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Chapter 17 accounting ii
- 1. ACC 2020 Principles II Chapter 17 Job Order Costing Learning Objectives 1. Distinguish between job order costing and process costing 2. Record materials and labor costs in a job order costing system 3. Calculate the predetermined overhead allocation rate and allocate overhead costs 4. Record the completion and sales of finished goods 5. Adjust for overallocated and underallocated overhead 17-1
- 2. Product costing helps managers to: • Set selling prices that will lead to profits • Compute cost of goods sold for the income statement • Compute the cost of inventory for the balance sheet 17-2
- 3. Costing Systems 17-3 Job Order Costing Process Costing • Unique product/ specialized service • Identical units • Accumulates costs by job • Accumulates costs by process • E.g., Furniture manufacturers, building contractors • E.g., Soft drink manufacturers, Corn chips manufacturers
- 4. Four-Step Method to Track Product Costs 1. Accumulate 2. Assign 3. Allocate 4. Adjust 17-4
- 5. Would the following companies most likely use job order costing or process costing? 1. Paint manufacturer 2. Print shop 3. Caterer 4. Soft drink bottler 5. Yacht builder 17-5 Process Costing Job order costing Job order costing Process costing Job order costing
- 6. Flow of Product Costs in Job Order Costing 17-6 Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records Exhibit 17-2 Flow of Product Costs in Job Order Costing Work-in-Process Inventory Costs Incurred Job 27 Job 28 Job 29 COGM Job 27 Job 28 Finished Goods Inventory COGM Job 27 Job 28 COGS Job 27 Cost of Goods Sold COGS Job 27 BALANCE SHEET INCOME STATEMENT Costs incurred for each job are added to WIP with debits When the job is completed, the costs are transferred out of WIP with a credit and transferred into FG with a debit. This amount is called the job’s Cost of Goods Manufactured (COGM) When the job is sold, the costs are transferred out of FG with a credit and transferred into COGS with a debit. This amount is the job’s Cost of Goods Sold (COGS). The manufacturing overhead costs allocated to each job via WIP are based on estimated costs for the whole factory/facility.
- 7. Purchasing Materials 17-7 Transaction 1—Materials Purchased: During 2016, Smart Touch purchased raw materials of $367,000 on account. Date Accounts and Explanations Debit Credit Trans. 1 Raw Materials Inventory 367,000 Accounts Payable 367,000 A ↑ = L ↑ + E RM ↑ A/P ↑ Raw Materials Inventory Bal. 70,000 Trans. 1 367,000 This is a product cost that accumulates in the Raw Materials Inventory account
- 8. Raw Materials Subsidiary Ledger 17-8
- 10. Job Cost Record for Job # 27: Direct Materials Assigned and Recorded 17-10
- 11. Using Materials 17-11 Transaction 2—Materials Used: In 2016, Smart Touch used direct materials costing $355,000 and indirect materials of $17,000. Date Accounts and Explanations Debit Credit Trans. 2 Work-in-Process Inventory (direct materials) 355,000 Manufacturing Overhead (indirect materials) 17,000 Raw Materials Inventory 372,000 A ↓ = L + E ↓ RM ↓ WIP ↑ MOH ↑ Raw Materials Inventory Bal. 70,000 Trans. 1 367,000 Trans. 2 372,000 Work-in-Process Inventory Bal. 80,000 Trans. 2 355,000 Manufacturing Overhead Trans. 2 17,000 Direct materials $355,000 assigned to WIP Indirect materials $17,000 accumulated in MOH
- 12. Job Cost Record for job # 27 Direct Labor assigned and Recorded 17-12You must learn how to complete a job order cost sheet (record).
