IPE 4439

Principles of Economics
and Cost Accounting
Course Teacher: Sharmin Akter Urmee
Lecturer, Department of MPE
Room No: 114, Old Academic Building
 CHAPTER 5

SYSTEMS DESIGN
JOB-ORDER COSTING
 Absorption costing

A costing method that includes all manufacturing costs—

direct materials, direct labour, and both variable and fixed
overhead—as part of the cost of a finished unit of product;
synonymous with full costing.

Full costing
Another name for absorption costing.
 Job-Order and Process Costing
In computing the cost of a product or a service,
managers face a difficult problem. Many costs (such as
rent) do not change much from month to month, while
production levels will go up in one month and then
down in another. In addition to variations in the level of
production, several different products or services may
be produced in the same period. Under these
conditions, how is it possible to accurately determine
the cost of a product or service?
 Process Costing
A costing system used in those manufacturing situations
where a single, homogeneous product (such as cement
or oil) flows in a continuous stream out of the
production process.
 Job-Order Costing
A costing system used in situations where many
different products, jobs, or services are produced each
period.

In a job-order costing system, costs are traced and

allocated to jobs, and then the costs of the job are
divided by the number of units in the job to arrive at
an average cost per unit.
 Job-order costing—an overview

To introduce job-order costing, we will follow a specific

job as it progresses through the manufacturing process.
This job consists of two experimental couplings that
ABY Precision Machining has agreed to produce for
Loops Unlimited, a manufacturer of roller coasters.
Couplings connect the cars on the roller coaster and are
a critical component in the performance and safety of
the ride.
 Measuring Direct Materials Cost
1. Bill of materials
A record that lists the type and quantity of each major item of the materials required
to make a product.

2. Production Order
A production order is issued when an agreement has been reached with the customer
concerning the quantities, prices, and shipment date for the order.

3. Materials requisition form

It is a document that (1) specifies the type and quantity of materials to be drawn
from the storeroom and (2) identifies the job to which the costs of the materials are
to be charged.
Materials Requisition Form
 Job Cost Sheet
A job cost sheet is a form prepared for each separate job that records
the materials, labour, and overhead costs charged to the job.
 Measuring Direct Labour Cost
Time ticket: A detailed source document that is used to record an
employee’s hour-by-hour activities during a day
 Computing Predetermined Overhead Rates
Assigning manufacturing overhead to units of product can be a difficult task.
There are four reasons for this:
1. Manufacturing overhead costs are indirect costs.
2. Manufacturing overhead consists of many different items, ranging from the
grease used in machines to the annual salary of the production manager.
3. Even though output may fluctuate due to seasonal or other factors,
manufacturing overhead costs tend to remain relatively constant due to the
presence of fixed costs.
4. The timing of payment of manufacturing overhead costs often varies. Some
items, such as property taxes for the land on which the factory is built, may
be paid once per year, while other items are paid for quarterly, monthly, or
as acquired. But we produce finished items continuously and rather
uniformly all year long
 Computing Predetermined Overhead Rates
Allocation base
A measure of activity, such as direct labour-hours or machine hours, that is used
to assign costs to cost objects
The most widely used allocation bases are direct labour-hours and direct labour
cost, with machine-hours and even units of product (where a company has only a
single product) also used to some extent.

Predetermined overhead rate

A rate used to charge overhead costs to jobs; the rate is established in advance
for each period using estimates of total manufacturing overhead cost and of the
total allocation base for the period.
 Computing Predetermined Overhead Rates
Overhead application
The process of charging manufacturing overhead cost to job cost sheets and to the
Work in Process account.
 Using the Predetermined Overhead Rate
The company has estimated its total manufacturing overhead costs will be
$320,000 for the year and its total direct labour-hours will be 40,000. Its
predetermined overhead rate for the year is $8 per direct labour-hour,
shown as follows:
A Completed Job Cost Sheet
 The Need for a Predetermined Rate
1.Managers would like to know the accounting system’s
valuation of completed jobs before the end of the
accounting period.
2.If actual overhead rates are computed frequently,
seasonal factors in overhead costs or in the allocation
base can produce fluctuations in the overhead rates.
3.The use of a predetermined overhead rate simplifies
record-keeping.
Choice of an Allocation Base for Overhead Cost
Cost driver
A factor that causes overhead costs, such as machine-hours, beds
occupied, computer time, or flight-hours.

If a base is used to compute overhead rates that does not

“drive” overhead costs, then the result will be inaccurate
overhead rates and distorted product costs.
Computation of Unit Costs
 Job-Order Costing—the Flow of Costs
To illustrate, we will consider a single month’s activity for Rand
Company, a producer of gold and silver commemorative
medallions.
Rand Company has two jobs in process during April, the first
month of its fiscal year. Job A, a special minting of 1,000 gold
medallions commemorating the 100th anniversary of the
Calgary Stampede, was started during March and had $30,000
in manufacturing costs already accumulated on April 1. Job B,
an order for 10,000 silver medallions commemorating the same
event, was started in April.
The Purchase and Issue of Materials
 The Purchase and Issue of Materials

$28,000 of the $50,000 in direct materials is charged to Job A’s cost

sheet and the remaining $22,000 is charged to Job B’s cost sheet.
The Purchase and Issue of Materials
 Labour Cost
In April, $60,000 was recorded for direct labour and $15,000 for indirect
labour, resulting in the following summary entry:

$40,000 of direct labour cost was charged to Job A, and the remaining $20,000
was charged to Job B.
Labour Cost
Manufacturing Overhead Costs
Manufacturing Overhead Costs
Manufacturing Overhead Costs
Manufacturing Overhead Costs
 Manufacturing Overhead Costs
Actual overhead costs are not charged to jobs; actual
overhead costs do not appear on the job cost sheet, nor
do they appear in the Work in Process account. Only the
applied overhead cost, based on the predetermined
overhead rate, appears on the job cost sheet and in the
Work in Process account.
Non-manufacturing Costs
Non-manufacturing Costs
Cost of goods manufactured
Cost of goods Sold
Summary of Rand Company Journal Entries
Summary of Cost Flows—Rand Company
Schedules of Cost of Goods Manufactured and
Cost of Goods Sold
Income Statement
 Underapplied and Overapplied Overhead
Underapplied overhead
A debit balance in the Manufacturing Overhead account that arises
when the amount of overhead cost actually incurred is greater than
the amount of overhead cost applied to Work in Process during a
period.
Overapplied overhead
A credit balance in the Manufacturing Overhead account that arises
when the amount of overhead cost applied to Work in Process is
greater than the amount of overhead cost actually incurred during a
period.
 Underapplied and Overapplied Overhead
To illustrate what can happen, suppose that two companies—Turbo Crafters and Black
& Howell—have prepared the following estimated data for the coming year:
Underapplied and Overapplied Overhead
 Disposition of Underapplied or Overapplied
Overhead Balances
The balance in the account must be treated in one of two
ways depending on whether it was under- or overapplied
during the year:

1. If overhead was underapplied, the remaining balance is

closed out to Cost of Goods Sold.
2. If overhead was overapplied, the remaining balance is
allocated among 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
Close out Underapplied Overhead to Cost of
Goods Sold
Allocate Overapplied Overhead among
Accounts
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