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Chapter 4 – Job Costing
Chapter 4
Job Costing
Teaching Notes For Cases
4-1. Constructo Inc. (Under or Overapplied Overhead)
This case has the learning objectives of: (1) explaining when it is appropriate for a company to
use a job costing system, (2) calculating overhead applied to various jobs, (3) determining the total cost of
a finished job and the total cost of an unfinished job, (4) explaining the proper accounting treatment for
over- or underapplied overhead balances at the end of an accounting period.
1. A job costing system is appropriate in any environment where costs can be readily identified
with specific products, batches, contracts, or projects.
2. The only job remaining in Constructo's work-in-process inventory at May 31, 2001 is DRS114.
The dollar value of DRS114 can be calculated as follows:
DRS114 balance 4/30/01 $250,000
May additions:
Direct materials $124,000
Purchased parts 87,000
Direct labor 200,500
Factory overhead
(19,500 hours x $7.50*) 146 ,250 557 ,750
Work-in-process inventory
5/31/01 $807,750
======
* Factory overhead rate = $4,500,000 / 600,000 hours
= $7.50 per hour
3. The dollar value of the playpens remaining in Constructo's finished goods inventory at May 31,
2001 is $455,600 calculated as follows:
Playpen Units
Finished goods inventory 4/30/01 19,400
Units completed in May 15,000
Units available 34,000
Units shipped in May 21,000
Finished goods inventory 5/31/01 13,400
=====
Since Constructo uses the FIFO inventory method, all units remaining in finished goods
inventory were completed in May.
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Chapter 4 – Job Costing
Unit cost of playpens completed in May
Work-in-process inventory 4/30/01 $420,000
May additions:
Direct materials $ 3,000
Purchased parts 10,800
Direct labor 43,200
Factory overhead
(4,400 x $7.50) 33 ,000 90 ,000
Total cost $510,000
======
Unit cost = Total cost / Units completed
= $510,000 / 15,000
= $34 per unit
Value of finished goods inventory
= unit cost x quantity
= $34 x 13,400
= $455,600
4. If the amount of overapplied or underapplied overhead is not material nor the result of an error
in the overhead application rate, the amount is generally treated as a period cost and charged to the cost of
goods sold. If the amount is significant, the amount should be prorated over the relevant accounts, i.e.,
work in process inventory, finished goods inventory, and cost of goods sold.
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Chapter 4 – Job Costing
Case 4-2 East River Manufacturing (A) (Problems of a Traditional Job Costing System)
This case has the learning objectives of:
(1) Describe the major economic and competitive trends affecting the power-generation industry and its
suppliers throughout the eighties.
(2) Understand some of the strategic issues associated which an investment in computer- integrated
manufacturing offers.
(3) Study some of the unique characteristics of accounting systems in a contract environment.
(4) Examine the implications, which an investment in advanced manufacturing technology has for
accounting system design.
Source: 1997 IMA Cases from Management Accounting Practice, Volumes 10 and 11, Case 8.
Suggested Solutions And Important Points
1. Briefly summarize and contrast the competitive environment in the pre-1980 era with that of the late
eighties and early nineties.
The pre- I 980's competitive environment for steam generation equipment manufacturers was
typical for U.S. industry in general during the post-World War 11 era. A combination of factors
including lack of competition, pent-up demand, rising standards of living, and a population explosion
fed by the baby boom from 1946-1964 drove business demand to unprecedented levels for twenty-five
years after the war. The prime beneficiaries of this boom were the utility and PSI and its OEM
competitors met industrial process firms whose power generation needs. However, for a variety of
reasons -some economic, some technological, some regulatory, and some demographic - the long
expansionary period after WW Il came to an abrupt end by the late seventies.
The competitive structure and the economics of the power business were changing rapidly. Utilities
and process intensive industries experienced dramatic cost increases. OEM orders dried up and the
once-predictable growth in demand for power-generation equipment vanished almost overnight. What
evolved was a highly competitive market fueled by new players, including mature foreign suppliers
business. As explained in the case, the key factors of success for the replacement market were, for the
most part, quite different from those for the OEM market.
2. What are the problems that plant management has to resolve?
Plant management, together with marketing, product engineering, and process engineering, needs to
develop strategies to:
Reduce cost
Increase flexibility to produce small orders
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Chapter 4 – Job Costing
Prior to 1992, the Tube Shop's manufacturing process had high manpower requirements, high
in-process inventories, and high maintenance costs. East River and the other OEM manufacturers were
not structured to meet the demands of serving the replacement-parts market- short lead-times, diverse
tube designs, and competitive cost. Changes in the cost of generating power in the late seventies led to a
rapid shift in demand for power-generation equipment away from huge OEM contracts toward
low-volume, highly specialized repair and replacement business. The economics of production for repair
and replacement parts place a premium on cost-efficient flexibility and fast turnaround. Traditionally
operated plants targeting the OEM market were not configured to produce a low-volume order efficiently.