- 13. Labor Costs Incurred 17-13 Transaction 3—Labor Costs Incurred: During 2016, Smart Touch incurred total labor costs of $197,000, of which $169,000 was direct labor and $28,000 was indirect labor. Date Accounts and Explanations Debit Credit Trans. 3 Work-in-Process Inventory (direct labor) 169,000 Manufacturing Overhead (indirect labor) 28,000 Wages Payable 197,000 A ↑ = L ↑ + E ↓ WIP ↑ Wages Pay ↑ MOH ↑ Wages Payable Trans. 3: 197,000 Work-in-Process Inventory Bal. 80,000 Trans. 2 355,000 Trans. 3 169,000 Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Direct labor $169,000 assigned to WIP Indirect labor $28,000 accumulated in MOH
- 14. Record the following journal entries for Smith Company: 6. Purchased materials on account, $10,000 Raw Materials Inventory 10,000 Accounts Payable 10,000 17-14 Raw Materials Inventory Try it 6: 10,000
- 15. Record the following journal entries for Smith Company: 7. Used $6,000 in direct materials and $500 in indirect materials in production. Work in Process Inventory 6,000 Manufacturing Overhead 500 Raw Materials Inventory 6,500 17-15 Raw Materials Inventory Try it 6: 10,000 Try it 7: 6,500 Work-in-Process Inventory Try it 7: 6,000 Manufacturing Overhead Try it 7: 500
- 16. Record the following journal entries for Smith Company: 8. Incurred $8,000 in labor costs, of which 80% was direct labor. Work in Process Inventory 6,400 Manufacturing Overhead 1,600 Wages Payable 8,000 17-16 Wages Payable Try it. 8: 8,000 Work in Process Inventory Try it. 7: 6,000 Try it. 8: 6,400 Manufacturing Overhead Try it. 7: 500 Try it. 8: 1,600
- 17. Transactions 4 – 7: Actual Overhead Costs Incurred • In addition to indirect materials and indirect labor, STL also incurred the following overhead costs: Depreciation on manufacturing plant and equipment: $20,000 Plant utilities: $7,000 Plant insurance, $6,000 Plant property taxes incurred but not yet paid, $5,000 17-17
- 18. Actual Overhead Costs Incurred accumulated in MOH 17-18 Date Accounts and Explanations Debit Credit Trans. 4 Manufacturing overhead 20,000 Accumulated Depreciation 20,000 Trans. 5 Manufacturing overhead 7,000 Cash 7,000 Trans. 6 Manufacturing overhead 6,000 Prepaid Insurance 6,000 Trans. 7 Manufacturing Overhead 5,000 Property Taxes Payable 5,000 A = L ↑ + E ↓ Prop Tax Pay ↑ MOH ↑ Manufacturing Overhead Trans. 2 17,000 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal 83,000
- 19. Allocating Overhead Costs WHY? The actual total overhead cost is known ONLY at the end of the fiscal year. But managers cannot wait that long for product cost information. Steps for Allocating Overhead Costs: 1. Calculating the predetermined overhead rate before the period 2. Allocating overhead during the period 3. Adjusting overhead at the end of the period 17-19
- 20. Predetermined Overhead Allocation Rate Total estimated overhead costs Total estimated quantity of the overhead allocation base Allocation base: is a denominator that connects indirect costs to cost objects Ideally, the allocation base is the primary cost driver of the indirect costs. 17-20
- 21. Traditional Cost Drivers Cost driver is the primary factor that causes a cost to increase or decrease • Direct labor hours (for labor-intensive production environments) • Direct labor cost (for labor-intensive production environments) • Machine hours (for machine-intensive production environments) 17-21
- 22. Predetermined Overhead Allocation Rate At the end of 2015, Smart Touch estimated that total overhead costs for 2016 would be $68,000 and direct labor cost would total $170,000. Total estimated overhead costs Total estimated quantity of the overhead allocation base $ 68,000 $170,000 = 0.40 = 40% 17-22
- 23. Allocating Overhead 17-23 Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job
- 24. Allocating Overhead 17-24 Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job Smart Touch Learning’s total direct labor cost for Job 27 was $1,250. How much overhead should be allocated to Job 27? = 40% × $1,250 = $500
- 25. Job Cost Record for Job # 27 Completed 17-25 Cost of goods manufactured Total units produced $4,500 15 tablets = $300 per tablet
