CHAPTER THREE

SECTION I: JOB ORDER COSTING

Introduction
A manufacturer must determine the unit cost of any individual product produced. Manufacturing
costs may be accumulated and assigned to individual products by use of one of two basic systems:
a job order cost system or a process cost system. In this chapter, we will discuss the nature of a job
order cost system, the situations in which its use is appropriate, and the flow of information through
the accounting records when a job order system is in use. Process costing will be discussed in the
next sub-section of the chapter.

How much cost is incurred in producing a product? How much cost did Proton incur to produce
its new car model? What was the cost incurred by Price Waterhouse Coopers to provide audit
services to its different clients? Cost information is needed by management for planning purposes
that are related to pricing, development of new products, external reporting requirements and other
production activities. In order to assist management in making these decisions, we must understand
the related costing methods. In this chapter of the module, we will be introduced to the job order
costing system, its basic characteristics and the documents involved. The accounting for materials,
labor and manufacturing overheads for the purpose of this costing system will also be explained.
LEARNING OBJECTIVES
After completing this section of the chapter, you should be able to:
 Describe the building-block concepts of costing systems
 Distinguish between process costing and job-order costing and identify companies that
would use each costing method
 Identify the documents used in a job-order costing system.
 Compute predetermined overhead rates and explain why estimated overhead costs (rather
than actual overhead costs) are used in the costing process
 Record the journal entries that reflect the flow of costs in a job-order costing system.
 Apply overhead cost to Work in Process using a predetermined overhead rate.
 Prepare schedules of cost of goods manufactured and cost of goods sold.
 Compute under- or over applied overhead cost and prepare the journal entry to close the
balance in Manufacturing Overhead to the appropriate accounts.
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3.1. Building-Block Concepts of Costing Systems
Before we explore further on the costing method, try to remember the types of cost involved in
producing a product. What are the costs and its examples? In costing, there are several terms that
you must know. Among these are:
Cost Object: Cost object is something that requires a separate cost measurement. For
example, a product (example, computer and car) or a service (example, cost to repair the
air-conditioner and medical cost).
Direct Cost for the Cost Object: Direct cost for the cost object is the cost related to the
cost object and can be traced directly with the cost object economically. For example, if
the cost object is a wooden table, the cost of wood is the direct cost to the cost object.
Indirect Cost for the Cost Object: Indirect cost for the cost object is the cost that is related
to the cost object but cannot be directly traced to the cost object economically. The
depreciation of a car factory used in the manufacturing of various car models is an example
of an indirect cost. The factory's depreciation cannot be traced directly to the individual
cost objects, which are the various car models.
Cost Pool: Cost pool is the cost of individual items that are pooled together.
Basis for Cost Allocation: The basis for cost allocation is related to how the cost is
allocated to the product. It has a systematic relationship with the indirect costs and the cost
object. Among the basis that can be used for the purpose of cost allocation is the allocation
according to machine hours and direct labor cost. As an example, the factory's rental is
allocated according to the area that is used for the production of each product.
Activity 3.1
Describe the building-block concepts of costing systems
_________________________________________________________________
_________________________________________________________________

3.2. Nature of Job order costing and process cost system

A cost accounting system records manufacturing activity using a perpetual inventory system. A
perpetual inventory system continuously updates the accounting and production records for costs
of materials, work in process, and finished goods inventories. Management accountants use two
basic types of costing systems to assign costs to products or services: Job-Costing and Process-
Costing Systems
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1. Job-Order Costing: Job-order costing is used when different types of products, jobs, or
batches are produced, typically over a rather short period of time. In a job-order costing system,
direct materials costs and direct labor costs are usually "traced" directly to jobs. Overhead
is applied to jobs using a predetermined rate. Actual overhead costs are not "traced" to jobs.
Examples of industries in which job-order costing is used include special order printing,
shipbuilding, construction, hospitals, professional services such as law firms, and movie
studios.
2. Process Costing: A process costing system is used where a single, homogeneous product or
service is produced. In a process costing system, total manufacturing costs are divided by total
number of units produced during a given period. The unit cost that results is a broad, average
figure. Examples of industries in which process costing is used include cement, flour, brick,
and oil refining etc.
Note that there are many situations where either job-order costing or process costing could be
selected, depending upon the level of detail needed and the desires of management.
What kinds of companies would be uses the job costing system?
A job order costing system is most suitable where the products manufactured differ in materials
and conversion requirements. Each product is made according to a customer’s specifications and
the price quoted is closely tied to estimated cost. The cost incurred in manufacturing a particular
job must therefore be matched to the goods produced. Examples of types of companies that might
use job order costing are printing, shipbuilding, aircraft, construction, and engineering firms.
Under a job order cost system, the three basic elements of cost; direct materials, direct labor, and
factory overhead, are accumulated according to assigned job numbers. The unit cost for each job
is obtained by dividing the total units for the job into the job’s total cost. A cost sheet is used to
summarize the applicable job costs. Selling and administrative expenses, which are based on a
percentage of manufacturing cost, are listed on the cost sheet to arrive at total cost. Direct material
requisitions and direct labor costs carry the particular job number; factory overhead is usually
applied to individual jobs based on a predetermined factory overhead application rate. The profit
or loss can be determined for each job and the unit cost computed for purposes of inventory costing.
Schedules are prepared to accumulate the information for the required journal entries.

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A process cost system (process costing) accumulates costs incurred to produce a product
according to the processes or departments a product goes through on its way to completion. For
example, companies making such as, paint, gasoline, steel, and rubber, plastic and similar products
are using process costing system. In these types of operations, accountants must accumulate costs
for each process or department involved in making the product.
3.2.1. Similarities between Job Costing and Process Costing Systems
Both systems have the same basic purposes-to assign material, labor, and overhead costs
to products and to provide mechanism for computing unit product cost.
Both systems use the same basic manufacturing accountants, including manufacturing
overhead, Raw materials, Work in process, and Finished Good.
The flow of costs through the manufacturing accounts is basically the same in both systems.
3.2.2. Difference between Job and Process Costing
The differences between job order costing and process costing arise from two factors. The first is
that the flow of units in a process costing system is more or less continuous, and the second is that
these units are indistinguishable from one another. Under process costing it makes no sense to try
to identify materials, labor, and overhead costs with a particular order from a customer ( as we do
with job order costing), since each order is just one of many that are filled from a continuous flow
of virtually identical units from the production line. Under process costing, we accumulate costs
by department rather than by order, assign these costs uniformly to all units that pass through the
department during a period.

A further difference between the two costing systems is that the job cost sheet is not used in process
costing, since the focal point of process costing is on departments. Instead of using job cost sheet
a production report is prepared for each department in which work is done on products. The
production report serves several functions. It provides a summary of number of units moving
through a department during a period, and it also provides a computation of unit costs. In addition,
it shows what costs were charged to the department and what disposition was made on these costs.
The department production report is a key document in a process costing system. These differences
are summarized in the below table;

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 Job Order Costing Process Costing
Many different jobs are worked on during each A single product is produced either on
period, with each job having different production continuous basis or for long periods. All
requirements. units of product are identical
Costs are accumulated by individual job. Costs are accumulated by departments.

Job cost sheet is the key document controlling The department production report is the key
the accumulation of costs by a job. document showing the accumulation and
disposition of costs.

Unit costs are computed by job on the job cost Unit costs are computed by department on
sheet. the department production report.

Activity 3.2:
1. What are the main characteristics of job order costing and process costing?
2. What are the differences and similarities in process costing and job order costing
procedures?

