Chapter 04 – Job Costing
Chapter 4
Job Costing
Learning Objectives
LO 4-1 Explain the types of costing systems.
LO 4-2 Explain the strategic role of product costing.
LO 4-3 Explain the flow of costs in a job costing system.
LO 4-4 Explain the application of factory overhead costs in a job costing system.
LO 4-5 Calculate underapplied and overapplied overhead and show how it is accounted for.
LO 4-6 Explain an operation costing system.
LO 4-7 Explain how to handle spoilage, rework, and scrap in a job costing system (appendix).
New in this Edition
New Real World Focus (RWF) item involving a new type of job shop production system
Four new or revised end-of-chapter problems
Teaching Suggestions
This chapter covers job costing, and has a unique presentationthe focus is on why a firm would
choose to use the job costing method. Rather than to present the procedural aspects only, there is a
discussion of why the method is used, and how the design of the cost system, and choice of a system such
as job costing fits the strategic objectives of the firm. The different costing methods are explained, and
there is a discussion of when and why each is used.
You should consider covering the chapter in two class meetings. In the first class, introduce
normal costing and overhead allocation and then go through a number of problems for practice. You may
also spend 10-15 minutes explaining which types of firms might use job costing while others would use
process costing. The focus is on the business purpose of the two methodshow the method fits the firm’s
operations. Consider including at least one example of a service firm. On the second day, go through the
issue of departmental versus plant wide overhead rates, and tie this into activity-based costing from
Chapter 5. You might want to cover activity-based costing following this chapter, and if so, we provide a
lead-in to ABC with this coverage of departmental rates.
On the second day you might also sometimes cover such issues as the effect of quarterly overhead
rates on pricing and profitability analysis. We find this discussion to be useful in pointing out to the
students how a seemingly reasonable approach (quarterly rates) can produce unexpected problems in
pricing and profitability analysis, especially when there is significant seasonality.
At the end of class consider brief coverage of how to dispose of the overapplied or underapplied
overhead at the end of the accounting period. We focus on the potential significant earnings effect, and go
through a simple case of variance proration.
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Chapter 04 – Job Costing
Assignment Matrix
End-of-Chapter Exercises & Problems Learning Objectives Text Features
X = included in Connect
1.
Explain the types of costing
systems
2.
Strategic role of job costing
3.
Flow of costs in a job costing
system
4.
Factory overhead rate
5.
Underapplied and overapplied
overhead
6.
Operation costing
7.
Explain spoilage, rework and
scrap
Strategy
Service
International
Ethics
Sustainability
Brief Exercises
4-17 4-17 – 05 min X
4-18 4-22 Moved X 10 min X X
4-19 4-19 X 10 min X
4-20 4-18 Moved X 05 min X
4-21 4-25 Moved X 10 min X
4-22 4-26 Revised X 10 min X
4-23 4-27 Revised – 10 min X
4-24 4-23 Moved – 05 min X
4-25 4-28 Moved – 05 min X
4-26 4-20 Moved X 10 min X
4-27 4-21 Moved X 10 min X
4-28 4-24 Moved 05 min X
Exercises
4-29 4-29 – 30 min. X X X X
4-30 4-30 – 30 min. X X X X
4-31 4-31 X 20 min. X X X
4-32 4-32 X 20 min. X X
4-33 4-33 X 30 min. X X
4-34 4-34 X 20 min. X X X X
4-35 4-35 X 20 min. X X
4-36 4-36 X 20 min. X X
4-37 4-37 X 15 min. X X X X
4-38 4-38 X 20 min. X
Problems
4-39 4-39 – 25 min. X X
4-40 4-40 – 30 min. X X X X
4-41 4-41 Revised – 30 min. X X X
4-42 4-42 – 25 min. X X X
4-43 Deleted – 40 min. X X X
4-43 4-47 Moved – 40 min. X X X
Continued on next page …
Chapter 4 assignment matrix continued
End-of-Chapter Exercises & Problems Learning Objectives Text Features
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Chapter 04 – Job Costing
1.
Explain the types of costing
systems
2.
Strategic role of job costing
3.
Flow of costs in a job costing
system
4.
Factory overhead rate
5.
Underapplied and overapplied
overhead
6.
Operation costing
7.