- 26. Overhead Allocation 17-26 Transaction 8—Overhead Allocation: Smart Touch’s total direct labor cost for 2016 was $169,000. Overhead was allocated based on direct labor cost. Date Accounts and Explanations Debit Credit Trans. 8 Work-in-Process Inventory 67,600 Manufacturing Overhead 67,600 A ↑ = L + E ↑ WIP ↑ MOH ↓ Manufacturing Overhead Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal 15,400 Work-in-Process Inventory Bal. 80,000 Trans. 2 355,000 Trans. 3 169,000 Trans. 8 67,600 Overhead Allocated 40% × $169,000
- 27. Smith Company expected to incur $10,000 in manufacturing overhead costs and use 4,000 machine hours for the year. Actual manu- facturing overhead was $9,700 and the company used 4,250 machine hours. 17-27
- 28. 9. Calculate the predetermined overhead allocation rate using machine hours as the allocation base. $10,000 4,000 machine hours $2.50 per machine hour 17-28
- 29. 10. How much manufacturing overhead was allocated during the year? $2.50 per machine hour × 4,250 machine hours = $10,625 17-29
- 30. Flow of Product Costs in Job Order Costing 17-30 Job Cost Record Job 27 Direct Materials Direct Labor Manufacturing Overhead Job Cost Record Job 28 Direct Materials Direct Labor Manufacturing Overhead Job Cost Record Job 29 Direct Materials Direct Labor Manufacturing Overhead Product costs for each job are recorded on individual job cost records Exhibit 17-8 Flow of Product Costs for Jobs 27, 28, and 29 Work-in-Process Inventory Costs Incurred Job 27 4,500 Job 28 6,000 Job 29 3,300 Bal 3,300 COGM Job 27 4,500 Job 28 6,000 Finished Goods Inventory COGM Job 27 4,500 Job 28 6,000 Bal 6,000 COGS Job 27 4,500 Cost of Goods Sold COGS Job 27 4,500 Bal 4,500 BALANCE SHEET INCOME STATEMENT Costs incurred for each job are added to WIP with debits When the job is completed, the costs are transferred out of WIP with a credit and transferred into FG with a debit. This amount is called the job’s Cost of Goods Manufactured (COGM) When the job is sold, the costs are transferred out of FG with a credit and transferred into COGS with a debit. This amount is the job’s Cost of Goods Sold (COGS).
- 31. Jobs Completed 17-31 Transaction 9—Jobs Completed: The $644,600 Cost of Goods Manufactured is the cost of all jobs Smart Touch completed during 2016. Date Accounts and Explanations Debit Credit Trans. 9 Finished Goods Inventory 644,600 Work-in-Process Inventory 644,600 A ↑ ↓ = L + E FG ↑ WIP ↓ Work-in-Process Inventory Bal. 80,000 Trans. 2 355,000 Trans. 9 644,600 Trans. 3 169,000 Trans. 8 67,600 Finished Goods Inventory Bal. 0 Trans. 9 644,600Cost of Goods Manufactured
- 32. Jobs Sold 17-32 Transaction 10—Jobs Sold: During 2016, sales on account were $1,200,000 Date Accounts and Explanations Debit Credit Trans. 10 Accounts Receivable 1,200,000 Sales Revenue 1,200,000 A ↑ = L + E ↑ A/R ↑ Sales ↑
- 33. Cost of Jobs Sold 17-33 Transaction 11—Cost of Jobs Sold: The cost of all jobs that Smart Touch sold during 2016 was $584,600. Date Accounts and Explanations Debit Credit Trans. 11 Cost of Goods Sold 584,600 Finished Goods Inventory 584,600 A ↓ = L + E ↓ FG ↓ COGS ↑ Cost of Goods Sold Trans. 11 584,600 Cost of Goods Sold Finished Goods Inventory Bal. 0 Trans. 9 644,600 Trans. 11 584,600
- 34. After the Completion and Sale of Jobs: the T-accounts for Smart Touch Learning’s manufacturing costs now show: 17-34 Work-in-Process Inventory Costs Incurred COGM Bal. 80,000 Trans. 2 355,000 Trans. 9 644,600 Trans. 3 169,000 Trans. 8 67,600 Bal. 27,000 Finished Goods Inventory COGM COGS Bal. 0 Trans. 9 644,600 Trans. 11 584,600 Bal. 60,000 Cost of Goods Sold COGS Trans. 11 584,600 BALANCE SHEET INCOME STATEMENT
- 35. The following information pertains to Smith Company, which you worked with previously in this chapter: 11. Smith Company completed jobs that cost $25,000 to manufacture. Record the journal entry. Finished Goods Inventory 25,000 Work-in-Process Inventory 25,000 17-35
- 36. 12. Smith Company sold jobs to customers on account for $52,000 that cost $22,000 to manufacture. Record the journal entries. Accounts Receivable 52,000 Sales Revenues 52,000 Cost of Goods Sold 22,000 Finished Goods Inventory 22,000 17-36
- 37. Manufacturing Overhead Balance 17-37 Manufacturing Overhead Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal. 15,400 Actual costs $83,000 Allocated costs
