Chapter 07 – Job Costing
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Chapter 7
Job Costing
Learning Objectives
1. Explain what job and job shop mean.
2. Assign costs in a job cost system.
3. Account for overhead using predetermined rates.
4. Apply job costing methods in service organizations.
5. Understand the ethical issues in job costing.
6. Describe the difference between jobs and projects.
Chapter Outline
I. DEFINING A JOB
II. USING ACCOUNTING RECORDS IN A JOB SHOP
III. COMPUTING THE COST OF A JOB
A. Production process at InShape
B. Records of costs at InShape
1. Inventory accounts
2. Direct materials
3. Direct labor
4. Manufacturing overhead
C. How manufacturing overhead costs are recorded at InShape
1. Predetermined rate
2. Application of manufacturing costs to jobs
D. The job cost sheet
E. Over- and underapplied overhead
1. An alternative method of recording and applying manufacturing
overhead
2. Writing off over- or underapplied overhead
3. Allocating over- or underapplied overhead
4. Using normal, actual, and standard costing
5. Choosing between actual and normal costing
F. Multiple allocation bases: The two-stage approach
G. Summary of steps in a job costing system
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IV. USING JOB COSTING IN SERVICE ORGANIZATIONS
V. ETHICAL ISSUES AND JOB COSTING
A. Misstating stage of completion
B. Charging costs to the wrong jobs
C. Misrepresenting the cost of jobs
VI. MANAGING PROJECTS
VII. SUMMARY
Key Concepts
LO 7-1 Explain what job and job shop mean.
♦ The main difference among costing systems is in the level at which costs are aggregated before
they are assigned to the individual units of product.
♦ A job is a cost object (product, service, customer, etc.) that can be distinguished easily from
others and for which a cost is desired; a job shop is a firm that produces jobs.
• Jobs can be distinguished because
(1) they are unique in some way, and
(2) separate documents are kept that record the costs of the jobs.
• These job cost records are important because
(1) the firm wants to be able to estimate the costs on similar work in the future; and
(2) it is common in job shops that the price for the product or service is related to the cost
recorded for the job.
♦ The cost accounting system records and keeps track of the costs incurred by the firm for the job
in the form of a job cost sheet, which is a record of the cost of the job kept in the accounting
system.
• As shown in Exhibit 7.7, there are three basic sections to a job cost sheet. The top
section provides information about the job. The second section shows the costs as they
are recorded for the job. The third section summarizes the total costs for the job.
• The job cost sheet is a subsidiary ledger account that provides the detail for the work-
in-process account, which is a control account.
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• A subsidiary ledger account records financial transactions for a specific customer,
vendor, or job. A control account is an account in the general ledger that summarizes a
set of subsidiary ledger accounts.
Example 1: A job shop is working on two jobs from scratch: Job #101 and Job #102.
These are the only current jobs. Job #101 uses $1,000 of direct materials, $800 of
direct labor and $960 of overhead; Job #102 uses $2,000 of direct materials, $600 of
direct labor and $720 of overhead.
The following T-accounts show how the subsidiary ledger accounts (job cost sheets)
are related to the control account (work-in-process inventory). The control total
represents the sum from all the jobs together.
Job #101
Job #102
DM 2,000
DL 600
OH 720
3,320
Work-in-process Inventory
DM 3,000
DL 1,400
OH 1,680
6,080
LO 7-2 Assign costs in a job cost system.
♦ The basic idea of product costing in the cost accounting system is for the cost flows to follow
the physical flows of the resources that are combined to produce the final product or service.
♦ The production process in job shops (such as InShape) involves several steps:
(1) Assign a job number,
(2) Identify and secure the components (direct materials) that will be required for the job,
(3) Assemble the various components by employees (direct labor) using a variety of machines
and tools (manufacturing overhead),
(4) Move individual, completed items to the finished goods inventory,
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(5) Inspect all items in the order for completion and quality,
(6) Ship the order to the client, and
(7) Invoice the client once the order is accepted. The job is considered sold and sales revenue
recognized.
♦ There are three inventory accounts for a manufacturing firm:
(1) Direct materials inventory,
(2) Work-in-process inventory, and
(3) Finished goods inventory.
♦ Direct materials: All direct materials used in assembling jobs are generally received at the
materials inventory, and recorded in the Material Inventory account. This account also records
supplies and other materials that are not charged (debited) directly to jobs.
