UNIT SIX: JOB ORDER COSTING SYSTEM

Content
6.0 Introduction
6.1 Objectives
6.2 Work flow and Cost flow
6.2.0 Overview
6.2.1 Objectives
6.2.2 Workflow
6.2.3 Recording Costs as Incurred
6.2.4 Product and Service Costing
6.3 Accounting Costs a Job-order Costing System
6.3.0 Overview
6.3.1 Objectives
6.3.2 Job Cost Sheet
6.3.3 Direct Material Costs
6.3.4 Direct Labor Costs
6.3.5 Manufacturing Over Head Costs
6.4 Illustration of Job-order Costing
6.4.0 Overview
6.4.1 Objectives
6.4.2 Purchase of Materials
6.4.3 Use of Direct Material and Indirect Material
6.4.4 Use of Direct Labor and Indirect Labor
6.4.5 Incurrence and Application of Manufacturing Overhead Costs
6.4.6 Selling and Administration Costs
6.4.7 Completion of a Production Job and Sales of Goods Completion of a
Production Job
6.4.8 Under Applied and Over Applied Overhead
6.4.9 Posting Journal Entries to the Ledger
6.5 Job-Order Cost Systems for Service Enterprise

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 6.6 Summary
6.7 Answers to Learning Activities
6.8 Answers to Check Your Progress Exercises
6.9 Model Exam Questions
6.10 Glossary

6.0 INTRODUCTION

This unit examines the details of job order costing system. Job order costing system is used by
companies where goods are produced in distinct batches and there are significant differences
among the batches. Examples of firms that use job order costing are aircraft manufacturers,
printers, custom furniture manufacturers, and custom machining firms. In job order costing
each distinct batch of production is called a job or job order. The cost accounting procedures
are designed to assign costs to each job. Then the costs assigned to each job are averaged over
the units of production in the job to obtain an average cost per unit.

Procedures similar to those used in job-order costing are also used in many service industry
firms, although these firms have no work in process or finished goods inventories. In a public
accounting firm, for example, costs are assigned to audit engagements in much the same way
they are assigned to a batch of products by a furniture manufacturer. Similar procedure are
used to assign costs to " cases" in health care facilities, to " programs" in government
agencies, to research " project " in universities and to "contracts" in consulting and
architectural firms.

Student are encouraged to devote much time on this unit regarding how a firm using job order
costing is organized, the design of the accounting system, and how accounting records and
procedures are established to record, transfer and summarize these manufacturing costs. Job
order costing system is one of the important topics in cost and management curriculum.

This unit has three important sections. The first section deals with the work how and cost
flow, the second section is about the accumulation of costs in job order costing system.
Illustration has been provided concerning the application of a job-order costing system. This
unit concludes with a brief description of how a job order costing system can be adopted for
use by service enterprise.

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6.1 OBJECTIVES

After completing this unit, you should be able to:

 Diagram the flow of costs through the manufacturing accounts used in product
costing.
 Understand how the job -order costing system is used.
 Compute a predetermined overhead rate, and explain its use in job-order costing.
 Prepare journal entries to record the costs of direct labor, direct material, and
manufacturing overhead in a job -order costing system.
 Understand how job -order costing system is used in a service enterprise.

6.2 WORK FLOW AND COST FLOW

6.2.0 Overview

The cost accounting system of a firm parallels the flow of its operations. This section
discusses the flow of products through the manufacturing operations and the flow of
manufacturing costs through the accounting system. It also discusses the purposes of product
and service costing.

6.2.1 Objectives

After completing this section you should describe the flow of costs and work flow in a
business organization, and explain the purposes of product and service costing for a business
organization.

6.2.2. Work flow

The cost accounting system of a firm parallels the flow is its operations. A firm that makes
and sells products may have four steps in its cycle of operation. There four steps form the
operating cycle of a firm and are chronological in nature. These steps are:

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1. Procurement

Procurement is the process of acquiring the necessary inputs for production. These inputs are
raw materials, labor and factory facilities. Factory facilities include manufacturing machinery,
utilities and similar facilities.

In the procurement step, we need to purchase the necessary materials, recruit the necessary
labor force and acquire the appropriate manufacturing facilities. Raw materials are converted
into finished products by means of manpower and factory facilities, such as machinery,
utilities and similar items. Raw materials have to be ordered, received and stored.
2. Production

Production refers to the actual conversion of raw materials by means of labor and factory
facilities. At this stage, raw materials are transferred from the store room to the factory floor.
Labor, tools, machines and other facilities are applied to complete the product.

3. Warehousing

Warehousing is the movement of the completed products form factory floor to warehouse to
await for sale. Those good that have been completed should be moved from factory to
warehouses.

4. Selling

Selling include finding customers and making shipments of merchandises. Customers are
found, agreement is reached on with the customers, goods will be shipped from the warehouse
and sales to customers are recorded.

6.2.3 Recording costs as incurred

As each cost is incurred, it must be recorded in an appropriate ledger account. At different

points in the operating cycle different accounts are needed.

1. Procurement
At this stage accountants should be provided to record the purchase of material cost, labor
cost and overhead costs. These costs will later be charged to production. Typical, general

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 ledger account titles used are raw material, factory payroll clearing and manufacturing
overhead control.

2. Production
An account is required to gather procurement costs as they become chargeable to
manufacturing operation and this account is called work-in-process inventory.

3. Warehousing
An account should be set up to record the cost of goods that have been completely
manufactured. This account is finished goods inventory.

4. Selling
The cost of completed goods that have been sold and must be recorded, and for this purpose a
general ledger account called cost of goods sold is maintained.

Learning Activity 1
What are the uses of product costs?

