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CHAPTER THREE
Job Costing, Process Costing, and Operations Costing
This chapter examines the product costing systems-job order costing,
process costing, and operations costing. In particular, it examines how
Key Concepts
• The type of costing system used depends upon the manufacturing
process and the nature and availability of cost data.
• Direct material cost includes the cost of the primary materials used in
production along with shipping cost and sales taxes.
• In order to provide relevant information for decision making, overhead
must often be estimated.
• Under normal costing, the cost of a product includes the actual
amount of direct materials, the actual amount of direct labor, and an
applied amount of manufacturing overhead.
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Learning Objectives
LO1— Contrast job costing, process costing, and operations costing and explain
how they are used to accumulate, track, and assign product costs.
LO5— Determine whether overhead has been over- or underapplied and
demonstrate the alternative treatments of the over- or underapplied
amount.
LO6— Describe basic process costing and the calculation of equivalent units of
production.
Lecture Outline
A. Introduction
1. One of the most important roles of managerial accountants is to
help determine the cost of the products or services being produced
and sold by a company.
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B. Product-Costing Systems (LO1)
1. Job Costing
o Job costing system accumulates, tracks, and assigns the
costs of production to the goods and services produced.
2. Process Costing
o Process costing system accumulates and tracks costs for
each process performed and then assigns those costs
3. Operations Costing
o Operations costing is a hybrid of job and process costing
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C. Basic Job Costing for Manufacturing and Service Companies (LO2)
1. Measuring and Tracking Direct Materials
o Direct material costs include the:
a. costs of the primary materials used in production,
2. Measuring and Tracking Direct Labor
o Direct labor cost is directly related to manufacturing a
product or providing a service.
Key Concept
The type of costing system used depends upon the manufacturing process
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o Idle time
a. Idle time is the worker time that is not used in the
production of the finished product.
o Overtime premium
a. Overtime premium is an additional amount added to the
basic hourly wage owing to overtime worked by the
workers.
D. Manufacturing overhead (LO3)
Overhead being indirect in nature cannot be directly tracked to products and
services but must instead be allocated to determine the true cost of
manufacturing a product or providing a service. Allocation is the process of
finding a logical method of assigning overhead costs to the products or
services a company produces or provides.
1. Cost Drivers and Overhead Rates
Key Concept
Direct material cost includes the cost of the primary materials used in
production along with shipping costs and sales taxes.
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o Cost drivers are factors that cause or drive the incurrence
of costs.
2. Plantwide overhead rates
o In labor-intensive manufacturing companies and service
industries, direct labor hours or direct labor costs have
often served as cost drivers.
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E. The Use of Estimates (LO4)
Managers often estimate the cost of a product to have timely cost
information and to normalize seasonal and random fluctuations in overhead
costs. Normal costing uses estimate of overheads instead of the actual
amount of overhead.
1. Predetermined overhead rates
o Predetermined overhead rates are used to apply overhead
o Allocation of overhead using predetermined overhead rates
is called an application of overhead.
Key Concept
Overhead cannot be directly tracked to products and services but must
instead be allocated using cost drivers.
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F. The problem of over- and underapplied overhead (LO5)
1. If applied overhead is greater than actual overhead, the company
overapplied overhead.
4. Under a normal costing system, as actual overhead costs are
incurred throughout the year, the manufacturing overhead account
is increased (debited) for the amount of the actual costs. The
relevant journal entry is:
Key Concept
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6. If all the units produced are sold, adjusting for over– or under
applied overhead involves adjusting the balance of the cost–of–
goods-sold account
o The journal entry to record the adjustment to cost of goods
sold in case of underapplied overhead is:
o The journal entry to record the adjustment to cost of goods
sold in case of overapplied overhead is:
7. If some of the units produced are not sold and some units are not
even finished, the amount of over- or underapplied overhead is
generally allocated to WIP, finished goods, and cost of goods sold
based on the amount of overhead in each account.
o The journal entry to allocate the underapplied overhead to
o The journal entry to allocate the overapplied overhead
WIP, finished goods and cost of goods sold is:
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Cost of Goods Sold xx
8. As an alternative to adjusting against three accounts, companies
may choose to adjust only the cost-of-goods-sold account if the
amount of the adjustment is immaterial.
G. Basic Process Costing (LO6)
1. Process costing systems accumulate and track direct material and
direct labor costs by department and then assign these costs
2. In companies with no beginning or ending inventories (all units are
finished), the mechanics of process costing are very simple.
3. When companies have inventories, equivalent units completed
4. Process cost systems require multiple WIP accounts—one for
every process.
Key Concept
Under normal costing, the cost of a product includes the actual amount of
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5. Materials, Labor and Overhead Cost Journal Entries
o Material Costs: The journal entry to record the materials
used in processing department A is as follows:
o Overhead Costs: The journal entry to record application of
manufacturing overhead to processing department A is as
follows:
Work in process inventory – Process A xx
Manufacturing Overhead xx
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o Transferring Costs to Finished Goods: The journal entry to
record the transfer of costs of completed units from
process C to finished goods is as follows:
H. Additional Topics in Process Costing (LO7)
When a company has both beginning and ending inventories of WIP, it is
useful to view process costing in four steps- analysis of physical flow of
units and their associated costs (step 1), computation of equivalent units
(step 2), computation of cost per equivalent unit (step 3) and allocation of
costs between finished units and ending WIP (step 4). The reconciliation
between costs to be accounted for and costs actually accounted for is
shown in the production report.
1. First-In, First-Out (FIFO)
o Step 1- Physical flow of units: The units in beginning WIP
Key Formula
Equivalent units of production = Equivalent units required to complete
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o Step 3- Cost per equivalent unit: Only the current-period
costs are included in the calculation of manufacturing costs
2. FIFO with Different Percent of Completion for DM and CC
o When products are not uniformly complete with respect to
3. Weighted Average Method
o Step 1- Physical flow of units: Units in beginning inventory
are treated as if they were started in the current period.
o Step 3- Cost per equivalent units: Last period’s costs are
combined with the current period’s costs in the calculation
Key Formula
Equivalent units of production = Units completely finished during the period
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o Step 4- Cost allocation between completed units and
4. Weighted Average with Different Percent of Completion for DM and
CC
o As with the FIFO, when products are not uniformly
I. Allocation of Service Department Costs to Production Departments (LO8)
There are three methods of allocating service department costs:
1. Direct Method
2. Step-Down or Sequential Method
o Step-down or sequential method recognizes that service
departments consume resources of other service
3. Reciprocal Method
o The reciprocal method is similar to the step-down method
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End-of-Chapter Material
Brief exercises, exercises, problems and a comprehensive case have been
provided at the end of the chapter. These end-of-chapter materials will facilitate