• The cost of each job is posted to the individual job cost sheets and summarized on the
work-in-process inventory account.
• Purchase of various materials for use in jobs on account:
Journal entry (1)
Materials inventory xx
Accounts payable xx
• Requisition of materials for different jobs:
Journal entry (2)
Work–in-process inventory xx
Materials inventory xx
• Exhibit 7.1 shows these cost flows through the T-accounts.
♦ Direct labor: Since there is no storage for direct labor, the labor cost is recorded in work-in-
process account as it is incurred. The accounting document used for this purpose is employee’s
time card, which can be a physical piece of paper the employee or supervisor fills in or a virtual
record updated in a computerized information system as the employee checks in and out and
enters the job numbers worked.
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• The time card includes fields for the job number and the start and end times. When
multiplied by the employee’s hourly pay (wages and benefits), the total represents the
direct labor cost for payroll purposes.
• The cost of each job is posted to the individual job cost sheets and summarized in the
work-in-process account.
• Direct labor cost incurred for different jobs:
Journal entry (3)
Work–in-process inventory xx
Wages payable xx
• Exhibit 7.2 shows the direct labor cost flows at InShape.
♦ Manufacturing overhead incurred: Manufacturing overhead costs are typically pooled together
into one account and allocated to individual jobs using a relatively arbitrary allocation base (for
example, number of machine hours or direct labor hours, see Chapter 6).
• Manufacturing overhead includes indirect materials, indirect labor, and other indirect
manufacturing costs such as utilities, rent, taxes, insurance, and depreciation associated
with the manufacturing facilities.
• Each department usually has its own manufacturing overhead control (or summary)
account so each department manger can be held accountable for departmental overhead
costs.
• Actual manufacturing overhead incurred during a period (debited to Manufacturing
overhead control account)
Journal entry (4) for indirect materials
Manufacturing overhead control xx
Materials inventory xx
Journal entry (5) for indirect labor
Manufacturing overhead control xx
Wages payable xx
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Journal entry (6) for other overhead costs
Manufacturing overhead control xx
Accounts payable xx
Prepaid expense xx
Accumulated depreciation xx
… xx
• Exhibit 7.3 shows cost flows through T-account for manufacturing overhead.
LO 7-3 Account for overhead using predetermined rates.
♦ Applied manufacturing overhead: By its very nature, the use of manufacturing overhead in the
production process will not trigger a journal entry as no “transaction” occurs. Instead, the
assignment of manufacturing overhead to jobs is periodically done on the job cost sheet when
(1) financial statements are being prepared for which work-in-process inventory needs to be
assessed, or
(2) a job is completed and its costs need to be recorded.
• The predetermined overhead rate is used for the assignment of overhead costs to jobs.
The overhead rate is computed in advance (usually at the beginning of the year, therefore
predetermined) so that jobs can be costed as they are completed.
• To calculate the predetermined overhead rate, annual estimated manufacturing overhead
is used to prevent random factors affecting the overhead charged to jobs.
• The predetermined overhead rate is simply the estimated manufacturing overhead for
the coming year divided by the estimated activity of the allocation base for the year.
• When direct labor cost is adopted as the allocation base, the formula becomes
Predetermined overhead rate =
Estimated manufacturing overhead
Estimated direct labor cost
.
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Example 2: A firework manufacturer operates only four months out of a year, May,
June (for July 4th event), November, and December (for New Year celebration). On
average, direct materials and direct labor cost $5 and $8 per unit, respectively. For
simplicity, the company uses units of output as the allocation base for overhead items.
The following table shows the relevant data for a typical year.
May
June
November
December
Total
Units of output
2,000
1,000
2,000
3,000
8,000
Overhead
$6,000
$5,000
$9,000
$18,000
$38,000
Overhead rate
$3
$5
$4.50
$6
$4.75
Unit cost
(DM+DL+OH)
$16
$18
$17.50
$19
$17.75
If the company charges overhead using monthly data, the unit cost fluctuates from
month to month ($16 in May, $18 in June, etc.) for essentially the same product
because of the erratic daily or monthly overhead costs or changing production volumes.