3.3. Source Documents for Job Order Costing

What are the source documents used in a job order costing system?
Information to be used for the purposes of costing must be obtained from related source documents.
The source documents are the original records that support the journal entries in the accounting
system.
Job Order Cost Sheet: A job order cost sheet summarizes the amount of direct materials, direct
labor, and applied factory overhead for each job processed. Direct materials and direct labor cost
information is obtained from materials requisitions and labor summaries, and is posted to the job
order cost sheet daily or weekly. Factory overhead is usually applied at the end of the job, as are
selling and administrative expenses. Besides of this Job order cost sheets are designed to provide
information needed by management and therefore will vary according to management’s desires or
needs. For example: some forms include selling and administrative expenses and selling price so
that estimated profit can be readily determined for each job. Other forms provide only basic factory
cost data, direct materials, direct labor, and factory overhead. Forms will also vary depending on
whether a firm is departmentalized. A job cost record records all the chargeable costs to a particular
job. The following is a sample of a job cost sheet;

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 JOB COST SHEET
XYZ com Job cost Sheet
Job Number: 2B47 Date Initiated March 2
Department B4 Date Completed March 8
Item: Wooden cargo Crate Unit completed:
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor March 8 -- 2
Manufacturing Overhead
Total Cost
Unit Product Cost
Authorized Signature __________________

The three important source documents for a job order costing process are:
a. Materials Requisitions: Requisition is the act of requesting or acquiring of a certain object
of material that is needed for the requester’s usage. A form is a type of paperwork or document
that is usually used for legal or formal request of money, object, or presence of an individual.
A materials requisition form is a source document that the production department uses to
request materials for manufacturing process. The production manager usually fills out the
materials requisition form and delivers it to the materials or storage department where all of
the raw materials are stored. Once the materials manager signs off on the request, the raw
materials are moved from storage and placed on the production floor.
Purchase of Materials: Raw materials and supplies used in production are ordered by the
purchasing department. These materials are kept in a materials storeroom under the control of a
clerk and are issued only when a properly approved requisition is presented.
Issuance of Materials: The next step in the manufacturing process is to obtain the needed raw
materials from the materials storeroom. There is one source document for the issuance of materials
in a job order cost system, a materials requisition. Any issuance of materials by the materials clerk
must be substantiated by a materials requisition approved by the production manager or the
department supervisor. Each requisition form shows the job order number, the department number,

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and the quantities and description of materials requested. The materials clerk enters the unit cost
and total cost on the requisition form.
Measuring Direct Material costs
Materials Requisition Form
XYZ Company
Materials Requisition Number 14873 Date March 2 ,2020
Job Number to Be Charged 2B47
Department B4
Description Quantity Unit Cost Total Cost
2x4, 12 feet 12 Br.3 Br.36
1x6, 12 feet 20 Br.4 Br.80

Br.116.00
Authorized Signature __________________
The rate and amount of the materials are entered in the Materials Requisition by the Costing Office.
The Materials Requisition is prepared in duplicate. One copy is sent to the store-keeper and another
is retained by the department which initiates it, for future reference. After receiving the Materials
Requisition, the store-keeper issues the materials to the job and enters the same in the appropriate
Bin Card. The signature of the person receiving the materials against the Materials Requisition
from the stores must also be obtained by the store-keeper on it.
b. Employee Time Ticket: A time ticket is a document used by an employee to record hours
worked. ... Once a pay period has ended, employees have their time tickets reviewed and
approved by a supervisor, after which they are used by the payroll staff to compile hours
worked, which is the basis for the calculation of gross pay. There are two source documents
for labor in a job order cost system, a time card and a labor job ticket:
i. Time (or clock) cards are inserted in a time clock by employees each day when they arrive,
go to and return from lunch, take breaks, and leave work for the day. This procedure
mechanically shows a record of total hours worked each day by each employee and thus
provides a reliable source for the computation and recording of payroll.
ii. Labor job tickets are prepared daily by each employee indicating the job worked on and
the number of hours worked. The wage rate of the employee is inserted by the payroll
department. The sum of the labor cost and hours incurred on various jobs (labor tickets)
should be equal to the total labor cost and total labor hours for the period (time cards). At

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 periodic intervals, time cards are summarized to record the payroll, and labor job tickets
are summarized to be charged to work-in-process inventory or factory overhead control.
Time card and job ticket hours should be reconciled.
Sample of Employee Time Ticket
XYZ Employee Time Ticket
Time Ticket No. 843 Date March 3 ,2020
Employee: I.M Skilled Station 42

Started Ended Time Rate Amount Job Number

Completed
8:00 12:00 4.0 Br.11 Br.44 2B47
1:00 5:00 4.0 11 Br.44 2B47

Totals 8 Br.88

Supervisor: __________________

A time ticket or time card is the document used to record the number of hours an employee worked
during a pay period. Time tickets come in all different shapes and sizes. Traditional time tickets
are physical cards that are stamped with starting and ending times of employees work days. After
the pay period is over, the bookkeeper or payroll accountant takes to time tickets, inspects them
for errors or fraudulent entries, and enters them into the payroll and accounting system. The time
cards are then stored in the payroll records.

These physical cards act as a record of employee hours worked and more importantly an internal
control. Employees can’t lie about their hours worked or alter work records because time tickets
will only be accepted if they are stamped with the official time clock stamp. Since time tickets also
require another employee to input the employee work hours, time tickets act as another internal
control. For example: The disadvantage to these traditional time tickets is that they are inefficient.
One employee has to punch the time and another employee must enter the time into the payroll
system. This problem is corrected with modern payroll systems.

In modern payroll systems, employees can sign into a computer system that enters the employee’s
time directly into the accounting and payroll system. This eliminates the dual entry of traditional

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systems while providing same level internal controls. Time tickets can also be used to keep track
of hours worked on specific jobs.
Activity 3.3
1. What is the reference or source that supports the recording of business transactions in
the accounting system?
2. What are the source documents involved in job order costing?
3. Explain the use of these documents.
c. Application of Manufacturing Overhead Cost: The third element to be included in
determining the total cost in a job order cost system is factory overhead. There is one source
document for the computation of factory overhead costs in a job order cost system—a
departmental factory overhead cost sheet, which each department maintains. This is a
subsidiary ledger of the Factory Overhead Control account. Reconciliation of the control and
subsidiary ledgers should be performed at regular intervals. It should be noted, however, that
factory overhead costs may be recorded for the factory in total and then distributed to
production departments for ultimate distribution to jobs. The distribution of factory overhead
to jobs is based on a predetermined “factory overhead application rate “. Factory overhead
application rates are expressed in terms of direct labor hours, direct labor dollars, direct
materials dollars, machine hours, or some other reasonable basis. When factory overhead is
not accumulated on a factory wide level for distribution to several departments, each
department will generally have a different rate.
Using a Predetermined Overhead Rate
How is the predetermined overhead rate would be calculated?
The goal is to allocate manufacturing overhead costs to jobs based on some common activity, such
as direct labor hours, machine hours, or direct labor costs. The activity used to allocate
manufacturing overhead costs to jobs is called an allocation base. Once the allocation base is
selected, a predetermined overhead rate can be established. The predetermined overhead rate is
calculated prior to the year in which it is used in allocating manufacturing overhead costs to jobs.
Predetermined overhead rates are used to apply overhead to jobs until we have all the actual costs
available. To create the rate, we use cost drivers to assign overhead to jobs.