- 38. Adjusting Manufacturing Overhead 17-38 Transaction 12—Adjusting Manufacturing Overhead: At the end of 2016, the Manufacturing Overhead account is closed. Date Accounts and Explanations Debit Credit Trans. 12 Cost of Goods Sold 15,400 Manufacturing Overhead 15,400 A = L + E ↑ ↓ COGS ↑ MOH ↓ Manufacturing Overhead Trans. 2 17,000 Trans. 8 67,600 Trans. 3 28,000 Trans. 4 20,000 Trans. 5 7,000 Trans. 6 6,000 Trans. 7 5,000 Bal. 15,400 Trans. 12 15,400 Bal. 0 Cost of Goods Sold Trans. 11 584,600 Trans. 12 15,400 Bal. 600,000 Underallocated Manufacturing Overhead
- 39. Accounting for Manufacturing Overhead 17-39 Exhibit 17-9 Accounting for Manufacturing Overhead Before the Period Calculating the Predetermined Overhead Allocation Rate Predetermined Overhead Allocation Rate = Total estimated manufacturing overhead costs Total estimated quantity of the overhead allocation base During the Period Allocating Overhead Allocated Manufacturing Overhead Cost = Predetermined Overhead Allocation Rate × Actual Quantity of the Allocation Base Used by Each Job At the End of the Period Adjusting for Overallocated and Underallocated Overhead Actual costs > allocated costs Actual costs < allocated costs Manufacturing Overhead Underallocated Overallocated Cost of Goods Sold Undercosted Overcosted Journal Entry DR – COGS ↑ CR – MOH ↓ DR – MOH ↑ CR – COGS ↓
- 40. Summary of Journal Entries 17-40 A ↑ = L ↑ + E RM ↑ A/P ↑ A ↓ = L + E ↓ RM ↓ WIP ↑ MOH ↑ A ↑ = L ↑ + E ↓ WIP ↑ Wages Pay ↑ MOH ↑
- 41. Summary of Journal Entries (continued) 17-41 A ↓ = L + E ↓ Accum Depr ↑ MOH ↑ A ↓ = L + E ↓ Cash ↓ MOH ↑ A ↓ = L + E ↓ Prepaid Insurance ↓ MOH ↑
- 42. Summary of Journal Entries (continued) 17-42 A ↑ = L + E ↑ WIP ↑ MOH ↓ A ↑↓ = L + E FG ↑ WIP ↓ A = L ↑ + E ↓ Prop Tax Pay ↑ MOH ↑
- 43. Summary of Journal Entries (continued) 17-43 A ↓ = L + E ↓ FG ↓ COGS ↑ A = L + E ↑↓ COGS ↑ MOH ↓ A ↑ = L + E ↑ A/R ↑ Sales Revenue ↑
- 44. 17-44
- 45. 17-45
- 46. The following information pertains to Smith Company for the year: Estimated manufacturing overhead $500,000 Estimated direct labor hours 10,000 hours Actual manufacturing overhead $550,000 Actual direct labor hours 10,500 hours Calculate the predetermined overhead allocation rate using direct labor hours as the allocation base. 17-46
- 47. 13. Calculate the predetermined overhead allocation rate using direct labor hours as the allocation base. $500,000 10,000 direct labor hours $50 per direct labor hour 17-47
- 48. 14. Determine the amount of overhead allocated during the year. Record the journal entry. $50 per direct labor hour × 10,500 hours = $525,000 Work-in-Process Inventory 525,000 Manufacturing Overhead 525,000 17-48
- 49. 15. Determine the amount of underallocated or overallocated overhead. Record the journal entry to adjust Manufacturing Overhead. Actual overhead $ 550,000 – Allocated overhead 525,000 Underallocated $ 25,000 Cost of Goods Sold 25,000 Manufacturing Overhead 25,000 17-49
- 50. Pricing Decisions The total hourly rate for the company is $80 ($50 per hour for direct labor plus $30 per hour for indirect costs). If the firm desires a profit equal to 75% of the firm’s cost, then the price would be: Markup = Total Cost × Markup Percentage = $80 per hour × 75% = $60 per hour Price = Total Cost + Markup = $80 per hour + $60 per hour = $140 per hour 17-50
- 51. Homework for next class • Read chapter 17 • Attempt summary problem 17-1 on p. 1032 • Complete the job order cost sheet for the in-class job order costing exercise: Manning Manufacturing. • Prepare for discussion during next class: E17-15 on p. 1042 E17-18D demo question on next slide E17-15 on p. 1042 E17-19 on p. 1043 P 17-29A on p. 1049 P 17-31A on p. 1051 • Start working on the My Accounting Lab exercises for chapter 16 and 17 17-51
- 52. E17-18D 17-52 Purchases of materials, on account $ 70,000 Materials requisitions: Direct materials 53,000 Indirect materials 8,000 Labor incurred (not yet paid): Direct labor 32,000 Indirect labor 11,000 Home Run Company makes baseball bats and reports the following data for the month. Journalize the entries relating to materials and labor.