For uniformity, the company can wait till the end of the year, when actual total
overhead costs become available, and calculate an overhead rate for all the yearly
output units (i.e., $17.75). The year-end single overhead rate does smoothes out the
fluctuations but creates another problem. Without the unit cost information during the
year, the salespeople can not price their products to ensure a reasonable profit.
Customers will not purchase the fireworks during the year without knowing the price
they have to pay until the end of the year.
Eventually, the company decides to estimate their yearly manufacturing overhead costs
(say $38,500), as well as the projected annual units of output (say 7,900 units), and
calculate a predetermined overhead rate ahead of time (approximately $4.87). The
estimated unit cost of $17.87 can be used to determine the price and fulfill record-
keeping purposes. It solves a lot of problems along the way.
• Manufacturing overhead costs are assigned to jobs using a procedure called overhead
application. The amount is determined by
Applied overhead = Direct labor cost incurred × Predetermined overhead rate.
• Applying manufacturing overhead to jobs completed or for financial statement purposes
(credited to Applied manufacturing overhead account)
Journal entry (7) (and later journal entry (11))
Work–in-process inventory xx
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Applied manufacturing overhead xx
♦ The following journal entries record the transfer of work-in-process inventory to finished
goods inventory when jobs are completed and the transfer of finished goods inventory to cost of
goods sold account when completed jobs are delivered to customers (and sales revenue
recognized).
• When jobs are completed
Journal entry (8)
Finished goods inventory xx
Work–in-process inventory xx
• When jobs are delivered to customers (and therefore sold)
Journal entry (9)
Cost of goods sold xx
Finished goods inventory xx
Journal entry (10)
Accounts receivable xx
Revenue xx
• See Exhibit 7.6 for a summary of the cost flows for the month of January and the
beginning and ending inventory balances at InShape on January 31.
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♦ The following illustration uses T-accounts to show the cost flows and the relations among
accounts, in correspondence with the journal entries above.
Accounts Payable
Materials Inventory
Work-in-process Inventory
xx (1)
BB
BB
xx (6)
(1) xx
xx (2)
(2) xx
xx (4)
(3) xx
EB
(7) xx
(11) xx
xx (8)
EB
Wages Payable
Manufacturing Overhead
Control
Finished Goods Inventory
xx (3)
(4) xx
BB
xx (5)
(5) xx
(8) xx
xx (9)
(6) xx
EB
Prepaid Expense
Applied Manufacturing
Overhead
Cost of Goods Sold
xx (6)
xx (7)
(9) xx
xx (11)
Accumulated Depreciation
xx (6)
Accounts Receivable
Revenue
(10) xx
xx (10)
Note: BB – Beginning Balance, EB – Ending Balance
• For each job, the accountant creates a job cost sheet that records the costs for the
individual jobs along with some additional information (see Exhibit 7.7).
• Job cost sheet has three sections:
(1) The top section provides basic information about the job.
(2) The second section shows the costs as they are recorded for the job.
(3) The third section summarizes the total costs for the job.
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♦ Debits to Manufacturing overhead control account reflect purchases of overhead items. When
overhead is applied to jobs based on the predetermined overhead rate, Applied manufacturing
overhead account is credited. The balances of these two overhead-related accounts are seldom
the same.
• When the actual overhead costs incurred (the debit balance of Manufacturing overhead
control account) are in excess of the applied overhead costs (the credit balance of Applied
manufacturing overhead account), the difference is called underapplied overhead.
When the opposite is the case, the difference is called overapplied overhead.
• Ultimately, the accounting system needs to account for the actual amount incurred. No
balances are kept for Manufacturing overhead control and Applied manufacturing
overhead because they are not balance sheet accounts.
• There are three approaches for dealing with over- or underapplied overhead.
(1) Writing off over- or underapplied overhead to cost of goods sold account.
For overapplied overhead,
Applied manufacturing overhead xx
Cost of goods sold xx
Manufacturing overhead control xx
For underapplied overhead,
Applied manufacturing overhead xx
Cost of goods sold xx
Manufacturing overhead control xx
The overhead accounts have no remaining balances.
(2) Prorating over- or underapplied overhead among work-in-process, finished goods,
and cost of goods sold accounts based on the dollar values of these accounts before
allocation.
For overapplied overhead,
Applied manufacturing overhead xx
Work–in-process inventory xx
Finished goods inventory xx
Cost of goods sold xx
Manufacturing overhead control xx