6.2.4 Product and service costing

Product costing system accumulates the costs incurred in a production process and assigns
these costs to the organization final products. As the following diagram shows, product costs
are the output is the product costing system.
Inputs of the Activities performed Output of the product
Product costing system by the system costing system

Costs incurred in Procedure used to accumulate

Production process and assign costs to final products Product costs

Product costs are needed for a variety of purposes in both financial accounting and
managerial accounting.

Use in Financial Accounting

In financial accounting, product cost are needed to value inventory on the balance sheet and to
compute cost of goods sold expense on the income statement. Under generally accepted

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accounting principles inventory is valued at its cost until it is sold. Then the cost of the
inventory becomes an expense of the period in which it is sold.

Use in Managerial Accounting

In managerial accounting, product costs are needed for planning, for cost control , and to
provide managers with data for decision making. Decisions about product prices, the mix of
products to be produced, and the quantity of output to be manufactured are among those for
which product cost information is needed.

Use in Reporting to Interested organization

In addition to financial statement preparation and internal decision making, there is an ever-
growing need for product cost information in relationships between firms and various outside
organizations. Public utilities such as electric and gas companies, record product costs to
justify rate increase that must be approved by regulating agencies.

6.3 ACCUMULATING COSTS IN A JOB -ORDER COSTING SYSTEM

6.3.0 Overview

In a job-order costing system, costs of a direct labor and manufacturing overhead are assigned
to each production job. These costs comprise the inputs of the product costing system. As
costs are incurred, they are added to the work -in-process inventory account in the ledger. To
keep track of the manufacturing costs assigned to each job, a subsidiary ledger is maintained.
The subsidiary ledger assigned to each job is a document called a job cost sheet.

6.3.1 Objectives

This section discusses the purpose of job-cost sheet and procedures used to accumulate the
costs of direct material, direct labor and manufacturing overhead for a job. A job constitutes
the set of activities performed by the job order costing system.

6.3.2 Job cost sheet

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Job cost sheet is a document on which the costs of direct material, direct labor, and
manufacturing overhead are recorded for a particular production job or batch. It is a
subsidiary ledger account for the work-in-process inventory account in the general ledger. An
example of a job-cost sheet is displayed below:

Job-cost sheet

Job Number____________ Description ______________

Date Started _____________ Date completed ___________
Number of units completed __________
Direct material
Date Requisition number Quantity Unit price Cost

Direct labor
Date Time card number Hours Rate Cost

Manufacturing overhead
Date Activity base Quantity Application Cost
rate

Cost summery
Cost item Amount
Total direct material
Total direct labor
Total manufacturing overhead
Total cost
Unit cost

Shipping summary
Rate Number of units shipped Cost balance

Three sections on the job-cost sheet are used to accumulate the costs of direct material, direct
labor and manufacturing overhead assigned to the job. The other two sections are used to

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record the total cost and average unit cost for the job, and to keep track of units shipped to
customers. A job cost sheet may be a paper document upon which the entries for direct
material, direct labor and manufacturing overhead are written.

The procedures used to accumulate the costs of direct material, direct labor and
manufacturing overhead for a job constitute the set of activities performed by the job-order
costing system. These procedures are discussed next.

6.3.3 Direct material costs

As raw materials are needed for the production process they are transferred from the
warehouse to the production department to authorize the release of materials. The production
department supervisor completes a material requisition form and presents it to the warehouse
supervisor. A copy of the material requisition form is given to the cost accounting department.
There it is used as the basis for transferring the cost of the requisitioned material from the
raw-material inventory account to the work-in-job cost sheet for the production job in process.
A document such as the material requisition form, which is used as the basis for an accounting
entry, is called a source document. An example of a material requisition form is shown below:

Material -Requisition Number 352 Date 1/12/1998

Job number to be charged J 621 department painting
Department supervisors Tamiru Desse
Item Quantity Unit cost Amount
White enamel paint 8 gallons Br .14. 00 Br .112
Clear Lacquer 2 gallons Br 11.00 22

In many factories material requisitions are entered directly into a computer terminal by the
production department supervisor. The requisition is automatically transmitted to terminals in
the warehouse and in the cost accounting department. Such automation reduces the flow of
paperwork, minimizes clerical errors, and speeds up the product costing process.

Material Requirements Planning

For producers and product components that are produced routinely, the required materials are
known is advance. For these products and components, material requisitions are based on a
bill of materials that lists all of the materials needed.

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In complex manufacturing operations in which production takes place in several stages,
materials requirement planning (MRP) may be used. MRP is an operations management tools
that assits manger in scheduling production in each stage of the manufacturing process. Such
careful planning ensures that, at each stage in the production process, the required sub-
assemblies, components, of partially processed materials will be ready for the next stage.
MRP system which are generally computerized , include files that list all of the component
parts and materials in inventory and all of the parts and materials needed in each stage of the
production process. The MRP is diagrammed as follows:

Material 1

Component A
Material 2

Final Product

Material 3

Material 4 Component B

Material 5
Production Production
Department I Department II
Material 6

As the diagram indicates, the bill of materials for component A includes materials 1, 2 and 3.
This bill of materials would be consulted by the supervisor of production department I when
requisitioning materials.

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6.3.4 Direct labor costs

The assignment of direct labor costs to jobs is based on time tickets filed out by employees. A
time-ticket is a form that records the amount of time an employee spends on each production
job. The time ticket is the source document used in the cost accounting department as the
bases for adding direct labor costs to work -in-process inventory and to the job-cost sheets for
the various jobs in process.