Editor's Notes
- Managers use cost accounting systems to plan and control. If the manager can calculate the cost of one unit of product, then he or she can use that information to plan a selling price that will produce profits for the company. In addition, this enables the manager to compute both the cost of goods sold on the income statement and the value of the ending inventory on the balance sheet. Once the cost per unit of product is known, the manager can plan and control those costs.
- There are two types of cost accounting systems: job order costing and process costing. Job order costing is used by businesses that produce unique products or provide specialized services. Costs are accumulated for each batch, or job. Examples of the types of companies that use job order costing are: accounting firms, music studios, health-care providers, building contractors, and custom furniture manufacturers In contrast, process costing is used by businesses that manufacture large quantities of identical units. Production is carried out through a series of steps or processes and costs are accumulated for each process. Examples of the types of companies that use process costing are: soft drink manufacturers, whose processes may include mixing, bottling, and packaging; surfboard manufacturers, whose processes may include sanding, painting, waxing, and packaging; and medical equipment manufacturers of a blood glucose meter whose processes may include soldering, assembling, and testing.
- There are four steps that are used to track product costs. These same four steps are followed whether we are using job order costing or process costing. The steps are: accumulate, assign, allocate, and adjust. These steps will be used as we follow how the product costs flow through the inventory accounts on the balance sheet to cost of goods sold on the income statement.
- When the job’s units are sold, the costing system moves the costs from finished goods inventory, which is an asset on the balance sheet, to cost of goods sold, which is an expense on the income statement. Here we see that Smart Touch sold all the units from Job 27. Taking a closer look, we see that the ending balance in work-in-process inventory is the cost of Job 29, which is the only job that is not complete and still in-process at the end of the period. The ending balance in finished goods inventory is the cost of Job 28, the only job that was completed but still not delivered to the customer. The ending balance in cost of goods sold is the cost of Job 27, the only job completed and sold during the period.
- This is a product cost that accumulates in the raw materials inventory account. Raw materials inventory is debited to increase the asset account. Accounts payable is credited to increase the liability account. It is important to note that Smart Touch’s raw materials inventory is a general ledger account. Smart Touch also has a subsidiary ledger for raw materials. The subsidiary ledger contains the details of a general ledger account, and the sum of the subsidiary ledger records equals the balance in the general ledger account.
- In this case, the raw materials subsidiary ledger would include a separate record for each type of material that Smart Touch Learning uses to produce its tablets. So, Smart Touch would have a separate page for the batteries, processors, cases, and other materials used. Exhibit 17-3 shows an example of Smart Touch’s raw materials subsidiary ledger for batteries. A subsidiary ledger allows for better control of inventory because it helps track each type of material used in production. Remember, the balance of the raw materials inventory account in the general ledger should always equal the sum of the balances in the raw materials subsidiary ledger.
- When Smart Touch started Job 27 on January 14, the production team requested materials for the job by filling out a materials requisition, as shown in Exhibit 17-4. A materials requisition is a request for the transfer of raw materials to the production floor. Note that the subsidiary ledger previously shown in Exhibit 17-3 records the materials requisition number (342) along with the number of units requisitioned and their cost.
- When the raw materials are received on the production floor, they are recorded on the job cost record. Exhibit 17-5 shows the job cost record for Job 27 after materials requisition 342 has been recorded. The raw materials added to Job 27 from this materials requisition are considered direct materials because the batteries can be easily and cost-effectively traced directly to the finished tablet.
- To record the use of direct materials, the cost of the direct materials is transferred out of raw materials inventory and is assigned to work-in-process inventory. The amount debited to work-in-process inventory is the total of the individual job cost records. To record the use of indirect materials, the cost of the indirect materials is also transferred out of the raw materials inventory account. However, these costs are accumulated in the manufacturing overhead account with a debit to that account. Manufacturing overhead is a temporary account used to accumulate indirect production costs during the accounting period. Because it is a temporary account, it is classified as an equity account. We will show how manufacturing overhead is adjusted later in this presentation.