A cost driver is a measure of activities, such as machine-hours, that is the cause of costs. To assign
overhead to jobs, the cost driver should be the cause of the overhead costs, or at least be reasonably
associated with the overhead costs. Just as automobile mileage is a good cost driver for measuring

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the cause of gasoline consumption, machine-hours is a measure of what causes energy costs. By
assigning energy costs to jobs based on the number of machine-minutes or hours the job uses, we
have a pretty good idea of the energy costs required to produce the job.

A predetermined overhead rate is an allocation rate that is given for indirect manufacturing costs
that are involved in the production of a product or various products. It is used to estimate the
manufacturing costs that will take place. The estimation takes place at the beginning of an
accounting period, before the commencement of any projects or specific jobs for which the rate is
needed. The allocation base is used to compute "predetermined overhead rate" in the following
formula or equation.

Calculation of Predetermined Overhead Rate:

𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞 𝐭𝐨𝐭𝐚𝐥 𝐌𝐚𝐧𝐮𝐟𝐚𝐜𝐭𝐮𝐫𝐢𝐧𝐠 𝐎𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐜𝐨𝐬𝐭
𝐏𝐫𝐞𝐝𝐞𝐭𝐞𝐫𝐦𝐢𝐧𝐞𝐝 𝐎𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐑𝐚𝐭𝐞 = 𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞 𝐭𝐨𝐭𝐚𝐥 𝐔𝐧𝐢𝐭𝐬 𝐢𝐧 𝐭𝐡𝐞 𝐚𝐥𝐥𝐨𝐜𝐚𝐭𝐢𝐨𝐧 𝐛𝐚𝐬𝐞

This formula of the predetermined overhead rate is purely based on estimates. Predetermined
overhead rate is used to apply manufacturing overhead to products or job orders and is usually
computed at the beginning of each period by dividing the estimated manufacturing overhead cost
by an allocation base (also known as activity base or activity driver). Commonly used allocation
bases are direct labor hours, direct labor dollars, machine hours, and direct materials.

*The numerator requires an estimate of all overhead costs for the year, such as indirect materials,
indirect labor, and other indirect costs associated with the factory. XYZ Company estimates annual
overhead costs to be Br.1400, 000 based on actual overhead costs last year. **The denominator
requires an estimate of activity in the allocation base for the year. Custom Furniture uses direct
labor hours as the allocation base and expects its direct labor workforce to record 350,000 direct
labor hours for the year. The predetermined overhead rate calculation for XYX Company is as
follows:

𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒 = 𝐵𝑖𝑟𝑟140,000 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡𝑠

38,000 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑑𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑢𝑟 ℎ𝑜𝑢𝑟𝑠
= 𝐵𝑖𝑟𝑟4 𝑝𝑒𝑟 𝑑𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑢𝑟 ℎ𝑜𝑢𝑟
Thus, each job will be assigned Br.4 in overhead costs for every direct labor hour charged to the job.
The assignment of overhead costs to jobs based on a predetermined overhead rate is called overhead
applied. Remember that overhead applied does not represent actual overhead costs incurred by the
job, nor does it represent direct labor or direct material costs. Instead, overhead applied represents a
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portion of estimated an overhead cost that is assigned to a particular job. Notice how the
predetermined rate is based on ESTIMATED overhead and the ESTIMATED base or level of
activity. To apply overhead, we will use the actual amount of the base or level of activity x the
predetermined overhead rate. Again, to apply overhead use this formula:
𝑨𝒑𝒑𝒍𝒊𝒆𝒅 𝑶𝒗𝒆𝒓𝒉𝒆𝒂𝒅 = 𝑨𝒄𝒕𝒖𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒃𝒂𝒔𝒆 𝑿 𝑷𝑶𝑯𝑹

𝑾𝒉𝒆𝒓𝒆 𝑷𝑶𝑯𝑹 − 𝑷𝒓𝒆𝒅𝒆𝒕𝒆𝒓𝒎𝒊𝒏𝒆𝒅 𝑶𝒗𝒆𝒓𝒉𝒆𝒂𝒅 𝑹𝒂𝒕𝒆

Predetermined overhead rate is based on estimates rather than actual results. This is because the
predetermined overhead rate is computed before the period begins and is used to apply overhead
cost throughout the period. The process of assigning overhead cost to jobs is called overhead
application.
JOB COST SHEET
XYZ com Job cost Sheet
Job Number: 2B47 Date Initiated March 2
Department B4 Date Completed March 8
Item: 2 Wooden cargo Crate Unit completed:
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
8
X8-7890 Br.116 36 Br. 88 8 4 32

Cost Summary Units Shipped

Direct Materials Br.116 Date Number Balance
Direct Labor Br.88 March 8 -- 2
Manufacturing Overhead Br.32
Total Cost Br.236
Unit Product Cost Br.118

The following summarizes the primary source documents used in a factory to allocate these costs.
Type of cost Name of source document Description of source document
Direct materials Materials requisition Authorizes materials to be taken from the
storeroom for use on a job.
Direct labor Employees time ticket A form filled out by employees that reports how
much time they spent on each job.
Factory overhead Accountant’s worksheet Factory overhead costs are not allocated to each
job based on actual costs. They are allocated

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 based on an estimate called a predetermined
overhead rate.
Example: Department A’s rate may be Br.2.30 per direct labor hour while Department B’s rate
may be Br.2.70 per direct labor hour. In addition, each department may use separate bases to
determine the rate of application. For example, factory overhead may be based on direct labor
hours in Department A and on machine hours in Department B. Application rates vary because of
the differences in activity and functions of individual production departments. To clarify, the
production department applies factory overhead at a rate of 75% of direct labor cost. Assume total
direct labor cost for a job amounted to Br.3, 500. Factory overhead applied would therefore be
Br.2, 625 (= 75% of Br.3, 500).
Activity 3.5: Suppose SUN company uses direct labor hours to assign manufacturing overhead
cost to job orders. The budget of the SUN company shows an estimated manufacturing overhead
cost of Br.8, 000 for the forthcoming year. The company estimates that 1,000 direct labors hours
will be worked in the forthcoming year. Using the above information, compute the predetermined
overhead rate
3.4. Recording the Flow of Costs in Job Order Costing
This section describes how manufacturing costs are recorded in a job order cost system. Although
we do not show the detailed journal entries, we use T-accounts to show how the manufacturing
costs flow through the various inventory accounts before eventually being recognized as Cost of
Goods Sold. The three inventory accounts that are used to record manufacturing costs follow:
Raw Materials Inventory represents the cost of materials purchased from suppliers but not
yet used in production. This account includes all raw materials, including the direct materials
that will be traced to specific jobs (lumber, piping) and the indirect materials that cannot be
traced to specific jobs (screws, nails, and so on).
Work in Process Inventory represents the total cost of jobs that are in process. Any cost that
is added to the Work in Process Inventory account must also be recorded on the individual job
cost sheet. Thus, the total cost of all jobs in process should equal the balance in Work in Process
Inventory.
Finished Goods Inventory represents the cost of jobs that have been completed but not yet
sold. The cost of a completed job remains in the Finished Goods Inventory account until it is
sold.

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In general, companies match the flow of costs to the physical flow of products through the
production process. They place materials received from suppliers in the materials storeroom and
record the cost of those materials when purchasing them to raw materials inventory. As they are
needed for production, the materials move from the materials storeroom (raw materials inventory)
to the production departments with their cost as shown below.