An example of time ticket is shown below:

Employees name Dereje Tariku Date 1/22/1997
Employee number 47 Department Drilling

Time Started Time Stopped Job Number

8:00 11:30 A267
11:30 12:00 Ship clean up
1:00 5:00 J122

As the example shows, most of the employee’s time was spent working on two different
production jobs. In the accounting department the time spent on each job will be multiplied by
the employee’s wage rate, and the cost will be recorded in the work in process inventory and
on the appropriate job cost sheets. The employee also spent one half hour on ship clean -up
duties. This time will be classified by the accounting department as indirect labor, and its cost
will be included in manufacturing overhead.

6.3.5 Manufacturing overhead costs

It is relatively simple to trace direct material and direct labor costs to production jobs, but
manufacturing overhead is not easily traced to jobs. By definition, manufacturing overhead is
a heterogeneous pool of indirect production costs such as indirect material, indirect labor,
utility costs, and depreciation. These costs often bear no obvious relationship to individual
jobs or units of product, but they must be incurred for production to take place. Therefore, it is
necessary to assign manufacturing overhead costs to jobs in order to have a complete picture
of product costs. The process of assigning manufacturing overhead costs to production jobs is
called overhead application (or sometimes overhead absorption).

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Overhead Application
For product costing information to be useful, it must be provided to managers on a timely
basis. Suppose the cost accounting department waited until the end of an accounting period so
that the actual costs of manufacturing overhead could be determined before applying
overhead costs to the firm's products. However, the information might be useless because it
was not available to managers for planning, control and decision making during the period.

Predetermined overhead rate

The solution to this problem is to apply overhead to products on the basis of estimates made at
the beginning of the accounting period. The accounting department chooses some measure of
productive activity to use as the basis for overhead application. In traditional product costly
systems, this measure usually is some volume based driver (or activity base) such as direct
labor hours, direct labor cost, or machine hours. An estimate is made of
i) The amount of manufacturing overhead that will be incurred during a specified period of
time and
ii) The amount of the cost driver (or activity base) that will be used or incurred during the
same time period.

Then a predetermined overhead rate is computed as follows:

Predetermined = budgeted manufacturing overhead cost

Overhead rate budgeted amount of cost driver (or activity base)
For example, suppose that Chairman Print has chosen machine hours as its cost driver (or
activity base). For the next year, the firm estimates that overhead cost will amount to Br
90,000 and that total machine hours used will be 10,000 hours. The predetermined overhead
rate is computed as follows:

Predetermined overhead rate = Br 90,000 =Br 9.00 per machine hour

10,000 hours
In our discussion of the predetermined overhead rate, we have emphasized the term cost
driver; because increasingly this term is replacing the more traditional term activity. Further
more, we have emphasized that traditional product costing systems tend to rely on a single,

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volume based driver. We will discuss more elaborate product costing systems based on
multiple cost drivers later in this unit.

Applying Overhead Costs

The predetermined overhead rate is used to apply manufacturing overhead costs to production
jobs. The quantity of the cost driver required by a particular job multiplied by the
predetermined overhead rate to determine the amount of overhead cost applied to the job. For
example, suppose Chairman Print’s job number C22, consisting of 1000 brochures, requires
three machine hours. The overhead applied to the job is computed as follows:

Predetermined overhead rate............................................................ Br. 9

Machine hours required by job C22................................................X 3
Overhead applied to job C22.......................................................... Br 27

The Br. 27 of applied overhead will be added to work in process inventory and recorded on
the job cost sheet for job C22. The accounting entries made to add manufacturing overhead to
work in process inventory may be made daily, weekly or monthly depending on the time
required to process production jobs. Before the end of accounting period, entries should be
made to record all manufacturing costs incurred to date in work in process inventory. This is
necessary to properly value work in process on the balance sheet.

Learning Activity 2

1. What is the purpose of job cost sheet?

2. What do we mean by overhead absorption?
3. How does use of materials requisition help control the issuance of materials
from the store room?
4. What is the formula for computing predetermined overhead rate?

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6.4 ILLUSTRATION OF JOB-ORDER COSTING

6.4.0 Overview
The preceding section examined the accumulation of costing in a job order costing system in a
manufacturing enterprise. This section illustrates the procedures used in job-order costing
system. It also discusses the application of job-order costing system for a service enterprise.

6.4.1 Objectives
This section exemplifies the application of job -order costing system in manufacturing
enterprises. It also describes the application of job-order costing system to a service
enterprise.

To illustrate the procedures used in job-order costing, we will examine the accounting entries
made by Oxorm Company during November of 1996. The company worked on two
production jobs:
Job number C12, 80 deluxe wooden canoes
Job number F16, 80 deluxe aluminum fishing boats.

The job numbers designate these as the twelfth canoe production job and the sixteenth fishing
boat production job undertaken during the year. The events of November are described below
along with the associated accounting entries.

6.4.2 Purchase of materials

Four thousand square feet of rolled aluminum sheet were purchased on account for Br.
50,000. The purchase is recorded with the following journal entry.

(1) Raw material Inventory --------------------------------------10,000

Accounts payable -----------------------------------------------------10,000
The posting of this and all subsequent journal entries to the ledger are shown is exhibit 6-1
later.

6.4.3 Use of Direct material and indirect material

Use of direct material

On November 1, the following material requisition was filed.

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Requisition number 802: 8000 board feet of lumber; at Br 2 per board foot for a total of (for
job number C12) cost of Br 16000.
Requisition number 803: 7200 square feet of aluminum sheet metal, at Br 2.50 per (for job
number F16) square foot, for a total cost of Br 18,000.