- Now that we know how to record the purchase and use of materials, we will take a look at how labor is recorded in a job order costing system. Exhibit 17-6 shows the job cost record for Job 27. Direct materials have been recorded, as shown previously. Direct labor costs are assigned to the job based on labor time records. These labor time records may be obtained electronically when employees swipe their ID cards and enter job information, or they many be obtained from a manual system. In either case, the labor time record reports the number of hours worked on the job and the hourly wage rate, and then computes the total direct labor cost for the job. In this example, a Smart Touch employee worked 5 hours on Job 27. The employee’s hourly rate was $18 per hour. Therefore, the total direct labor cost is $90, which is calculated by multiplying the 5 hours worked by the $18 hourly rate.
- The total cost of direct labor is debited to work-in-process inventory. The indirect labor costs are accumulated in manufacturing overhead by debiting that account. This is the same treatment as the direct and indirect materials illustrated in Transaction 2.
- Manufacturing overhead is debited for the actual overhead cost of $5,000, and property taxes payable is increased with a credit. Throughout the year, Smart Touch has debited manufacturing overhead for actual manufacturing overhead costs as they occur. By the end of the year, the manufacturing overhead account has accumulated all of the $83,000 of actual overhead costs as debits. As you can see, overhead includes a variety of costs that the company cannot trace to individual jobs. For example, it is impossible to say how much of the cost of plant utilities is related to Job 27. Yet manufacturing overhead costs are as essential as direct materials and direct labor, so Smart Touch must find some way to allocate overhead costs to specific jobs. Otherwise, each job would not bear its fair share of the total cost.
- To determine the amount of overhead to allocate to specific jobs, there is a three-step process that occurs at three different points in the accounting cycle: First, a predetermined overhead is calculated before the accounting period. Next, the overhead is allocated during the period. Finally, the overhead is adjusted at the end of the period.
- If we wanted to make the most accurate allocation of overhead, we could only do this when the total overhead cost was known—and that is not until the end of the period. However, managers cannot wait that long for product cost information. Therefore, a predetermined overhead rate is used to allocate estimated overhead costs to individual jobs. This predetermined overhead allocation rate is calculated before the period begins. The formula to calculate the rate is: total estimated overhead costs for the period divided by total estimated quantity of the overhead allocation base. What do we mean by “overhead allocation base”? The allocation base is a denominator that links overhead costs to the products. It is the primary cost driver of manufacturing overhead. In other words, a cost driver is the primary factor that causes, or drives, a cost. For example, the cost of electricity to operate machinery increases with increased machine use. Therefore, the cost driver for electricity is machine usage. So, the allocation base would be the number of hours the machine runs. There is a relationship between the overhead cost and the allocation base; that is, the higher the quantity of the allocation base, the higher the overhead costs, and vice versa.
- There are three cost drivers that are commonly used by manufacturers. Direct labor hours or direct labor cost are appropriate cost drivers for companies whose production is labor-intensive. Machine hours are used when production is machine-intensive.
- We take Smart Touch’s estimated overhead costs of $68,000 for the year and divide by their estimated direct labor cost of $170,000 for the year. The result is a rate of 40%.
- So, how does a company allocate overhead costs to jobs? As jobs are completed, the company will use the predetermined overhead allocation rate to allocate overhead costs to the particular job as follows: the predetermined overhead rate will be multiplied by the actual quantity of the allocation base used by each job.
- To allocate overhead to Job 27, Smart Touch will multiply the predetermined overhead allocation rate of 40% by the actual direct labor cost for the job. The result is that $500 of overhead is allocated to Job 27. Smart Touch uses the same predetermined overhead rate to allocate manufacturing overhead to all jobs worked on throughout the year, including jobs still in process at the end of the accounting period.
- Exhibit 17-7 shows the completed cost record for Job 27. The actual direct material costs of $2,750, actual direct labor costs of $1,250, and allocated overhead of $500 are recorded for Job 27. As a result, the total cost to produce 15 tablets is $4,500, for a unit cost of $300 per tablet.