During production, the materials processed by workers and machines become partially
manufactured products. At any time during production, these partially manufactured products are
collectively known as work in process (or goods in process). For example, if accountants compute
the inventory when the company has partially finished products at the end of the year, this
inventory is work in process inventory.

Completed products are finished goods. When the products are completed and transferred to the
finished goods storeroom, the company removes their costs from Work in Process Inventory and
assigns them to Finished Goods Inventory. As the goods are sold, the company transfers related
costs from Finished Goods Inventory to Cost of Goods Sold.

The accounting flow of costs follows the physical flow of the manufacturing process in most
companies. We assume costs follow the physical flow of products. In discussing product costing;
we described how accountants and managers assign costs to products. Recall that products can be

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either goods or services, so this discussion applies to service and merchandising companies as well
as to manufacturing companies.
Manufacturing Cost Categories: As you learned in Chapter two, manufacturing costs are
divided into three categories:
1. Accounting for Materials: Knowledge on recording procedures for raw materials and
documents involved can increase the understanding on the journal entry and basic
information included in the selected costing method. The raw material recording procedures
are as follows:
a. Receipt of Raw Materials: When raw material is received, it must be checked to ensure
the quantity and quality is correct as ordered. This receipt detail will be recorded in the
goods received note. This good received note will become the source document to update
stock account.
b. Issue of Raw Materials: Thereafter, the stock will be taken out from the store if there is
request for the stock. Requisitions can be made using the store requisition form. This form
will list the types of goods/stocks requested together with the quantities. Besides that, it
also includes information on the job number, product code and overhead account involved.
This document will then be used as the basis for stock account recording. At the end of the
period, the balance of each raw material will be calculated.
c. Charge of Raw Materials Cost to the Job/Process: Thereafter, the raw material cost will
be charged to the job or process as shown in the store requisition form. See the following
example to help your understanding.
Example 3.1
Transaction 1: Receipt and purchase of raw materials (direct and indirect) on credit amounted
to Br.79, 000 in January 2020. The raw materials control account will increase (debited) by Br.79,
000 and accounts payable control account will also increase (credited) by Br.79, 000. Both of these
accounts are control accounts as the detailed records for each transaction are found in the smaller
ledger/subsidiary.
Journal entry:
Raw Materials (Control) 79,000
Accounts Payable (Control) 79,000
Posting to the general ledger:

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 Raw Materials (Control) Accounts Payable (Control)
79,000 79,000
Transaction 2: The issue of raw materials from the store to the production line. The direct raw
materials taken are Br.71, 000 and indirect raw materials are Br.3, 000. This transaction will cause
the work in process control account to increase (debited) by Br.71, 000 and manufacturing
overhead control account to increase (debited) by Br.3, 000. Meanwhile, the raw materials control
account will reduce (credited) by Br.74, 000.
Journal entry:
Work in Process (Control) 71,000
Manufacturing Overhead 3,000
Raw Materials (Control) 74,000
Posting to general ledger:
Raw Materials (Control) Work in Process (Control)
c 79,000 d 74,000 d 71,000
Manufacturing Overhead
d 3,000
2. Accounting for labor: It is important to record the labor working hours to calculate the wages
and salary for the purpose of costing as well as planning and controlling. The gross salaries
can be calculated based on the information from the employee’s personnel records, for
example, the attendance records and production records. Each employee’s record is kept
separately, and shows their salary history, current pay rate and deductions allowable (for
example, deductions for Inland Revenue board, tithe, loans, and employee’s provident fund).
The time card (also known as punch card) will provide information on the working hours, time
in and out and overtime work done by an employee. If payment is made based on the number
of products produced, then the product ticket will be analyzed to determine the employees'
wages. The gross salary will then be deducted with the deductions allowable to obtain net
salary. Thereafter, this labor cost must be charged to the related product.
Transaction 3: The total direct labor cost and indirect labor cost for January are Br.30, 000 and
Br.15, 000. This transaction will cause the work in process control account to increase (debited)
by Br.30, 000 and the manufacturing overhead control account to increase (debited) by Br.15, 000.
Meanwhile, the liability account, which is the salaries payable account will increase (credited) by
Br.45, 000.
Journal entry:

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 Work in Process (Control) 30,000
Manufacturing Overhead 15,000
Salaries Payable 45,000
Posting to general journal:
Salaries Payable Work in Process (Control)
e 45,000 d 71,000
e 30,000
Manufacturing Overhead
d 3,000
e 15,000
3. Accounting for Overheads: Overheads are indirect costs. They include for example, the
indirect materials (glue used in making chairs) and indirect labour (factory supervisor's salary).
Indirect costs cannot be traced directly to the product. Therefore, it must be allocated to the
product based on the most appropriate allocation method. Examples of methods that can be
used to allocate the manufacturing overheads are allocations based on the area used (factory
rental) and machine hours (factory machines' maintenance expenses).
Transaction4: Other manufacturing overhead costs in January are as follows: machine
maintenance, Br.21, 000 and machine depreciation Br.13, 000. These transactions will cause the
manufacturing overhead control account to increase (debited) by Br.34, 000. Meanwhile, the
liability account, which is the accounts payable control account will increase (credited) by Br.21,
000 and the accumulated depreciation account of the machine will increase (credited) by Br.13,
000
Journal entry:
Manufacturing overhead 34,000
Accounts payable (control) 21,000
Accumulated depreciation of machine 13,000
Posting to general ledger:
Accumulated depreciation of machine Accounts Payable (Control)
f 13,000 c 79,000
f 13,000
Manufacturing overhead
d 3,000
e 15,000
f 34,000
Transaction 5: Allocation of overhead cost to the job, Br.50, 000. This transaction will cause the
work in process control account to increase (debited) by Br.50, 000 and manufacturing overhead
control account to reduce (credited) by Br.50, 000. However, the decrease in the manufacturing

~ 60 ~
overhead control account will be shown in its contra account, which is the allocated manufacturing
overhead account. This allocated manufacturing overhead account will show the overhead amount
allocated to each job or product based on the allocation method used by the entity.
Journal entry:
Work in process (control) 50,000
Allocated manufacturing overhead 50,000
Posting to general ledger:
Allocated manufacturing overhead Work in process (control)
g 50,000 d 71,000
e 30,000
g 50,000
Transaction 6: The process of completing and transferring to finished goods account of Br.130,
000. This transaction will cause the finished goods control account to increase (debited) by
Br.130,000 and work in process control account to decrease (credited) by Br.130,000 to denote the
completed jobs.
Journal entry:
Finished goods (control) 130,000
Work in process (control) 130,000
Posting to general ledger:
Finished goods (control) Work in process (control)
h 130,000 d 71,000 h 130,000
e 30,000
g 50,000
Balance: 21,000
The debit balance of Br.21, 000 in the work in process control account is the total uncompleted
job at the end of January 2020