The following journal entry records the release of these raw materials to production

(2) Work in process Inventory --------------------------------34,000

Raw materials Inventory---------------------------------------------34,000
The associated ledger posting is shown in exhibit 6-1. These direct material costs are also
recorded on the job cost sheet for each job. The job cost sheet for job number F16 is displayed
below. Since the job cost sheet for job number C12 similar, it is not shown.

Job cost Sheet

Job number F16 Description 80 deluxe aluminum fishing boats

Date started Nov 1, 1996 Date completed Nov. 22, 1996
Number of units completed 80
Direct material
Date Requisition number Quantity Unit price Cost
11/196 803 7200 sq Br 2.50 Br. 18,000
Direct labor
Date Time card number Hours Rate Cost
Various Various time cards 600 Br. 20 Br, 12,000
Date
Manufacturing overhead
Date Activity base Quantity Application rate Cost
11/30/96 Machine hours 2000 Br 9.00 Br 18,000

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 Cost summary
Cost item Amount
Total direct material Br 18,000
Total direct labor 12,000
Total manufacturing overhead 18,000
Total cost Br 48,000
Unit cost Br 6000
Shipping summary
Date Units shipped Units Remaining inventory Cost Balance
11/30/96 60 20 Br 12,000

Use of Indirect material

On November 15, the following material requisition was filed.

Requisition number 804: 5 gallons of bonding glue, at Br 10 per gallon, for a total cost of Br
50.

Small amounts bonding glue are used in the production of all classes of boats manufactured
by Oxorm Company. Since the cost incurred is small, no attempt is made to trace the cost of
glue to specific jobs. Instead, glue is considered an indirect material, and its cost is included in
manufacturing overhead. The company accumulates all manufacturing overhead costs in the
manufacturing overhead account. All actual overhead costs are recorded by debiting this
account. The account is debited when indirect materials are requested, when indirect labor
costs are incurred, when utility bills are paid, when depreciation is recorded on manufacturing
equipment and so forth. The journal entry made to record the usage of glue is as follow:

3) Manufacturing overhead -------------------------------------------50

Manufacturing supplies inventory --------------------------------------------50

The posting of this journal entry to the ledger is shown in exhibit 6-1. No entry is made on
any job cost sheet for the usage of glue, since its cost is not traced to individual production
jobs:

6.4.4 Use of direct labor and indirect labor

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Use of Direct labor
At the end of November, the cost accounting departments uses the labor time tickets filed
during the month to determine the following direct labor costs of each job.

Direct labor job number C12 ---------------------------------Br 9,000

Direct labor job number F16 -------------------------------------12,000
-------------------------------------12,000
Total direct labor Br 21,000

The journal entry made to record there costs is shown below:

(4) Work -in-process inventory ------------------------------ 21,000
Wages payable -----------------------------------------------------21,000

The associated posting is shown is exhibit 6-1. These direct labor costs are also recorded on
the job cost sheet for each job. The job cost sheet for job number F16 is shown above. Only
one direct labor entry is shown on the job cost sheet. In practice, there would be numerous
entries made on different date at a variety of wage rates for different employees.

Use of Indirect labor

The analysis of labor time cards undertaken on November 30 also revealed the following use
of indirect labor.

Indirect labor: not charged to any particular job, Br 14,000

This cost is comprised of the production supervisor’s salary and the wages of various
employees who spent some of their time on maintenance and general cleaning duties during
November. The following journals entry is made to add indirect labor costs to manufacturing
overhead.

5) Manufacturing overhead -------------------------------14,000

Wages payable ------------------------------------------------------14,000

No entry is made on any job cost sheet, since indirect labor costs are not traceable to any
particular job. In practice, journal entries (4) and (5) are usually combined into one compound
entry as follows:

Work in process inventory ---------------------------------21,000

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Manufacturing overhead ----------------------------------- 14,000
Wages payable -------------------------------------------------------35,000

6.4.5 Incurrence and Application of Manufacturing Overhead Costs

Incurrence of manufacturing overhead costs

The following manufacturing overhead costs were incurred during November

Manufacturing overhead:
Rent on factory building -----------------------------------Br 3000
Depreciation on equipment -------------------------------- 5000
Utilities (electricity natural gas -------------------------- 4000
Property taxes ------------------------------------------------- 2000
Insurance ------------------------------------------------------ 1000
Total --------------------------------------------------------- Br 15,000

The following compound journal entry is made on November 30 to record these costs.
6) Manufacturing overhead -----------------------------------15,000
Prepaid Rent -------------------------------------------------------------30,000
Accumulated depreciation ---------------------------------------------5000
Accounts payable (utilities and property taxes) -------------------- 6000
Prepaid Insurance -------------------------------------------------------- 1000

The entry is posted in exhibit 6-1. No entry is made on any job cost sheet, since
manufacturing overhead costs are not traceable to any particular job.

Application of manufacturing overhead

Various manufacturing overhead costs were incurred during November and these costs were
accumulated by debiting the manufacturing overhead account. However no manufacturing
overhead costs have yet been added to work in process inventory or recorded on the job cost
sheets. The application of overhead to the firm's products is based on predetermined overhead
rate. This rate was computed by the accounting department at the beginning of 1996 as
follows:

Predetermined overhead rate = budgeted total manufacturing overhead for 1996

Budgeted total machine hours for 1996

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 = Br 360.00 = Br 9. 00 per machine hour
40,000
Factory machine usage records indicate the following usage of machine hours during
November.

Machine hours used: job number C12-----------------------------------1,200 hours

Machine hours used: job number F16 --------------------------------- 2,000 hours
Total machine hours -----------------------------------------------------Br.
-----------------------------------------------------Br. 3200 hours

The total manufacturing overhead applied to work in process inventory during November is
calculated as follows:
Machine predetermined Manufacturing
Hours overhead rate overhead applied
Job number C12 1200 X Br 9.00 = Br 10,800
Job number F16 2000 X 9.00 = 18,000
Total manufacturing overhead applied ------------------------------ Br 28,800

The entry is posted in exhibit 6-1 and the manufacturing overhead applied to job number F16
is entered on the job cost sheet above.