Another disadvantage was that these plants often lacked the manufacturing flexibility needed to meet
did so at considerable cost and disruption to production schedules.
Furthermore, productivity and product quality were suffering for several reasons. As product variety
increased, the workload was more complex and rework was more frequent. Also, relations among
management, first-line supervisors, and the union workforce were not on the best of terms, which
probably had a residual effect on product quality.
Whatever the solution, East River would continue to face heightened competition for a decreasing
number of orders. Survival was dependent upon their success at reducing cost, improving response time,
and making further inroads into the replacement-parts market.
3. What potential problems may occur between the as-sold cost estimates and the actual contract cost?
Part of the problem is endemic to the business. Cost estimators need to generate expedient bid
proposals. Under the "Proposal Front-end" system, product design engineers and cost estimators consult
historical data bases for information on previous orders - tube geometry, bill -of-materials, routings - to
develop a tube design scenario and estimate the tube's manufacturing and material cost. There may be
little or no passing of information to the contract stage if the proposal is accepted.
If the proposal becomes a contract, product design engineers create detailed product structures.
The as-sold estimates may differ from the actual engineering design in significant respects. The contract
cost accounting system had the capability to query the system to identify where engineered standards
differed from the base estimating dam used to develop the proposal.
There was also a problem with the information used to develop bids. Base estimating data used
first time. Age and wear and tear on the stud welders' controls had caused tolerances to loosen and
deteriorate over time, thereby causing more man-hours to manually reweld some spot welds off line.
4. Diagram the structure of the existing cost system and explain how cost information is used for
decision-making, cost control, and performance evaluation purposes.
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Chapter 4 – Job Costing
Cost estimators prepare ASEs based upon specifications supplied by the customer and from parts
and cost records of similar parts and assemblies on past contracts. However, once a quote was accepted, a
more detailed product design process began. (Design work was not necessary for replacement tubes on
PSI original equipment.) Design decisions affected materials composition, process routings, and
resources used. Design engineers did not feel obligated to stay with the original ASE specifications. Their
motivation was to design and build the best component/part for the situation.
However, the cost system provided no incentive for design engineers to consider the long-term
consequences of engineering so many unique parts. If there was a significant cost overrun on a project
and actual man-hours were running ahead of estimated hours, it could just as easily are due to differences
and graphics time was accumulated and charged directly to the contract. However, it is unusual to see
machine setup and material handling costs directly charged to a contract, component, or part as they are
under this system.
Nonetheless, the cost system was prone to some of the same cost distortions typical of cost
systems of this time period. Every project bore some of the costs of every resource - all shop
supervision, all direct overhead, all depreciation, all repair costs of every piece of equipment in the
Tube Shop. This system is a shotgun approach to contract and component costing. All resources were
charged to the contract through the man-hour rate, regardless of the actual resources used in processing
5. Is the labor-based cost system appropriate for this facility? Should activity-based costing be
implemented to analyze product costs?
There was some dissatisfaction with the cost system prior to implementation of the CIM line. The
overall cost competitiveness of the pre- 1992 manufacturing process was the main concern. For instance,
marketing was frequently dissatisfied because they often felt costs were too high to allow a competitive
price. Most of the dissatisfaction was directed at the overall level of costs assigned to a contract and not
with the cost system per se.
Since the primary cost object is the contract or project, then the adequacy of the cost system
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Chapter 4 – Job Costing
the product or the project than to get procedures for allocating costs to stages along the production
process." (Ingersoll Milling Machine Company, Teaching Note 5-188053, Harvard Business School
(1988): 5.) Given the number and size of OEM projects, it may not be important that individual loose
tubes be costed correctly so long as any distortions at the part level average out at the project level. If
that was the case, the labor-based system was probably adequate when the majority of the workload
related to 20 to 30 large OEM projects being processed at any given time.
Today, the majority of the Tube Shop's orders are for replacement parts. These typically consist
of orders ranging anywhere from a single tube to a batch of fifteen tubes to an entire replacement
component. Understanding costs at the part and component level takes on much more importance in the
current environment. Shop overhead, plant support services, and operating-all-works are assigned to
6. Prepare a set of recommendations for changes in the cost system. Describe a general framework for
costing products in an automated facility.
Whether the pre- 1992 labor focused cost system was adequate or not is no longer the issue. Given the
nature of the CIM system, clearly there is no longer much of a relationship between direct labor and
work performed by CNC machines. A new cost assignment process was needed to accommodate the
new production process. Since elements of the old manual line were still needed to process tubes, which
exceeded the machine constraints on the CIM line, the activities chosen to assign costs should relate to
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