Activity 3.6
Sun company is a company producing car fiber. the following transactions were incurred in
February 2020:
1. The business purchases direct raw materials worth Br.30, 000 from supplier.
2. Raw materials of Br.25, 000 were issued from the store to the production line.
3. The production operators’ salaries for February 2020 were Br.15, 000.
4. Salaries for the factory supervisor and factory manager were Br.21, 000.
5. The machine's insurance expense for February was Br.6, 000.
6. Factory rental for February was Br.8, 000.
7. The overhead cost allocated to the job was Br.10, 000.
Required:
A. Provide the journal entry for each transaction above.
B. Calculate the amount issued to the work in process control account.
3.5. Normal Costing versus Actual Costing
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Two ways are commonly used to measure the costs associated with production: Normal costing
and Actual costing.
3.5.1. General Approach to Job Costing Using Normal Costing
Normal Costing: In cost accounting, the accountant finds production cost that is based on the
estimated price of input which is multiplied by the actual quantity of material and other input used
by the company. A seven-step approach is used to assign costs to an individual job. This approach
is used by manufacturers, merchandisers, and companies in the service sector.
Step 1:Identify the Job that Is the Chosen Cost Object. The source documents (original
records that support journal entries in an accounting system) such as the job-cost sheet, the
material-requisition record, and the labor-time record assist managers in gathering information
about the costs incurred on a job.
Step 2:Identify the Direct Costs of the Job. Most manufacturing operations have two direct-
cost categories, direct materials and direct manufacturing labor. Direct materials are ordered by
means of a materials requisition. Quantities needed are based upon engineering specifications.
As previously indicated, the labor-time record indicates the amount of time an employee spends
on a particular job.
Step 3:Select the Cost-Allocation Bases to Use for Allocating Indirect Costs to the Job.
Because these costs cannot be traced to the job, they must be allocated in a systematic manner.
Step 4:Identify the Indirect Costs Associated with Each Cost-Allocation Base. Hopefully, a
cause-and-effect relationship can be established between the costs incurred and the cost-
allocation base (or cost driver).
Step 5:Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate Indirect
Costs to the Job. Budgeted manufacturing overhead rate = Budgeted manufacturing overhead
costs/Budgeted total quantity of cost allocation base.
Step 6:Compute the Indirect Costs Allocated to the Job. Multiply the actual quantity of each
different allocation base by the indirect cost rate for each allocation base.
Step 7:Compute the Total Cost of the Job by Adding All Direct and Indirect Costs
Assigned to the Job.
Actual Overhead Rate and Pre-determined Overhead Rate: Overhead rates setup for the
absorption of overhead may be divided into two parts:

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 i. Pre-determined Overhead Rate
ii. Actual Overhead Rate
Pre-Determined Overhead Rate (Budgeted Manufacturing overhead rate): Pre-determined
overhead rate is based on the anticipated amount of overhead and the anticipated quantum or value
of the base. It is worked out by dividing the estimated amount of overhead by the estimated value
of the base before actual production commences and is applied for the absorption of overhead
during the period for which it has been computed.

Budgeted Manufacturing Overhead Costs

Budgeted Manufacturing Overhead Rate = Budgeted Direct Manufacturing Labor Costs

Total Manufacturing Overhead Rate Allocated Under Normal costing

= Actual Manufacturing Labor Costs X Budgeted Overhead Rate
Notice: The only difference between normal costing and actual costing is that normal costing uses
budgeted indirect-cost rates, whereas actual uses actual indirect-cost rates, calculated at the end
of the year
Actual Costing: Actual costing is a method of cost accounting that records the cost on the actual
basis, means cost of labor, material and overhead are recorded at their actual value. The analysis
of actual cost is important to reduce wastage at workplace.
Actual Overhead Rate: Actual overhead rate is that which is based on the actual amount of
overhead to be absorbed and the actual value of the base selected such as direct wages, materials
cost, machine hours, direct labor hours, etc. Actual overhead rate enables the recovery of the actual
amount of overhead but its main drawback is that it is historical in nature which can be ascertained
only after the overhead costs have been incurred and measured. As such the actual overhead rate
is useless from the point of view of cost control. It is a costing system that traces direct costs to a
cost object by using the actual direct cost rates times the actual quantities of the direct cost inputs.
It allocates indirect costs based on the actual indirect cost rates times the actual quantities of the
cost allocation base. The actual indirect cost rate is calculated by dividing actual total indirect costs
by the actual total quantity of the cost allocation base.
Actual Manufacturing Overhead Costs
Actual Manufacturing Overhead Rate = Actual Direct Manufacturing Labor Costs

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 Actual Manufacturing Overhead incurred
= Actual Units of the allocation base incurred during the period
X Actual Manufacturing Overhead Rate

Example 3.2: Wehib Chemical Trading produces a range of chemical products for industries on
getting bulk orders. It uses a job-costing system to calculate the cost of a particular job. Materials
and labors used in the manufacturing process are direct in nature, but manufacturing overhead is
allocated to different jobs using direct manufacturing labor costs. Wehib Chemical Trading
provides the following information:

Budget for 2020 Actual Results for 2020

Direct material costs Br. 2,750,000 Br.3,000,000
Direct manufacturing labor costs 1,830,000 2,250,000
Manufacturing overhead costs 3,294,000 3,780,000
Required:
1. Compute the actual and budgeted manufacturing overhead rates for 2020.
2. During March, the job-cost records for Job 635 contained the following information:
Direct materials used Br.73, 500
Direct manufacturing labor costs Br.51, 000
i. Compute the cost of Job 635 using (a) actual costing and (b) normal costing.
3. At the end of 2020, compute the under- or over allocated manufacturing overhead under normal
costing. Why is there no under- or over allocated overhead under actual costing?
Budgeted Manufacturing Overhead Costs
Budgeted Manufacturing Overhead Rate =
Budgeted Direct Manufacturing labor costs
Br3,294,000
= = 1.80 0r 180%
Br1,830,000
Actual Manufacturing Overhead Costs
Actual Manufacturing Overhead Rate =
Actual Direct Manufacturing labor cost
Br 3,294,000
= = 1.68
Br 2,250,000
(Answer Required - 2)
Actual costing Normal costing
Direct materials Br.73,500 Br. 73,500
Direct manufacturing labor costs 51,000 51,000
Manufacturing overhead costs
Br.51,000 X 1.68; Br.51,000 X 1.80 85,680 91,800
Total manufacturing costs of Job 635 Br.210,180 Br.216,300
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 (Answer Required - 3)
Total manufacturing overhead allocated under normal costing
Total Manufacturing Overhead allocated under Normal costing
= Actual Manufacturing labor costs X Budgeted Overhead rate
= Br 2,250,000X 1.8 = Br 4,050,000
Overall allocated Manufacturing Overhead
= Manufacturing Overhead allocated − Actual Manufacturing Overhead costs
= Br4,050,00 − Br 3,780,000 = Br 270,000
There is no under- or over-allocated overhead under actual costing because overhead is allocated
under actual costing by multiplying actual manufacturing labor costs and the actual manufacturing
overhead rate. This, of course, equals the actual manufacturing overhead costs. All actual overhead
costs are allocated to products. Hence, there is no under- or over-allocated overhead.
Activity 3.7
Distinguish between actual costing and normal costing
___________________________________________________________________________________
_______________________________________

3.6. Overapplied Or Underapplied Manufacturing Overhead

What the difference is between applied overhead versus actual overhead?
In the above illustration, we have discussed using the predetermined overhead rate to apply
overhead to jobs. This applied overhead is an approximation. What about actual spending for
overhead costs? Let’s review how we got applied overhead. First, we calculated the predetermined
overhead rate by dividing estimated overhead by estimated activity. Because applied
manufacturing overhead is based on a predetermined overhead rate that is estimated before the
accounting period begins, it will probably differ from the actual manufacturing overhead cost
incurred during the period. The difference between actual and applied overhead is called over
applied or under applied overhead. Overhead cost is over applied if the amount applied is more
than the actual overhead cost. It is under applied if the amount applied is less than the actual cost.