Summary of overhead Accounting

As the following time line shows, three concepts are used in accounting for overhead.
Overhead is budgeted at the beginning of the accounting period, it is applied during the
period, and actual overhead is measured at the end of the period.

Time
Beginning of _________________________________________ End of accounting
Accounting period Period

The following diagram summarizes the accounting procedures for manufacturing overhead.

Manufacturing overhead
Actual manufacturing overhead costs manufacturing overhead is applied

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are accumulated as they are incurred to production jobs

Various Account work in process inventor

The associated credits are to various accounts Manufacturing overhead is added related to
manufacturing overhead costs to work in process inventory

The left side of the manufacturing overhead account is used to accumulate actual
manufacturing overhead costs as they are incurred throughout the accounting period. The
actual costs incurred for indirect material, indirect labor, factory rental, equipment
depreciation, utilities property taxes, and insurance are recorded as debits to the account.

The right side of the manufacturing overhead account is used to record overhead applied to
work in process inventory.

When the left side of the manufacturing overhead account accumulates actual overhead costs,
the right side applies overhead costs using the predetermined overhead rate, based on
estimated overhead costs. The estimates used to calculate the predetermined overhead rate
will generally prove to be incorrect to some degree. Consequently; there will usually be a
non- zero balance left in the manufacturing overhead account at the end of the year. This
balance is usually relatively small, and its disposition is covered later in this illustration.

6.4.6 Selling and Administration costs

During the month of November, Oxorm Company incurred selling and administrative costs as
follows:

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Rental of sales and administrative offices -------------------------------Br 1500
Salaries of sales personnel -------------------------------------------------- 4000
Salaries of management --------------------------------------------------------8000
Advertising -----------------------------------------------------------------------1000
Offices supplies used ----------------------------------------------------------- 300
Total -------------------------------------------------------------------------------14,000
-------------------------------------------------------------------------------14,000

Since there are not manufacturing costs, they are not added to work in process inventory.
Selling and administration costs are period costs, not product costs; they are treated as
expenses of the accounting period. The following journal entry is made.

8) Selling and administrative expense -------------------------14,800

Wage payable ------------------------------------------------------------12,000
Accounts payable -------------------------------------------------------10,000
Prepaid rent ------------------------------------------------------------- 1500
Office supplies inventory --------------------------------------------- 300

6.4.7 Completion of a Production Job and Sales of Goods Completion of a

Production Job.

Job number F16 was completed during November whereas job number C12 remained in
process. As the job cost sheet above indicates, the total cost of job number F16 was Birr
48,000. The following journal entry records the transfer of these jobs costs from work in
process Inventory to finished goods inventory.

10) Accounts Receivable ----------------------------54,000

Sales Revenue ------------------------------------------------54,000

11) Cost of goods sold ------------------------------36,000

Finished goods inventory ----------------------------------36,000

The remainder of the manufacturing costs for job number F16 remains in finished goods
inventory until some subsequent accounting period when the units are sold. Therefore, the
cost balance for job number F16 remaining in inventory is Br, 12,000 (20 units remaining
times Br 600 per unit). The balance is shown on the job cost sheet above.

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6.4.8 Under applied and over applied overhead

During November, Oxorm Company incurred total actual manufacturing overhead costs of
Br. 29,050 but only Br. 28,800 of overhead was applied to work-in-process inventory. The
amount by which actual overhead exceeds applied overhead, called under applied overhead is
calculated below.

Actual manufacturing overhead (50 +14,000+15,000) Br 29,050

Applied manufacturing overhead (9X3200)
(9X3200) 28,800
Under applied overhead Br 250

If actual overhead had been less than applied overhead the difference would have been called
over applied overhead. Under applied or over applied overhead is caused by errors in the
estimates of overhead and activity used to compute the predetermined overhead rate. In this
illustration, Oxorm Company’s predetermined overhead rate was understated by a small
amount.

Disposition of under applied or over applied overhead

At the end of an accounting period, the cost accountant has two alternatives for the disposition
of over applied overhead. Under, the most common alternative the under applied or over
applied overhead is closed to cost of goods sold. This is the method used by Oxrom
Company, and the required journal entry is shown below.

12) Cost of goods sold --------------------------------------------------250

Manufacturing overhead-----------------------------------------------------250

The entry which is posted in exhibit 6-1 brings the balance in the manufacturing account to
zero. This account is then clear to accumulate manufacturing overhead costs incurred in the
next accounting period. Journal entry (12) has the effect of increasing cost of goods sold
expense. This reflects the fact that the cost of the units sold had been understated due to the
slightly understated predetermined overhead rate. Most companies use this approach because
of it is simple and the amount of under applied or over applied overhead is usually small.
Moreover, most firms wait until the end of the year to close under applied or over applied
overhead into cost of goods sold rather than making the entry monthly as in this illustration.

