Chapter 03 – Product Costing and Cost Accumulation in a Batch Production Environment
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CHAPTER 3
PRODUCT COSTING AND COST ACCUMULATION IN A
BATCH PRODUCTION ENVIRONMENT
Learning Objectives
1. Discuss the role of product and service costing in manufacturing and
nonmanufacturing firms.
2. Diagram and explain the flow of costs through the manufacturing accounts used
in product costing.
3. Distinguish between job-order costing and process costing.
4. Compute a predetermined overhead rate, and explain its use in job-order costing
for job-shop and batch-production environments.
6. Prepare a schedule of cost of goods manufactured, a schedule of cost of goods
sold, and an income statement for a manufacturer.
7. Describe the two-stage allocation process used to assign manufacturing overhead
costs to production jobs.
Chapter 03 – Product Costing and Cost Accumulation in a Batch Production Environment
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Chapter Overview
I. Product and Service Costing
A. Use in financial accounting
B. Use in managerial accounting
C. Use in cost management
D. Use in reporting to interested organizations
II. Flow of Costs in Manufacturing Firms
A. Work-in-process inventory
III. Types of Product-Costing Systems
A. Job-order costing systems
B. Process-costing systems
IV. Accumulating Costs in a Job-Order Costing System
A. Job-cost record
B. Direct materials costs
C. Direct labor costs
D. Manufacturing-overhead costs
2. Predetermined overhead rate
3. Applying overhead costs
V. Illustration of Job-Order Costing
A. Purchase of material
B. Use of direct material
C. Use of indirect material
D. Use of direct labor
E. Use of indirect labor
F. Incurrence of manufacturing-overhead costs
G. Application of manufacturing overhead
H. Summary of overhead accounting
I. Selling and administrative costs
J. Completion of a production job
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O. Posting journal entries to the ledger
VI. Further Aspects of Overhead Application
A. Actual and normal costing
B. Choosing the cost driver for overhead application
C. Departmental overhead rates
VII. Two-stage cost allocation
VIII. Project Costing: Job-Order Costing in Nonmanufacturing Organizations
Key Lecture Concepts
I. Product and Service Costing
• A product-costing costing system accumulates the total cost of making
products and facilitates the calculation of a per-unit cost. Applications
exist in:
➢ Financial accounting: Valuation of ending inventory on the balance
sheet and determination of cost of goods sold for the income
statement
➢ Managerial accounting: Planning, cost control, and decision making
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• Managers of nonmanufacturing organizations need product-cost
information as well. For example, product costs are used by accounting
II. Flow of Costs in Manufacturing Firms
• As production takes place, manufacturing costs are tracked in the Work-
in-Process Inventory account. Every product is made up of three cost
components: direct materials, direct labor, and manufacturing overhead.
III. Types of Product-Costing Systems
• A product-costing system must be adapted to match the environment in
which it operates.
• A job-order costing system is used in an industry where products are
made individually, or in relatively small batches, and one product or
batch is readily distinguishable from the other.
➢ Candidates for job-costing systems would be custom
• A process-costing system is employed in an environment at the other end
of the continuum: the mass production of like units. Users might include
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IV. Accumulating Costs in a Job-Order Costing System
• A job-cost record is used to accumulate the actual direct materials, actual
direct labor, and applied manufacturing overhead costs for each job. The
recording of costs on this record and in the general ledger is triggered by
various source documents.
• Supply chain—the flow of all goods, services, and information into and
• Time records are used to gather the amount of direct labor worked on a
specific job.
• Overhead accounting involves a number of steps. Chapter 3 focuses on
the final step: the application of overhead to jobs and products.
➢ Although overhead cannot be directly traced to the product, the
use of an application rate should allocate an equitable amount of
cost to each job (known as overhead application).
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➢ Step 2: Use the predetermined overhead rate to apply an equitable
portion of overhead to each job. As the actual number of cost-
driver units used on a job becomes known, it is multiplied by the
predetermined overhead rate.
➢ Actual overhead costs incurred during the year are debited to the
➢ The year-end difference between actual and applied amounts is
known as over- or underapplied overhead. This figure is adjusted
in the process of closing the Manufacturing Overhead account to
zero by either:
▪ Charging or crediting the amount to cost of goods sold. This
approach is acceptable if the over- or underapplication is
Teaching Tip: Emphasize that under- and overapplied overhead is the difference between
actual and applied overhead, not actual and budgeted overhead. The budgeted figure is
used solely in the determination of the predetermined rate.