Then we multiplied the predetermined overhead rate by the actual activity to calculate applied
overhead. So far, we haven’t used a single actual overhead figure in our calculations. Actual
overhead is the amount that the company actually incurred. Imagine that there are two groups of
accountants inside a company. One group is applying overhead based on the actual activity and
the predetermined overhead rate. These accountants are adding direct materials, direct labor and
applied overhead to jobs to calculate the cost of goods sold on every job that is sold.
~ 65 ~
The second group of accountants is recording actual bills and totaling up actual overhead costs.
Except, these actual overhead costs are not included in cost of goods sold. They are held off to the
side. At the end of the year, the applied accountants and the actual accountants come together to
reconcile cost of goods sold to ensure that the actual numbers are what ends up in cost of goods
sold at the end of the year.
Over applied or under applied?
What do we do when we have the actual overhead numbers? We need to compare the actual
overhead incurred to the applied overhead that is currently attached to our jobs. We need to see if
we applied too much overhead or too little overhead to our jobs. The over or under-applied
manufacturing overhead is defined as the difference between manufacturing overhead cost applied
to work in process and manufacturing overhead cost actually incurred during a period.
Applied Manufacturing overhead > Actual Manufacturing Costs = Over applied
Manufacturing Overhead
Applied Manufacturing Overhead < Actual Manufacturing Costs = Over Applied
Manufacturing Overhead
If the manufacturing overhead cost applied to work in process is more than the manufacturing
overhead cost actually incurred during a period, the difference is known as over-applied
manufacturing overhead. On the other hand; if the manufacturing overhead cost applied to work
in process is less than the manufacturing overhead cost actually incurred during a period, the
difference is known as under-applied manufacturing overhead.

If too much overhead has been applied to the jobs, we say that overhead is over applied. If too
little overhead has been applied to the jobs, we say that overhead is under applied. we like to figure
this out before we even calculate the dollar figure. Compare applied overhead to actual overhead.
Have you applied too much or too little? Remember that applied overhead is what is in cost of
goods sold right now. We need to adjust cost of goods sold to actual at the end of the year.

Once you have determined if overhead is under applied or over applied. Calculate the difference
between applied overhead and actual overhead. This is the amount that you must adjust cost of
goods sold to bring it to the actual cost.

o If overhead is over applied, meaning you have too much overhead in cost of goods sold,
subtract the amount that is over applied.

~ 66 ~
 o If overhead is under applied, meaning you have too little overheard in cost of goods sold,
add the amount that is under applied.
Example 3.3: Midroc Furniture estimated overhead at the beginning of the year to be Br.567, 000.
Over the course of the year, Midroc’s applied Br.578, 000 worth of inventory to its jobs. At the
end of the year, actual overhead incurred was Br.572, 000. Calculate the amount of overhead that
was over applied or under applied. How much cost of goods sold should be reported if unadjusted
cost of goods sold is Br.2, 134,000? We’ve got a lot of figures for such a short problem. We have
three overhead figures. This is why knowing the terminology is really important. If you have the
terminology clear, this problem is easy. First, let’s review the terminology.

Estimated overhead is budgeted at the beginning of the year and used to calculate the
predetermined overhead rate. Applied overhead is the amount that is added to jobs as work is
completed. This is done during the year as work is completed using the predetermined overhead
rate and actual activity. Actual overhead is the amount of overhead cost that the company actually
incurred.

When determining if overhead has been over applied or under applied, we have to compare how
much overhead has been applied to how much was actually incurred. Applied overhead is Br.578,
000. Actual overhead is Br.572, 000. Estimated overhead is not used here. Remember that
estimated overhead is ONLY used to calculate the predetermined overhead rate.

First determine if overhead is over applied or under applied. Actual overhead is what should be in
cost of goods sold. Applied overhead is what is currently in the account. So right now, there is
Br.578, 000 in the account but there should be Br.572, 000. Is there too much overhead or too little
overhead? There is too much overhead. If we do the math, there is Br.6, 000 too much in cost of
goods sold.

Therefore, overhead is Br.6, 000 over applied? That also means that cost of goods sold is Br.6,
000 too high. When overhead is over applied, we must subtract the amount from cost of goods
sold. Cost of goods sold is currently overstated. Br.2, 134,000 – Br.6, 000 over applied overhead
= Br.2, 128,000 adjusted cost of goods sold.

~ 67 ~
 Activity 3.8:
Assume Kedir Brothers estimates the total manufacturing overhead cost for the upcoming year
to be Br.750, 000 and total direct labor hours to be 10,000. Based on these estimates,
calculated predetermined overhead rate?
3.7. Disposition of Under Applied or Over Applied Overhead Balances
What disposition should be made of an under applied overhead or over applied overhead
balance remaining in the manufacturing overhead account at the end of a period?
At the end of the year, the balance in manufacturing overhead account (over or under-applied
manufacturing overhead) is disposed of by either allocating it among work in process, finished
goods and cost of goods sold accounts or transferring the entire amount to cost of goods sold
account. These two methods have been discussed below:
Closed out to cost of goods sold. This is a simplest approach is to close out the under- or over
applied overhead to Cost of Goods Sold. This is the method that is used in most of the exercises
and problems because it is easiest for students to understand and master.
1. Proration (Allocation) Method: This is the second approach to allocate the under- or over
applied balance to Cost of Goods Sold and to the Work in Process and Finished Goods
inventory accounts. The basis of allocation is the amount of overhead applied during the period
in the ending balance of each of these accounts. This method is equivalent to waiting until the
end of the period to allocate the actual overhead costs based on the actual amount of the
allocation base incurred.
2. Closed Out to Cost of Goods Sold: Transferring the entire amount of over or under-applied
to cost of goods sold. Closing out the balance in manufacturing overhead account to cost of
goods sold is simpler than the allocation method.
o Where the overhead is under applied following journal entry is made:
Date Account Title Post. Debit Credit
Ref
Cost of goods sold xx
Manufacturing overhead xx
o Where the overhead is over applied the following journal-entry is made:

Date Account Title Post. Debit Credit

Ref
Manufacturing overhead xx
Cost of goods sold xx
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After passing one of these journal entries, cost of goods sold is adjusted. Consequently, cost of
goods sold is increased by the amount of under applied and decreased by the amount of over
applied overhead. This method is not as accurate as second method. Companies use this method
because it is less time consuming and easy to use.
Example 3.4: Assume ABC Company uses normal costing. It allocates manufacturing overhead
costs using a budgeted rate per machine-hour. The following data are available for 2020:
▪ Estimated manufacturing overhead ▪ Actual manufacturing overhead costs
costs Br.30, 000 Br.95, 000
▪ Budgeted machine-hours 5,000 ▪ Actual machine-hours 15,000
Required: Calculate the amount of overhead that was over applied or under applied. How much
cost of goods sold should be reported if unadjusted cost of goods sold is Br. Birr118, 500?
Cost of Goods Manufactured:
Direct materials Birr 50,000
Direct labor Birr 60,000
Manufacturing overhead applied to work in process Birr90,000*
Total Manufacturing cost Birr200,000
Add: Beginning work in process Birr 30,000
Birr230,000
Deduct: Ending work in process inventory Birr72,000
Cost of goods manufactured Birr 158,000
Cost of Goods Sold:
Finished goods inventory beginning Birr10,000
Birr158,000
Goods available for sale Birr 168,000
Deduct: Finished goods inventory ending Birr49,500
Unadjusted cost of goods sold Birr118,500
Add: Under applied overhead Birr5,000*
Adjusted cost of goods sold Birr123,500