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Peroration of under applied or over applied overhead

Some companies use a more accurate procedure to dispose of under applied of over applied
overhead. . This approach recognizes that underestimation or overestimation of the
predetermined overhead rate affects not only the cost of goods sold, but also work -in-process
inventory and finished goods inventory. As shown below, applied overhead passes through all
three of these accounts. Therefore all three accounts are affected by any inaccuracy in the
predetermined overhead rate.
Work in process inventory Finished goods inventory Cost of goods sold
Applied overhead Applied overhead applied overhead is
Is added to work is included in cost included in cost of goods
in Process of goods completed sold.
When under applied or over applied overhead is allocated among the three accounts shown
above, the process is called proportion. The amount of the current periods applied overhead
remaining in each account is the basis for the proration procedure. In the Oxorm company
illustration the amounts of applied overhead remaining in the three accounts on November 30
are determined as follows: Finished goods Inventory Cost of
goods sold
Overhead applied
To job C12 10,800 Applied overhead Applied overheadtransferred Over
applied to job transferred to finished goods to cost of goods sold when 60
F16 18,000 when job F16 was completed out of 80 units wide 13,500
Applied overhead remaining in each account in November 30 is
Account Explanation Amount Percentage Calculation of
percentage
Work in process Job C12 only Br 10,000 37.5% 10,800 /28,800
Finished good ¼ of units in job 16 4500 15.6% 4500/28,800
Cost of goods sold ¾ of units in job F16 13,500 46.9% 13500/28,800
Total overhead applied in November Br 28,800 100%

Using the percentages calculated above, the peroration of Oxurm Company under applied
overhead is determined as follows:

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Account Under applied Percentage Amount added to
overhead account
Work in process Br 250 37.5% Br 93.75
Finished goods 250 15.6% 39.00
Cost of goods sold 250 46.9% 117.25
Total under applied
prorated Br 250
If Oxorm Company had chosen to prorate under applied overhead, the following journal entry
would have been made.
Work in process inventory-------------93.75
Finished goods inventory---------------39
Cost of goods sold------------------------117.25
Manufacturing overhead-----------------------------250

Since this is not the method used by Oxurm Company in our controlling illustration, this entry
is not posted to the ledger in exhibit 6-1.

6.9 POSTING JOURNAL ENTRIES TO THE LEDGER

All of the journal entries in the Oxurm company illustration are posted to the ledger in exhibit
6-1. An examination of these T-accounts provides a summary of the cost flows discussed
throughout the illustration.

Exhibit 6-1 Ledger Accounts for Oxorm Company Illustration

Accounts Receivable
Receivable Account payable
Bal. 11,000 3000 bal
(10) 54,000 10,000 (1)
6000 (6)
1000 (8)
Prepaid enhance wages payable
10,000 Bal
Bal.2000 1000(6) 21,000 (4)
14,000(5)
12,000 (8)

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Prepaid rent Office supplies inventory
Bal 5000 3000(6)
1500(8) Bal 900 300 (8)

Manufacturing supplies inventory Accumulated depreciation equipment

Bal 750 50 (3) 105,000 Bal
5000 (6)

Raw materials Inventory manufacturing overhead

Bal 30,000 34,000 (2) (3) 50 28,800 (7)
(1) 10,000 (5) 14,000 250 (12)
(6) 15,000

Work is process inventory Selling and Administration expenses

Bal 4000 48,000 (9) 14,850
(2) 34,000
(4) 21,000
(7) 28,800

Finished goods inventory Sales Revenue

Bal 12,000 36,000 (11) 54,000 (10)

(9) 48,000

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6.5 JOBS -ORDER COST SYSTEMS FOR SERVICE ENTERPRISE

A job order cost accounting system may be useful to the management of a service enterprise
in planning and controlling operations. Since the “product" of such an enterprise is service,
management focus is on direct labor and overhead costs. The cost of any materials or supplies
used in rendering services for a client is usually small in amount and is normally included as
part of the overhead.

The direct labor and overhead costs of rendering services to clients are accumulated in a work
in process account, which is supported by a cost ledger. A job cost sheet is used to accumulate
the costs for each client’s job. When a job is completed and the client is billed, the costs are
transferred to a cost of services account. This account is similar to the cost of merchandise
sold account for a merchandising enterprise or the cost of goods sold account for a
manufacturing enterprise. A finished goods account is not necessary, since the revenues
associated with the service are recorded after the services have been rendered.

In practice, additional accounting consideration unique to service enterprise may need to be

considered. For example, a service enterprise may bill clients on a weekly or monthly basis
rather than waiting until a job is completed. In these situations, a portion of the costs related to
each billing should be transferred from the work in process account to the cost of service
account.

Learning Activity 3
Record the entry for the following transactions.
a. Purchase of materials on account , Br 2500
b. Factory overhead costs incurred on account, Br 300.
c. Depreciation of machinery , Br 1500
d. Direct materials request turned and direct factory labor used is respectively Br
600 and Br 5000 respectively.
e. The factory overhead rate is 50% of direct labor cost.

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Check your progress exercises

I. Multiple choice questions

1. The account maintained by a manufacturing business for inventory of goods in the process
of manufacture is:

A. Finished goods C. Work in process

B. Materials D. None

2. If the factory overhead account has a credit balance, factory overhead is said to be:

A. Under applied C. Under absorbed

B. Over applied D. None of the above

3. For which of the following would the job order cost system be appropriate?

A. Antique furniture repair shop C. coal manufactures

B. Rubber manufactures D. All of the above

4. Which of the following is not a volume based out driver?

A. Machines hours C. Direct labor costs
B. Direct labor hours D. None of the above

5. When a job is completed and the client is billed, the costs are trampled to what account in a
cost accounting system for a service enterprise?
A. Accounts payable C. Purchase account
B. Cost of service account D. None of the above

6. Product costing in a manufacturing firm is the process of:

A. Accumulating the companies period costs

B. Allocating costs among the organizational departments
C. Placing a value on the company's fixed assets
D. Assigning costs to the organizations inventory
E. Assigning costs to the company's financial statement

