Debit Manufacturing overhead (for indirect labor) Credit Wages payable (or cash) in both cases Wages payable 200 12, 000 Manufacturing overhead 12, 000 80 26 Work in process DM 140 DL 200 MOH 80 Budgeted MOH=$68, 000 Budgeted DL=$170, 000 Let’s do it Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Manufacturing Overhead on Job Cost Record 27 Copyright © 2012 Pearson Education, Inc. Publishing

Calculate POHR Bob Co. Expects to expend $100, 000 in manufacturing overhead. They plan to use 20, 000 direct labor hours and feel that labor is closely linked to overhead use. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Calculate POHR Bob Co. Expects to expend $100, 000 in manufacturing overhead. They plan to use 20, 000 direct labor hours and feel that labor is closely linked to overhead use. POHR = $100, 000 Total Manufacturing overhead 20, 000 Direct Labor hours POHR = $5. 0 per Direct Labor Hour For each Direct Labor hour used by a job, $5. 00 of factory overhead will be applied (added) to the cost of that job. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Exercise: Deep Thoughts What just happened to the cost of labor when we added $5. 00 per hour to it? Would this have any effect on questions of how management should use labor versus other resources? Hint: Assume you are the product manager and you are measured on profitability of your product line. When is labor a good choice or a bad choice to apply overhead? Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Assignment of Overhead to Jobs This process is not perfect. We debit MOH when we incur costs. We credit MOH to assign costs based estimates At the end of the period, when a balance exists If allocated amount is less than actual overhead— underallocated If allocated amount is more than actual overhead— overallocated 31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

4 Adjustment for under- or overallocated overhead 32 Copyright © 2012 Pearson Education, Inc.

Overapplied and Underapplied Manufacturing Overhead $5, 400 may be allocated $5, 400 may be to these accounts based on closed directly to weighted $ average cost of goods sold. in each account. OR Work in Process Finished Goods Cost of Goods Sold 33 Cost of Goods Sold Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Identifying over/under allocation of MOH and closing to COGS S 17 -6 On the

5 Calculate unit costs for a service company 35 Copyright © 2012 Pearson Education,

Service Companies: Direct Labor Have no inventories, no WIP account Take an average hourly employee rate, and multiply times hours tracked for a given job. Hourly rate to the employer x Total expected direct labor costs Expected use Direct labor hours How do service firms trace direct labor to individual jobs? STEP 1: Compute the average hourly rate STEP 2: Allocate Direct labor costs to jobs by multiplying the hourly rate (Step 1) by the actual number of direct labor hours used by each job 36 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Service Companies: Indirect costs Have no inventories, so all costs are period costs For planning purposes, may treat all indirect costs similar to MOH in a manufacturing company. Predetermined indirect cost allocation rate x Total expected indirect costs Expected use of allocation base Tracing indirect costs to service jobs: STEP 1: Compute the predetermined indirect cost allocation rate STEP 2: Allocate indirect costs to jobs by multiplying the predetermined indirect cost allocation rate (Step 1) by the actual quantity of the allocation base used by each job 37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Roth Accounting pays Jaclyn Sawyer $104, 400 per year. Sawyer works 1, 800 hours per year. 1. What is the hourly cost of Sawyer’s work to Roth? $104, 400÷ 1, 800 = $58 2. What direct labor cost would be traced to client 507 if Sawyer works 12 hours to prepare client 507’s financial statements? $58 x 12 = $696 In total, Roth’s budgets 8, 000 direct labor hours. Roth’s estimated total indirect costs are $240, 000 1. What is Roth’s indirect cost allocation rate? $240, 000÷ 8, 000 = $30 2. How much indirect costs will be allocated to client 507? $30 x 12 hours = $360 3. Calculate the total cost of job 507. 38 $696 + $360 = $1, 056 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Manufacturing cost flow review First an easy demonstration recap Moves faster if you help! Then, a group activity to plan production output and track production costs in a business simulation 39 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Product Cost flow transactions for P 17 -27 A T accounts on the board Note key points and their place in the cost of goods manufactured and cost of goods sold schedule. 40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Fly? : Airplane accounting Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Budgeting for Production Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Reporting Actual Performance Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Instructor Notes First round: buy fewer plans than built Plan for selling 4 planes each Encourage buying to build Customer buys 3 out of 4 planes Outcomes Overbuild: obsolescence, carrying costs Under build: Lost sales, lost market share Supplier shortfall: Broken promises How do producers build this uncertainty into their forecasting models? Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