V. Illustration of Job-Order Costing
• As noted earlier, the Work-in-Process Inventory account contains charges
for direct materials used, direct labor, and applied manufacturing
overhead.
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Teaching Tip: Although the text illustration appears relatively complicated, it is simply
presenting the details that accompany the flow of goods (and costs) from work in
process, to finished goods, to cost of goods sold.
• The schedule of cost of goods manufactured details the activity in the
Work-in-Process account (beginning balance, direct materials used, direct
VI. Further Aspects of Overhead Application
• Actual and normal costing
➢ Accountants prefer predetermined application rates, which are
used in a normal-costing system. Such rates help to smooth
product costs over time and allow users to cost products/jobs upon
completion.
▪ In contrast, users of actual-costing systems derive an actual
• Choosing an appropriate cost driver
➢ Direct labor has been a very common and appropriate cost driver.
Past processes were labor intensive, and products incurring more
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• Single vs. multiple overhead rates
➢ Companies commonly use multiple (rather than single) application
VII. Two-stage cost allocation
• Stage one: Overhead is first accumulated in production departments. This
VIII. Project Costing: Job-Order Costing in Nonmanufacturing Organizations
• Project costing refers to job costing in a nonmanufacturing environment.
“Jobs” in this case refer to cases, contracts, and/or programs.
IX. Changing Technology in Manufacturing Operations
• Technology such as bar coding may be used to track appropriate costs to
projects, although this is just one of many possible applications. Service
providers, along with manufacturers, are also making use of:
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Teaching Overview
I begin the topic of job costing by explaining that students should not expect to apply a
so-called “textbook system” to any real-world company, because cost systems must be
designed to meet a firm’s unique needs. However, the two traditional system models,
job order and process costing, give users the ability to build-in various modifications for
use in actual situations.
The second area in need of clarification is the sequence of procedures for overhead
application: calculating predetermined overhead rates, using the rates, and adjusting
the over- or underapplied amount. This problem stems from the fact that students are
doing textbook assignments where all the information is given simultaneously.
Therefore, the question arises, “Why use an imperfect predetermined overhead rate
when I have all the totally correct, actual data in the next paragraph?” It is helpful to be
on the lookout for this line of thinking when discussing homework assignments and to
remind students how and when information becomes available in the real world. (I
suspect this is a problem mainly for undergraduates with limited work experience.)
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After the preceding issues have been handled, students generally are quite interested in
job-costing concepts, particularly those who have worked in a family business or who
plan to start their own business. Students are also interested in job costing in a service
Links to the Text
Homework Grid – CHAPTER 3
Item No.
Learning
Objectives
Completion
Time (min.)
Exercises:
3-23
1, 3
10
3-24
2, 4, 6
20
3-25
2, 3, 4
25
3-26
2, 6
15
3-27
5
5
3-28
1, 4
15
3-29
1, 3
30
3-30
2, 5, 6
20
3-31
2, 6
20
3-32
2, 6
30
3-33
4
20
3-34
4, 5
5
3-35
4, 5
15
3-36
5
20
3-37
1, 8
10
3-38
3, 5
15
3-39
1, 4
15
3-40
1, 7
15
3-41
8
10
Problems:
3-42
4, 5
20
3-43
2, 4
35
Chapter 03 – Product Costing and Cost Accumulation in a Batch Production Environment
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3-44
6
45
3-45
2, 5
25
3-46
2, 5
35
3-47
2, 4, 7
30
3-48
1, 2, 4, 8
30
3-49
6
45
3-50
2, 6
15
3-51
4, 5
25
3-52
1, 2, 4, 6
40
3-53
2, 6
30
3-54
2, 4, 5, 6
30
Item No.
Learning
Objectives
Completion
Time (min.)
3-55
2, 4, 6
45
3-56
4
25
3-57
2, 4, 5
55
3-58
2, 4, 5, 6
75
3-59
2, 3, 4
20
3-60
1, 7
50
Cases:
3-61
1, 2, 3, 4, 6
45
3-62
2, 4, 6
50