Budgeted manufacturing overhead

Budgeted manufacturing overhead rate =
Budgeted machine hours
𝐵𝑟.30,000
= = Br. 6 per machine hours
𝐵𝑟.5,000
Manufacturing Overhead applied = Birr 90,000 (15,000 Actual machine-hours × Birr6.00
Predetermined overhead rate)
Actual overhead = Birr 95,000
Under applied overhead = Birr 95,000 - Birr90,000 = Birr 5,000
Entry to close the Birr 5,000 of under applied to cost of goods sold would be as follows:

~ 69 ~
 Cost of goods sold-------------------------- 5,000 Dr
Manufacturing overhead------------------------- 5,000 Cr
3. Allocated Between Accounts: Allocation of under or over applied overhead between work in
process (WIP), finished goods and cost of goods sold (COGS) is more accurate than closing
the entire balance into cost of goods sold. The reason is that allocation assigns overhead costs
to where they would have gone in the first place had it not been for the errors in the estimates
going into the predetermined overhead rate. The following journal entry is made to dispose of
an over or under-applied overhead:
o When overhead is under-applied:
Account Name Debit Credit
Work in process xxxx
Finished goods xxxx
Cost of goods sold xxxx
Manufacturing Overhead xxxx
When overhead is over-applied:
Account Name Debit Credit
Manufacturing Overhead xxxx
Work in process xxxx
Finished goods xxxx
Cost of goods sold xxxx
This method is more accurate than the first method. The only disadvantage of this method is that
it is more time consuming
Example 3.5: Allocation of under-applied overhead among work in process, finished goods, and
cost of goods sold accounts:

Manufacturing overhead Account Balances

Actual Birr 220,000 Work in process inventory Birr 45,640
Applied Birr 260,000 Finished goods inventory Birr 78,240
Over applied Birr 40,000 Cost of goods sold Birr 528,120
Total Birr 652,000
Solution: Add balances of accounts and determine proportional relationship
Balances Proportion Percentage
Work in process Birr Birr 45,640 x 100% 7%
inventory 45,640 = Birr 652,000
Finished goods Birr = Birr 78,240 x 100% 12%
inventory 78,240 Birr 652,000
Cost of goods Birr Birr 528,120 x 100% 81%
sold 528,120 = Birr 652,000 100%

~ 70 ~
 1. Multiply percentages times over applied amounts to determine the amount of adjustment
needed:
Account of % X over applied OH
Work in process inventory 7% X 40,000 = Birr 2,800
Finished goods inventory 12% X 40,000 = Birr 4,800
Cost of goods sold 81% X 40,000 = Birr 32,400
2. Prepare journal entry to close manufacturing overhead account and assign adjustment
amount to appropriate accounts:
Manufacturing overhead……………………….40, 000
Work in process inventory…………………. Birr 2,800
Finished goods inventory……………………. Birr 4,800
Cost of goods sold…………………………… Birr 32,400
If the amount of under-applied or over-applied overhead is significant, it should be allocated
among the accounts containing applied overhead: Work in Process Inventory, Finished Goods
Inventory, and Cost of Goods Sold. A significant amount of “under-applied” or “over-applied”
overhead means that the balances in these accounts are quite different from what they would have
been if actual overhead costs had been assigned to production
Allocation restates the account balances to conform more closely to actual historical cost as
required for external reporting by generally accepted accounting principles. The above
figure uses assumed data for the Cutting and Mounting Department to illustrate the proration of
over-applied overhead among the necessary accounts; had the amount been under-applied, the
accounts debited and credited in the journal entry would be the reverse of that presented for over-
applied overhead.

Theoretically, under-applied or over-applied overhead should be allocated based on the amounts

of applied overhead contained in each account rather than on total account balances. Use of total
account balances could cause distortion because they contain direct material and direct labor costs
that are not related to actual or applied overhead. In spite of this potential distortion, use of total
balances is more common in practice for two reasons: First, the theoretical method is complex and
requires detailed account analysis. Second, overhead tends to lose its identity after leaving Work
in Process Inventory, thus making more difficult the determination of the amount of overhead in
Finished Goods Inventory and Cost of Goods Sold account balances.

~ 71 ~
3.7.1. The Effect of under- and over applied Overhead on Net Income
If overhead is under applied, less overhead has been applied to inventory than has actually
been incurred. Enough overhead must be applied retroactively to Cost of Goods Sold (and
perhaps ending inventories) to eliminate this discrepancy. Since Cost of Goods Sold is
increased, under applied overhead reduces net income.
If overhead is over applied, more overhead has been applied to inventory than has actually
been incurred. Enough overhead must be removed retroactively from Cost of Goods Sold (and
perhaps ending inventories) to eliminate this discrepancy. Since Cost of Goods Sold is
decreased, over applied overhead increases net income.
Activity 3.9
During the year 2020, Fanta company started two jobs – job A and job B. Job A consisted of
1,000 units and job B consisted of 500 units. At the end of the year 2020, job A was completed
but job B was in process. The information about manufacturing overhead cost applied to job A
and B was as follows:
Overhead applied to job A Br.65,000
Overhead applied to job B Br.35,000
Total Overhead applied Br.100,000
The actual manufacturing overhead cost incurred by the company during 2020 was Br.108,
000. Out of 1,000 units in job A, 750 units had been sold before the end of 2020.
Required: Calculate over or under applied manufacturing overhead and make journal entries
required to dispose off over or under applied manufacturing overhead assuming:
1. It is disposed off by allocating between inventory and cost of goods sold accounts.
2. It is disposed off by transferring to cost of goods sold.
3.8. Recording Non-manufacturing Costs in a Job Order Costing System
Non-manufacturing expenses have no effect on the production cost of the company because they
are treated as period costs. Non-manufacturing costs are not included in manufacturing overhead
account but are charged directly to income statement. Examples of non-manufacturing expenses
are sales commission, advertising expenses, rent of office building, and depreciation on the
equipment used in office etc.
Journal entries to record non-manufacturing costs: To understand how entries for non-
manufacturing costs are made, consider the following example: GX Company uses job order
costing system and has incurred the following non-manufacturing expenses for the most recent
period:

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 1. Selling and administrative salary: Br.60,000
2. Depreciation on office expenses furniture: Br.14,000
3. Advertising expenses: Br.84,000
4. Other selling and administrative expenses: Br.16,000
Required: Make journal entries from the information provided above.
Journal entries:
Account Name Debit Credit
Salaries Expense 60,000
Salaries payable 60,000

Depreciation Expense 14,000

Accumulated Depreciation 14,000

Advertising Expense 84,000

Other marketing & admin. Expense 16,000
Account Payable 100,000
Note: In entry 2, the depreciation on office furniture has been debited to depreciation expense
because depreciation on office furniture or equipment is treated as period cost. If it were
depreciation on factory equipment, it would have been debited to manufacturing overhead because
depreciation on factory equipment is treated as manufacturing or product cost.
3.9. Job Order Costing System Service Organization
Job-order costing is used in service organizations such as law firms, movie studios, hospitals, and
repair shops, as well as in manufacturing companies. In a law firm, for example, each client is a
“job,” and the costs of that job are accumulated day by day on a job cost sheet as the client's case
is handled by the firm. Legal forms and similar inputs represent the direct materials for the job;
the time expended by attorneys is like direct labor; and the costs of secretaries and legal aids, rent,
depreciation, and so forth, represent the overhead.
Job order costing is a system company’s use when they can trace costs to a specific product or
service. It allows managers to accumulate costs by jobs instead of departments. A job could refer
to a service performed or a customer. Job order costing gives companies in all industries the ability
to evaluate costs accurately and price services correctly.
Examples of job order costing systems: The way job order costing is used can often vary
depending on the specific business using this system. Below are examples of different types of
companies using job order costing systems to track inventory and how the process differs.

