Chapter 03 – Lecture Notes
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2. In journal entry form:
a. Debit Manufacturing Overhead and
credit various accounts as shown.
iv. Applying manufacturing overhead costs to
work in process
1. In T-account form:
a. Work in process is debited and
Manufacturing Overhead is credited
by the amount of the actual quantity
of the allocation base multiplied by
the predetermined rate.
b. Actual manufacturing overhead
costs are not debited to Work in
Process, nor are they charged to jobs
via the job cost sheets.
c. The Manufacturing Overhead
account is a clearing account. The
actual amount of overhead incurred
during the period on the debit side of
the account will almost certainly not
equal the amount applied to Work in
Process as shown on the credit side
of the account. This requires a year-
end adjusting entry that will be
discussed shortly.
2. In journal entry form:
a. Debit Work in Process and credit
Manufacturing Overhead.
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Helpful Hint: Students sometimes have difficulty
understanding the use of Manufacturing Overhead as a
clearing account. Explain that the purpose of the
clearing account is to find any discrepancy that exists
between the amount of overhead applied to inventory
and the amount of overhead actually incurred. Actual
overhead incurred is debited to the account. Overhead
applied to inventory using the predetermined rate is
credited to the account.
v. Accounting for nonmanufacturing costs
Helpful Hint: Review the concepts of product and
period costs at this point. Since period costs are not
directly related to the actual manufacture of the
products, they are expensed as incurred.
1. Companies that use job-order cost systems to
assign manufacturing costs to products also
incur nonmanufacturing costs.
2. Nonmanufacturing costs should not go into
the Manufacturing Overhead account.
3. Nonmanufacturing costs are not assigned to
individual jobs, rather they are expensed in
the period incurred. For example:
a. The salary expenses of employees
that work in a marketing, selling, or
administrative capacity are expensed
in the period incurred.
b. Advertising expenses are expensed in
the period incurred.
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vi. Transferring completed units from work in
process to finished goods
1. In T-account form:
a. The sum of all amounts transferred
from work in process to finished
goods represents the cost of goods
manufactured for the period.
b. The Finished Goods Inventory is
debited and the Work in Process
account is credited.
2. In journal entry form:
a. Debit Finished Goods and credit
Work in Process.
vii. Transferring finished goods to cost of goods sold
1. In T-account form:
a. Debit Cost of Goods Sold and credit
Finished Goods.
b. If only a portion of the units
associated with a particular job are
shipped, then the unit cost figure
from the job cost sheet is used to
determine the amount of the journal
entry.
c. This journal entry is also
accompanied by a journal entry that
recognizes the sales revenue.
2. In journal entry form:
a. Debit Accounts Receivable and credit
Sales.
b. Debit Cost of Goods Sold and credit
Finished Goods.
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Chapter 03 – Lecture Notes
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Helpful Hint: As a concluding thought, remind students
that all inventory accounts are governed by the same
logic: Beginning inventory + Additions = Ending
Inventory + Transfers out. In the case of raw materials,
transfers out consist of both direct and indirect
materials requisitions. Direct materials requisitions are
added to Work in Process inventory. Indirect materials
requisitions are debited to Manufacturing Overhead.
Additions to Work in Process consist of direct materials
requisitions, direct labor, and overhead applied.
Transfers out of Work in Process consist of costs
transferred to Finished Goods. Transfers out of
Finished Goods consist of Cost of Goods Sold.
IV. Schedules of cost of goods manufactured and cost of
goods sold
Learning Objective 6: Prepare schedules of cost of
goods manufactured and cost of goods sold and an
income statement.
A. Key concepts
i. This schedule contains three types of costs,
namely direct materials, direct labor, and
manufacturing overhead.
ii. It calculates the cost of raw material and
direct labor used in production and the
amount of manufacturing overhead applied to
production.
iii. It calculates the manufacturing costs
associated with goods that were finished
during the period.
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B. Product cost flows
iv. To create a schedule of cost of goods
manufactured, as well as a balance sheet and
income statement, it is important to
understand the flow of product costs:
1. Raw material purchases made during the
period are added to beginning raw materials
inventory. The ending raw materials
inventory is deducted to arrive at the raw
materials used in production.
a. As items are removed from raw
materials inventory and placed into the
production process, they are called
direct materials.
2. Direct labor used in production and
manufacturing overhead applied to
production are added to direct materials to
arrive at total manufacturing costs.
3. Total manufacturing costs are added to the
beginning work in process to arrive at total
work in process.
4. The ending work in process inventory is
deducted from the total work in process for
the period to arrive at the cost of goods
manufactured.
5. The cost of goods manufactured is added to
the beginning finished goods inventory to
arrive at cost of goods available for sale.