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7. XYZ company incurred Br 50,000 of direct labor and Br 2000 of indirect labor the proper
journal entry to record there events would include a debit to work in process for:
A. Br 0 because work in process should be credited
B. Br 0 because work in process is not affected
C. Br 2000
D. Br 50,000
E. Br 52,000
8. ABC company, which applies overhead at rate of 150% of direct labor cost, began work on
job no 101 during February. The job was completed in March and sold during April,
having accumulated direct material and labor chapter of Br. 15,000 and Br 6000
respectively. On the bases of this information, the total overhead applied to job no 101
amounted to:

A. Br 0 D. Br 8000
B. Br 4000 E. Br 9000
C. Br 6000

9. The left side of the manufacturing overhead amount is used to accumulate

A. actual manufacturing overhead costs ad incurred throughout the accounting period
B. Overhead applied to work in process inventory
C. under applied overhead
D. Predetermined overhead
E. Over applied overhead

10. As production takes place, all manufacturing costs are added to the:
A. work in process inventory account
B. Manufacturing overhead inventory account
C. Cost of goods sold account
D. Finished goods inventory account
E. Production labor account

11. A print shop would likely utilize

A. Job -order costly
B. Process costing

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C. Job-order brightly
D. Process budget
E. Joint costing
12. A typical job-cost sheet would practice information about all of the following items
related to an order except.
A. the art of direct materials used
B. administration costs
C. Direct labor costs incurred
D. Applied manufacturing overhead
E. Direct labor hearts worked

13. Walton manufacturing recently sold goods that cost Br 35,000 for Br 42,000 cash. The
journal entries to record this transaction would include:
A. A credit to work in process inventory for Br 35,000
B. a debit to sales account for Br 42,000
C. A credit to profit on sales for Br 7000
D. A debit to finished goods inventory for Br 35,000
E. A credit to sales revenue for Br 42,000

14. TOT Company worked on four jobs during its first year of operations: No 410,402,403
and 404 Nos. 401 and 402 were completed by year end, and no 401 was sold at a profit of
40% cost. A review of job no 403's cost sheet revealed direct materials charges of Br
20,000 and total manufacturing costs of Br. 25,000. It Tokyo company applies overhead at
150% of direct labor cost, the overhead applied to job no 403 must have been:
A. Br 0
B. Br 2000
C. Br 3000
D. Br 3333
E. Br 5000

15. Which of the following entries walled not likely be a user of job costing system?
A. Custom furniture manufactories
B. Consuming firms

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C. Hospitals
D. Law firms
E. None of the above, as all are likely users
The following data apply to question # 6 through 8.
Selected data concerning the past fiscal year’s operations of the Eyoha Manufacturing
Company are presented below:
Inventories
Beginning Ending
Direct materials Br.75, 000 Br.85, 000
Work in process 80, 000 30, 000
Finished goods 90, 000 110,000
Other data follows:
Direct materials used……………………………………..Br.326, 000
Total manufacturing costs charged to production…………… 686, 000*
* Include direct materials, direct labor, and factory overhead applied at the rate of 60% of
direct labor cost. Assume no under or over applied manufacturing overhead.
16. The cost of direct materials purchased during the year amounted to:
A. Br.411, 000 D. Br.336, 000
B. Br.360, 000 E. None of the above
C Br.316, 000

17. Direct labor costs charged to production during the year amounted to:
A. Br.135, 000 D. Br.216, 000
B. Br.225, 000 E. None of the above
C Br.360, 000

18. The costs of goods manufactured during the year was

A. Br.636, 000 D. Br.716, 000
B. Br.766, 000 E. None of the above
C Br.736, 000
19. All of the following statements are correct when referring to job order costing except:
A. All the costs appearing on a job cost sheet are actual costs.

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 B. Indirect materials are not charged to a specific job.
C. Job order costing would be appropriate for a textbook publisher.
D. Job order costing is applicable to those industries in which work is done against
orders received from customers.
E. None of the above.

II. Exercises

1. The related data that follow relate to the Berger furniture company

Direct material purchased ---------------------Br 160,000

Direct material used --------------------------- 79,000
Direct labor-------------------------------------- 170,000
Manufacturing overhead incurred ---------- 100.000
Manufacturing overhead applied ----------- 90,000

During the year, products costing Br 310,000 were completed, and products costing Br
316,000 were sold for Br 455,000
Required: propose journal entries to record the preceding transaction and events.

2. Company which uses a job costing system is a labor intensive firm, with many skilled
crafts people on the payroll. Job No 789 was the only job in process on January 1, having
costs of Br 22,500 as of that date: Direct materials used and direct labor incurred January
were:

Job No Direct Materials Direct Labour

Job. No 789 Br 2000 Br 6000
Job No 790 9000 10,000
Job no 791 14,000 8000
Job no 791 was the only job in production as of January 31

Required
A. Should mono company use direct labor or machine hours as a cost driver why?
B. Assume that the company decided to use direct labor as its art driver. If the budgeted
amount of direct labor and manufacturing overhead are anticipated to be Br 200,000
and Br 300,000 respectively. What is the firm's predetermined overhead rate?

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 C. Compute the cost of work in process inventory as of January 31
D. Compute the cost of completed jobs during January
E. Suppose that the company sold its completed jobs, adding a 40% markup to cost. How
much would the firm report as ( 1) art of goods sold and ( 2) sales revenue?

6.6 SUMMARY

Product costly is the process of accumulating the costs of a production process and assigning
them to the firm's products. Product costs are needed for three major purposes: 1) to value
inventory and cost of goods sold in financial accounting 2) to provide managerial accounting
information to managers for planning, cost control and decision making and (3) to provide
cost data to various organizations outside the firm, such as equipment agencies or insurance
companies. Information about the costs of producing goods and services is needed in
manufacturing companies, service industry firm and unprofitable organization.