- Smart Touch allocated manufacturing overhead to each of the jobs worked on in 2016, including jobs still in process at the end of the year. We calculate the total overhead allocated to all jobs by multiplying the predetermined overhead allocation rate of 40% by the $169,000 direct labor cost. The result is $67,600 of overhead being allocated to the work-in-process inventory. Work-in-Process is increased with a debit for the allocated overhead cost of $67,600, and manufacturing overhead is decreased with a credit. After Transaction 8, the manufacturing overhead account has a debit balance of $15,400. This means that Smart Touch’s actual overhead costs of $83,000 were greater than the allocated overhead of $67,600. We say that Smart Touch’s manufacturing overhead is underallocated because the company allocated less costs to jobs than actual costs incurred. Recall that manufacturing overhead is a temporary account used to accumulate indirect production costs during the accounting period. At the end of the accounting period, the manufacturing overhead account must have a zero balance. Therefore, an adjustment is required if overhead is underallocated or overallocated at the end of the period. We will show how to prepare this adjustment after we account for the completion and sale of the goods.
- Let’s review the flow of costs through the accounts. Exhibit 17-8 shows the flow of costs of three jobs at Smart Touch—Job 27, Job 28, and Job 29. When Job 27 and Job 28 were completed, their costs were transferred from work-in-process inventory to finished goods inventory. The amount transferred is the cost of goods manufactured. The ending balance in work-in-process inventory is equal to the cost of partially completed Job 29. Looking next at the finished goods inventory account, we see that Job 27 was sold and its costs were transferred to cost of goods sold. Therefore, the ending balance in finished goods inventory is equal to Job 28, which is the only job completed but not sold. The balance in cost of goods sold is equal to the cost of Job 27, which was the only job sold.
- To accomplish this, finished goods inventory is increased with a debit of $644,600, and work-in-process inventory is decreased with a credit.
- The asset accounts receivable is increased with a debit, and sales revenue is increased with a credit.
- Cost of goods sold is increased with a debit, and the asset finished goods inventory is decreased with a credit.
- To summarize the flow of costs through the accounts when jobs are completed and sold, we look at the work-in-process accounts, which are assets on the balance sheet; and cost of goods sold, which is an expense on the income statement. As jobs are completed, their costs are transferred from work-in-process inventory to finished goods inventory. The $27,000 ending balance in the work-in-process inventory account represents the cost of jobs started but not finished at the end of the period. The cost of all jobs sold is transferred from finished goods inventory to cost of goods sold. The $60,000 ending balance in finished goods inventory represents the cost of all jobs that are completed but not sold.
- The last step of recording costs in a job order costing system is to adjust the manufacturing overhead account for the amount of overallocated or underallocated overhead. The total debits to the Manufacturing Overhead account rarely equal the total credits because overhead is allocated using a predetermined overhead allocate rate based on estimates. At the end of the accounting period, Smart Touch has a $15,400 debit balance in the manufacturing overhead account. When there is a debit balance in the manufacturing overhead account, we say that overhead is underallocated because the manufacturing overhead allocated to work-in-process inventory was less than the actual overhead cost. If there is a credit balance in the manufacturing overhead account, we say that overhead is overallocated. This occurs when the actual manufacturing overhead costs are less than allocated manufacturing costs.
- In order to bring the balance of Smart Touch’s manufacturing overhead account to zero, we need to credit the account. The debit portion of the entry increases the cost of goods sold account. The underallocated overhead indicates that Smart Touch undercosted jobs by $15,400 during the year. The costs flowed through work-in-process inventory, finished goods inventory, and ultimately were transferred to cost of goods sold. Therefore, the adjustment is made to cost of goods sold. After transaction 12, the manufacturing overhead balance is zero, and the cost of goods sold is up to date.
- If actual manufacturing overhead costs were less than allocated manufacturing overhead costs, manufacturing overhead is overallocated and cost of goods sold is overcosted. To close manufacturing overhead, manufacturing overhead is increased with a debit, and cost of goods sold is decreased with a credit.
- As costs flow through the job order costing system, we go through a four-step process to accumulate, assign, allocate and adjust. Exhibit 17-10 is a list of all journal entries illustrated in the chapter with notations on the four steps.
- Exhibit 17-11 shows the schedule of cost of goods manufactured for Smart Touch for 2016, as shown previously in chapter 18.
- Exhibit 17-12 shows the income statement for the same period, as shown previously in Chapter 18.
- In this example, Walsh would need to bill its clients $140 per hour to earn the desired markup.