The ending finished goods inventory is
deducted from this figure to arrive at cost of
goods sold.
Quick Check
−
product cost flows
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V. Underapplied and overapplied overhead—a closer look
Learning Objective 7: Compute underapplied or
overapplied overhead cost and prepare the journal
entry to close the balance in Manufacturing Overhead
to the appropriate accounts.
A. There are two key concepts related to this topic, the
first of which is:
i. Defining and computing underapplied and
overapplied overhead
1. The difference between the overhead cost
applied to Work in Process and the actual
overhead costs of a period is termed either
underapplied or overapplied overhead.
a. Underapplied overhead exists when
the amount of overhead applied to
jobs during the period using the
predetermined overhead rate is less
than the total amount of overhead
actually incurred during the period.
b. Overapplied overhead exists when
the amount of overhead applied to
jobs during the period using the
predetermined overhead rate is
greater than the total amount of
overhead actually incurred during the
period.
Helpful Hint: Students need to understand that factory
overhead must be estimated at the beginning of the
production period. Therefore, there most likely will be a
difference between actual and applied overhead. A
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debit balance in the Manufacturing Overhead account
indicates more overhead has been incurred than has
been applied to inventory and overhead is
underapplied. A credit balance indicates more
overhead has been applied than has been incurred and
overhead is overapplied.
2. Computing underapplied or overapplied
overhead, an example:
a. Assume that PearCo’s actual
overhead and direct labor hours for
the year were $650,000 and 170,000,
respectively.
b. Recall that PearCo’s total estimated
overhead and direct labor hours for
the year were $640,000 and 160,000,
respectively. Therefore, the
predetermined overhead rate would
be $4 per direct labor hour.
c. The amount of overhead applied to
jobs during the year would be
170,000 direct labor hours × $4 per
hour = $680,000.
d. In this example, overhead was
overapplied by $680,000 − $650,000
= $30,000.
Quick Check
−
underapplied and overapplied overhead
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ii. Disposition of underapplied or overapplied
overhead balances
1. Any remaining balance in the Manufacturing
Overhead account, such as PearCo.’s
$30,000 of overapplied overhead, is disposed
of in one of two ways:
a. It can be closed out to Cost of Goods
Sold.
b. It can be allocated between Work in
Process, Finished Goods, and Cost
of Goods Sold in proportion to the
overhead applied during the current
period in the ending balances of these
accounts.
2. The journal entry, in T-account form, to
close out PearCo’s $30,000 of overapplied
overhead into Cost of Goods Sold would be
as follows:
a. Debit Manufacturing Overhead and
credit Cost of Goods Sold.
3. Calculating the allocation of underapplied or
overapplied overhead between Work in
Process, Finished Goods, and Cost of
Goods Sold.
a. Assume the overhead applied in
Ending Work in Process Inventory,
Ending Finished Goods Inventory,
and Cost of Goods Sold is $68,000,
$204,000, and $408,000, respectively
(total value of accounts $680,000).
b. In this case, the allocation
percentages for Work in Process,
Finished Goods, and Cost of Goods
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c. Sold would be 10%, 30%, and 60%,
respectively.
d. The allocation of the $30,000 of
overapplied overhead would be:
Work in Process, $3,000; Finished
Goods, $9,000; and Cost of Goods
Sold, $18,000.
4. The journal entry to close out the $30,000
of overapplied overhead to each of the three
accounts would be:
a. Debit Manufacturing Overhead and
credit Work in Process, Finished
Goods, and Cost of Goods Sold.
5. In summary, there are two methods for
disposing of underapplied and overapplied
overhead.
a. Close out to Cost of Goods Sold.
b. Allocate between Work in Process,
Finished Goods, and Cost of Goods
Sold.
c. The latter method is considered more
accurate, but it is more complex to
compute.
Quick Check
−
under- and overapplied overhead
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Chapter 03 – Lecture Notes
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VI. Selected topics
A. Multiple predetermined overhead rates
i. The chapter discussion assumes that there is a
single predetermined overhead rate for an entire
factory called a plantwide overhead rate.
ii. In larger companies, multiple predetermined
overhead rates are often used. For example, each
production department may have its own
predetermined overhead rate.
iii. While using multiple predetermined overhead rates
is more complex, it is also more accurate because it
reflects differences across departments in how
overhead costs are incurred.
B. Job–order costing in services companies
i. Although our attention has focused upon
manufacturing applications, it bears re-emphasizing
that job-order costing is also used in services
industries.
1. For example, in a law firm, each client
represents a “job.” Legal forms and similar
inputs represent direct materials. The time
expended by attorneys represents direct
labor. The costs of secretaries, clerks, rent,
depreciation, and so forth, represent the
overhead.
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