Two types of product costing systems are used, depending on the type of product
manufactured. Process costing is used by companies that produce large number of nearly
identical products, such as cannot dog food and motor oil. Job order costing, the topic of this
unit, is used by firm's that produce relatively small members of dissimilar products such as
custom furniture and major kitchen appliances.

In job order costing system, the costs of direct materials, direct labor and manufacturing
overhead are first entered into the work -in-process inventory account. When goods are
completed, the accumulated manufacturing costs are transferred from work-in costs are
transferred from finished goods inventory. Finally there product costs are transferred from
finished goods inventory. Finally, there product costs are transferred from finished goods
inventory to cost of goods sold when sales occur direct material to cost of goods sold when
sales occur. Direct material and direct labor are traced easily to specific batches of production
called job orders. In contrast, manufacturing overhead is an indirect cost with prospect job
orders or units of product. Therefore overhead is applied for production jobs using a
predetermined overhead rate, which is based on estimates of manufacturing overhead and the
level of some cost driver. The most commonly used volume based cost drivers are direct labor

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hours direct labor cost, and machine hours, since there estimates will seldom be completely
accurate, the amount of overhead applied during an account period to work-in-process
inventory will usually differ from the actual costs incurred for overhead items. The difference
between actual overhead and applied overhead , called over applied or under applied may be
closed out into cost of goods sold or prorated among work-in process inventory, finished
goods inventory and cost of goods sold.

6.7 ANSWER TO LEARNING ACTIVITY

Learning activity 1
1. The uses of product costs are for valuing inventory on the balance sheet and to
compute cost of goods sold expense on the income statement for financial accounting)
for planning cost entry ( for managerial accounting); and for reporting to interested
organization.

Learning Activity 2
1. Job cost sheet is used to record cost of direct material, direct labor and manufacturing
overhead for a particular job or batch. It is a subsidiary ledger account for the work in
process inventory account in the general ledger.
2. Overhead absorption is the third step in assigning manufacturing overhead costs. All
costs associated with each production department are assigned to the product units on
which a department has worked.
3. Materials are transferred from the store room to the factory in response to materials
requisitions which may be issued by the manufacturing department concerned or by a
central scheduling department shrerool personnel records the issuances on the
materials requisition by in the physical quantity data. Transfer of responsibility for the
materials is evidenced by the signature or initials of the storeroom and factory
personnel contained.
4. Predetermined overhead rate= budgeted manufacturing overhead cost
Budgeted amount is cost driver
Learning Activity 3
a. Materials -------------------------------------------2500
Accounts payable --------------------------------------------2500

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 b. Factory overhead -----------------------------------300
Account payable --------------------------------------------3000
c. Factory overhead ------------------------------------1500
Accumulated depreciation machinery --------------------1500
d. work-in-process-------------------------------------5600
Materials------------------------------------------------------ 600
Wages payable ----------------------------------------------5000
e. work-in -process --------------------------------------2500
Factory overhead -----------------------------------------------2500

6.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISE

I. Multiple choices

1. C 2.B 3.A 4. D 5. B

6. D 7. D 8. E 9. A 10. A

11. A 12. B 13. E 14. C 15. E

6.9 MODEL EXAM QUESTIONS

Raw material inventory ---------------------------------160,000
Accounts payable -----------------------------------------------------160,000
Work in process inventory ------------------------------79,000
Raw material inventory ----------------------------------------------79,000
Work in process inventory ------------------------------170,00
Wages payable --------------------------------------------------------170,000
Work in process inventory ----------------------------- 90,000
Manufacturing overhead ---------------------------------------------90,000
Finished goods inventory -------------------------------310,00
Work in process inventory ------------------------------------------310,00
Cost of goods sold ---------------------------------------316,00
Finished goods inventory ---------------------------------------------316,00
Accounts receivable ---------------------------------------455,00

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 Sales revenue -----------------------------------------------------------455,00

A. The company should use direct labor because it is a labor intensive firm, with many skilled
crafts people on the payroll. More than likely a majority of overhead is “driven “by people
rather than machine operation.
B. Br 300,000 Br 200,000 = 150% of direct labor cost
C. Direct material -------------------------------------------Br 14,000
Direct labor -------------------------------------------------- 8,000
Manufacturing overhead (Br 8,000 *150%) ------------ -12,000
Total cost of job No 791----------------------------------- Br 34,000
D. Beginning work in process -------------------------- Br 22,500
Direct material ( Br 2000 +Br 9000) --------------- 11,000
Direct labor (6000 +Br 10,000) -------------------- 16,000
Manufacturing overhead (Br 16,000 *15%) ----- 24,000
Total cost of job no 779 and 1790 --------------- Br 73,500
E. Cost of goods sold: Br 73,550
Sales revenue: Br 102,900 (Br 73,550 *140%)

6.10 GLOSSARY

1. Activity base (or cost driver): a meaner of an organization activity that is used as a
basis for specifying cost behavior.
2. Job cost sheet: A document on which the costs of direct material, direct labor and
manufacturing overhead are recorded for a particular production job orders of
production.
3. Job -order costing system: a product costly system in which costs are assigned to
batches or job orders of production.
4. Material requisition form: a document up on which the production department
supervisor requests the release of raw materials for production.
5. Peroration: The process is allocating under applied or over applied overhead to work
in process inventory, finished goods inventory and cost of goods sold.

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6. The ticket: a document that records the amount of time an employee spends on each
production job.
7. Volume based cost driver: a cost driver that is closely associated with production
volume such as direct labor hours or machine hours.

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