~ 73 ~
 ▪ Retail companies ▪ Medical services
▪ Law firms and accounting ▪ Film studios
businesses ▪ Construction companies
Retail companies
With job order costing, products are made individually or in a smaller group, rather than in a large
bulk of items. For example: Say a customer bought shoes personalized with their name written on
the sides and shoelaces made of cotton, rather a basic nylon material. Since this order is unique, a
business would use job order costing to create a unique price to charge the customer for their
custom-made shoe.
Law firms and accounting businesses: Since lawyers and accountants work with different clients
on unique accounts, many will use a job order costing system to track how much time and resources
were used for each customer. For example: A divorce attorney may work with a client to provide
basic legal advice and assistance for a case that doesn't require an excessive amount of legal
research, client-attorney meetings or additional resources. If the divorce attorney worked on a
complex case that required additional hours of research, meetings and other resources, they would
use job order costing to calculate the exact amount the client owes for the resources used to
successfully complete this service.
Medical services: Hospitals and clinics use job order costing to determine how much to charge
each patient. If a patient arrives at the clinic needing a checkup, they obviously require less care
than someone who needs complex surgery that requires a multiple night stay. Since each patient's
experience can vary according to their needs, the hospital or clinic's accounting team creates a
separate job order cost for each service to make sure the hospital is making enough money to
support their resources.
Film studios: In film studios, job order costing is used to track employee salaries as well as the
cost of props, costumes, set location and filming equipment. Some film studios also use job sheets
as estimates to determine how much it will cost to purchase each item and hire each employee in
order to build a specific budget for each film. Once the budget is created, they hire their film crew
and purchase the necessary resources to make the film. Every time an employee works, they
typically submit a time card to track the project they worked on. Each film item and other resources
are tracked on the job sheet.

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Construction companies: Many construction workers design buildings that are custom made and
catered toward the needs of a specific property owner or manager. They often estimate the cost of
each product needed to construct the building or property piece. Once estimated on a job cost sheet,
they will present this estimate to the property manager or owner. If it's approved, the construction
company will use the job order sheet to track their progress and amount spent, making sure to stay
within the agreed-upon budget.
CHAPTER SUMMARY
A cost accounting system should be compatible with the manufacturing environment in which it
is used. Job order costing and process costing are two traditional cost accounting systems. Job
order costing is used in companies that make a limited quantity of products or provide a limited
number of services uniquely tailored to customer specifications. This system is especially
appropriate and useful for many service businesses, such as advertising, legal, and architectural
firms. Process costing is appropriate in production situations in which large quantities of
homogeneous products are manufactured on a continuous flow basis.

A job order costing system considers the “job” as the cost object for which costs are accumulated.
A job can consist of one or more units of output, and job costs are accumulated on a job order cost
sheet. Job order cost sheets for uncompleted jobs serve as the Work in Process Inventory subsidiary
ledger. Cost sheets for completed jobs not yet delivered to customers constitute the Finished Goods
Inventory subsidiary ledger, and cost sheets for completed and sold jobs compose the Cost of
Goods Sold subsidiary ledger.

In an actual or a normal cost job order system, direct material and direct labor are traced,
respectively, using material requisition forms and employee time sheets, to individual jobs in
process. Service companies may not attempt to trace direct material to jobs, but instead consider
the costs of direct material to be part of overhead. Tracing is not considered necessary when the
materials cost is insignificant in relation to the job’s total cost.

Technology is playing an increasing role in aiding the management of jobs and in tracking job
costs. Even basic accounting software typically has a job costing module. By automating the data
entry processes, more accurate and timely data are gathered and employees are relieved of the
recurring burden of logging data. The latest technology being adopted in job shops is project

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 management software. These programs allow operational and financial data about jobs to be shared
throughout the firm. Intranets are being created to facilitate the dissemination of this information.

In an actual cost system, actual overhead is assigned to jobs. More commonly, however, a normal
costing system is used in which overhead is applied using one or more predetermined overhead
rates multiplied by the actual activity base(s) incurred. Overhead is applied to Work in Process
Inventory at the end of the month or when the job is complete, whichever is earlier.

Standard costing can be utilized in a job shop environment. Standards may be established both for
the quantities of production inputs and the prices of those inputs. By using standard costs rather
than actual costs, managers have a basis for evaluating the efficiency of operations. Differences
between actual costs and standard costs are captured in variance accounts. By analyzing the
variances, managers gain an understanding of the factors that cause costs to differ from the
expected amounts. Standard costing is most easily adopted in job shops that routinely produce
batches of similar products.

Job order costing assists management in planning, controlling, decision making, and evaluating
performance. It allows managers to trace costs associated with specific current jobs to better
estimate costs for future jobs. Additionally, managers using job order costing can better control
the costs associated with current production, especially if comparisons with budgets or standards
are used. Attachment of costs to jobs is also necessary to price jobs that are contracted on a cost-
plus basis. Last, because costs are accumulated by jobs, managers can more readily determine
which jobs or types of jobs are most profitable to the organization.
 Self-Assessment Questions
Part I: Write “True” if the statement is correct and “False” if it is incorrect
1. A company that manufactures large quantities of homogenous goods will use a job order
costing system.
2. In an actual job order costing system, factory overhead is assigned to a job on a periodic basis.
3. A company that produces sugar will use a job order costing system to track production costs.
4. In a normal job order costing system, factory overhead is applied using predetermined rates
times actual input.
5. When raw materials are placed into production, the materials inventory account is debited.

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 Part II: Choose the best answer from the given alternatives
1. For which of the following industries would job-order costing most likely not be appropriate?
A. Small business printing C. Home construction
B. Cereal production D. Aircraft assembly
2. In a job order cost accounting system, which account would be debited in recording a purchase
invoice for raw materials?
A. Raw Materials Inventory C. Factory Overhead
B. Goods in Process Inventory D. Finished Goods Inventory
3. The predetermined overhead rate is Br.6.10 per direct labor hour. Job 213 required 210 direct
labor hours of which 150 hours were incurred during the current accounting period. How much
overhead should be applied to Job 213 during the current accounting period?
A. Br. 366 C. Br.1,218
B. Br. 915 D. Br.1,281
4. Job 21 was unfinished at the end of the accounting period. The total cost assigned to the job is
Br.12, 000 of which Br.3, 000 is direct material. Factory overhead is allocated to goods in
process at 150% of direct labor cost. What was the amount of direct labor charged to Job 21?
A. Br.9, 000 C. Br.4, 000
B. Br.3, 600 D. Br.3, 000
5. Which of the following equations is the definition of the predetermined overhead rate?
A. Actual annual overhead / Actual annual activity level
B. Actual annual overhead / Budgeted annual activity level
C. Budgeted annual overhead / Actual annual activity level
D. Budgeted annual overhead / Budgeted annual activity level
6. The source document used to accumulate the manufacturing costs for a job is the:
A. Job-order cost sheet. C. Overhead application ticket.
B. Materials requisition form. D. Time ticket.
Part II: Workout Question
Problem 1: Perry Company uses a job order costing system and has the following information for
the first week of June:
1. Direct labor and direct materials used:

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