Explain spoilage, rework and
scrap
Strategy
Service
International
Ethics
Sustainability
4-44 4-44 – 20 min. X X X
4-45 4-45 – 20 min. X X X
4-46 4-46 Revised – 40 min. X X X
4-47 Moved to 4-43 –
4-47 4-48 Revised – 15 min. X X X
4-48 4-49 – 40 min. X X
4-49 4-50 – 40 min. X X X
4-50 4-51 – 20 min. X X
4-51 4-52 – 30 min. X
4-52 4-53 – 20 min. X
Lecture Notes
A. Product costing is the process of accumulating, classifying, and assigning direct materials, direct
labor, and factory overhead costs to products or services. Product costing provides useful cost information
for both manufacturing and nonmanufacturing firms for the purposes of: (1) product and service cost
determination and inventory measurement, (2) management planning, cost control, and performance
evaluation, and (3) strategic and operational decision-making.
Many strategic and operational decisions managers must make are based primarily on
information about the cost of products or services. These decisions include:
1. Determination of product or service pricing.
What is the minimum rate a gas company must charge residential users in order to cover its costs?
How should a restaurant price its menu in order to cover costs?
2. Assessment of the financial effect of adding or deleting a product, division, or subsidiary.
Should an automobile manufacturer add an off-road vehicle to its product line? Should a department
store close its sporting goods section?
3. Make or buy decision.
Should a medical clinic do its own blood tests or purchase services from an outside laboratory?
Should a toy manufacturing company make or buy some of the plastic components?
4. Evaluation of product, service, or division performance.
What was last month’s “printer product line” profit for a computer peripheral manufacturer?
What profit was made last year in the “deluxe fishing boat product line” of a boat manufacturer?
B. Cost system design/selection guidelines. Several different types of product costing systems are
available and can be classified by: (1) cost accumulation method — job or processing costing systems; (2)
cost measurement method — actual, normal, or standard costing systems; (3) overhead assignment method
— traditional or activity-based costing systems.
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Chapter 04 – Job Costing
The choice of a particular system depends on (1) the nature of the industry and the product or service,
(2) the firm’s strategy and its management information needs, and (3) the costs and benefits of acquiring,
designing, modifying, and operating a particular system.
C. The strategic role of job costing. Job costing systems provide information for managers to make
strategic decisions regarding choice of products and customers, manufacturing methods, pricing
decisions, and other long term issues.
D. Job versus process costing systems. Job costing is a product costing system that accumulates
and assigns costs to a specific job. It is typically used by firms having a wide variety of products or
services such as printing shops, shipbuilders, custom furniture-manufacturing plants, contractors, film-
producing companies, accounting firms, law firms, advertising agencies, consulting firms, medical
clinics, construction companies, and engineering firms.
Process costing accumulates product or service costs by process or department and then assigns them
to a large number of nearly identical product units. It is used by firms continuously mass producing one
or a few homogeneous products or services such as chemical plants, food processors, household appliance
manufacturers, textile companies, petroleum product manufacturers, paper, lumber and pulp mills, glass
factories, bakeries, cement factories, and sugar factories.
E. Actual, Normal, and Standard Costing and the use of a predetermined overhead rate.
For most manufacturers, actual factory overhead costs are not always readily available at the end of a
production process or period, nor can they easily be traced to individual products. These conditions limit
the use of a costing system based purely on actual costs. In practice, many firms adopt a normal costing,
which uses actual costs for direct materials and direct labor and applies factory overhead to various jobs
using a predetermined basis.
Predetermined factory overhead rate is an estimated factory overhead rate used to apply factory
overhead cost to a specific job. The amount of overhead assigned to a specific job using a predetermined
factory overhead rate is called the factory overhead applied.
The determination of a predetermined overhead rate has four steps:
1. Determine the budgeted factory overhead costs for an appropriate operating period, usually a year.
2. Select the most appropriate cost driver(s) for charging the factory overhead costs.
3. Estimate the total amount or activity level of the chosen cost driver(s) for the operating period.
4. Divide the budgeted factory overhead costs by the estimated activity level of the chosen cost
driver(s) to obtain the predetermined overhead rate(s).
Standard costing is an extension of the idea behind using a predetermined overhead rate that also is used
for material and labor costs.
F. Flow of costs. Job costing uses several general ledger accounts to control the product cost flows.
Direct materials costs are debited to the Materials Inventory account at purchase time, and debited to the
Working-in-Process Inventory account when materials are requested to production. Direct labor costs are
debited to the Work-in-Process Inventory account when they are incurred. Actual factory overhead costs
are debited to the Factory Overhead account when they are incurred. Factory overhead applied using the
predetermined factory overhead rate in normal costing is debited to the Work-in-Process Inventory
account and credited to the Factory Overhead Applied account. When a job is complete, the cost of goods
manufactured is transferred from the Work-in-Process Inventory account to the Finished Goods Inventory
account.