6 Allocate costs using a process costing system— weighted-average method (see Appendix 17 A)

Process Costing Used where large quantities of similar products are produced Costs accumulated in each manufacturing process Company then assigns these costs to products passing through that process Even costs assigned to each product Sum of the costs applied to units produced to determine costs per unit 46 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Job Order Costing 47 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Process Costing 48 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Process Costing: Building Blocks Two cost categories: Direct materials Conversion costs Direct labor and manufacturing overhead combined Costs incurred to convert materials into finished products Equivalent units Allow measurement of partially finished goods Express production in terms of fully completed units Materials may have different percentage completed than conversion costs 49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Steps of Process Costing Summarize the flow of physical units Compute output in equivalent units Compute the cost per equivalent unit Assign costs to completed and ending inventory units 50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

P 17 A-10: Process Costing Example Approximates the total number of units made. Output + Units impacted by cost incurrences caused by these factors ending balance qty. . 51 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

P 17 A-10: Process Costing Example Calculates a per unit cost, based on processes completed and costs incurred Cool Spring Cost incurrence type to be assigned Cost per Equivalent Unit - Bottling Department Month Ended February 28, 2013 Transferred In Step 3: Cost per Equivalent Unit Costs: Beginning work in process, Conversion Costs Total Costs $ 1, 700 $ 0 $ 1, 030 a $ 2, 730 Costs added during February 134, 800 30, 400 49, 400 b 214, 600 Total costs to account for $136, 500 $30, 400 $50, 430 $217, 330 Total equivalent units ÷ 175, 000 ÷ 152, 000 ÷ 168, 100 Cost per equivalent unit $ 0. 78 $ 0. 20 $ 0. 30 $ 1. 28 January 31 52 Direct Materials Tallies expenditures & divides by units incurring costs in each Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. bucket

P 17 A-10: Process Costing Example Finalizes Output & WIP balance costs. 53 Cost elements of output & WIP balance Output and ending WIP summary. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 17 Summary A job order costing system accumulates costs for each individual batch, or job. Process costing accumulates costs for each individual process needed to complete the product. Direct materials and direct labor associated with a specific job are tracked to a job costing record based on a job number. When direct materials costs are incurred for a job, Work in process inventory is debited and Materials inventory is credited. 60 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 17 Summary When direct labor costs are incurred on a job, Work in process inventory is debited and Wages payable is credited. Indirect materials and indirect labor utilized are debited to the Manufacturing overhead account to be allocated to jobs later. Manufacturing overhead is allocated to jobs based on a predetermined manufacturing overhead rate. The rate should be based on the main cost driver—that is, the item that drives manufacturing overhead costs up or down. 61 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 17 Summary Once the predetermined manufacturing overhead rate is determined, manufacturing overhead is allocated (assigned) to jobs based on this rate. At the end of the period, the balance in manufacturing overhead will be the difference between actual costs (debits) and costs allocated to jobs (credits). The total actual manufacturing overhead costs (debits) rarely equal the total manufacturing overhead costs allocated to jobs (credits). 62 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 17 Summary At the end of the period, we must adjust the under-allocated or overallocated Manufacturing overhead account balance. Closing the Manufacturing overhead account means zeroing it out. The balance is closed out to Cost of goods sold. Service firms must also allocate overhead to jobs to determine each job’s real cost. Just like with manufacturing firms, a predetermined indirect cost allocation rate must be determined. The rate is then used to allocate overhead costs to service jobs. 63 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Summary of the Appendix As we saw earlier in this chapter, accountants prepare cost reports to help production managers evaluate the efficiency of their manufacturing operations. Both job order and process costing are similar in that they: accumulate costs as the product moves through production. assign costs to the units (such as gallons of gasoline or number of crayons) passing through that process. 64 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Summary of the Appendix The difference between job order costing and process costing lies in the way costs are accumulated. Job order costing uses a job cost sheet and process costing uses a production cost report. 65 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

66 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. 67 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.