G. Plantwide, departmental and multiple cost driver rates.
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Chapter 04 – Job Costing
1. A plant-wide overhead rate is a single overhead rate used throughout the entire production facility. It
is computed by dividing total plant factory overhead by an activity base or cost driver that is common to
all jobs worked in all departments.
2. A departmental overhead rate is an overhead rate calculated for a single production department. It is
computed by dividing total budgeted departmental factory overhead by the budgeted level of a cost driver
that is common to all jobs worked or processed by the department. Only products that flow through a
department get applied overhead from the department.
3. A plant-wide rate is appropriate when all products pass through the same processes, or all departments
are similar. Departmental rates are appropriate when the converse is true.
4. In some production processes, the relationship between factory overhead costs and various cost drivers
differs substantially among production departments. Then multiple overhead rates with multiple cost
drivers, both volume-based and nonvolume-based cost drivers based on activity consumption should be
used.
H. Disposition of underapplied and overapplied overhead. Use of a predetermined overhead
rate can result in the actual overhead not being exactly equal to the amount of overhead applied,
resulting in over or under applied overhead. Underapplied or overapplied overhead can be disposed
the Cost of Goods Sold accounts.
If the amount of underapplied or overapplied overhead is not a material amount, the under- or over-
applied overhead is generally treated as a period cost and adjusted to the cost of goods sold. On the other
hand, if the amount is significant, proration often is performed.
I. Potential Errors in Overhead Application
The application of overhead is a critical step in costing, and since it is based on estimates, it is subject to
potential errors in determining the cost of a product or service. There are three types of potential errors:
1. Aggregation error. This costing error arises when, for example, a single plantwide rate is used instead
of departmental rates. The departmental rates are more accurate when the departments differ significantly
in the amount of cost or the amount of the cost drivers.
2. Specification error. This error arises when the wrong cost driver is used in the application rate. For
3. Measurement error. This is a common type of error that arises when the amounts used for estimated
overhead or estimated cost drivers are incorrect.
The management accountant uses care in developing a cost system that minimizes these potential errors;
the management accountant also tries to balance the cost of improving the cost system for more accuracy
versus the benefits of the improved accuracy.
J. Job costing for service industries. Job costing is used extensively in service industries such as
advertising agencies, banks, construction companies, hospitals, and repair shops, as well as in consulting,
architecture, accounting, and law firms.
K. Operation costing. Operation costing is a hybrid costing system that uses job costing to assign
direct materials costs, and process costing to assign conversion costs to products or services.
Operation costing is used in manufacturing operations where the conversion activities are very similar
across high-volume production of several product lines, but the direct materials used in the various
products differ significantly. Operations or departments accumulate direct labor and factory overhead
conversion costs, and process costing methods are used to assign these costs to products or services.
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Chapter 04 – Job Costing
L. Spoilage, rework, and scrap. In today’s contemporary manufacturing environment, firms adopt
various quality improvement programs to reduce spoilage, scrap, and rework units. Spoilage denotes
unacceptable units that are discarded or sold for disposal value. Scrap is the part of the product that has
little or no value. Rework units are product units that are economically reworked into firsts and seconds
and sold in regular channels.
1. Spoilage. There are two types of spoilage: normal spoilage and abnormal spoilage. Normal
spoilage is what occurs under efficient operating conditions. It is uncontrollable in the short-term and is
considered a part of product cost. That is, the good units produced absorb lost unit costs. Abnormal
spoilage is the excess over the spoilage expected under efficient operating conditions, and is charged as a
loss to operations in the period detected.
There are two types of normal spoilage: (1) normal spoilage for a particular job, and (2) normal
spoilage common to all jobs because it related to production process in general. For the first type of
spoilage, the cost of a particular job will be reduced by the estimated disposal price of the spoiled goods
related to the job. For the second type of spoilage, the spoilage cost will be transferred out from the
particular job cost into the factory overhead control account and be spread across all jobs. Abnormal
spoilage is charged to the Loss from Abnormal Spoilage account.
2. Rework. Rework cost is charged to one of three accounts depending on its nature. Normal rework
due to a particular job is charged to the Work-in-Process Control of that a specific job. Normal rework
common to all jobs is charged to the Factory Overhead Control. Abnormal rework is charged to the Loss
from Abnormal Rework account.
3. Scrap. There are two types of scrap: (1) scrap due to a specific job, and (2) scrap common to all
jobs. The accounting for first type of scrap is to reduce the Work-in-Process Inventory account by the sale
price of the scrap, while the second type is to reduce the Factory Overhead account by the sale price of
the scrap.
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