MGA B03

Introduction
to
Managerial
Accounting

Fall 2024
Session 4 & 5
1
 Job Costing

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Copyright ©2021 John Wiley & Sons Canada, Ltd.

 Product vs. Period Costs

• Product costs are involved in the purchasing or making of a product and are
the direct and indirect costs of producing goods or services
o Accumulated on the balance sheet as inventory until the product is sold
o Examples: direct materials, direct labour

• Period costs are operating costs that are not related to the purchasing or
making of a product
o These costs are expensed as incurred
Week 2 Concept Review
o Examples: selling and admin expenses
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 Merchandising Companies
• Merchandising companies purchase inventory from suppliers and
calculate the cost of goods sold as follows:
o Cost of Goods Sold = Beginning Merchandise Inventory + Purchases -
Ending Merchandise Inventory

• Purchases include the cost of the products themselves plus costs such as
freight, duty, and taxes that are incurred in bringing the inventory to the
seller’s location

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 Manufacturing Companies
• Manufacturing companies produce inventory in-house and
calculate cost of goods sold as follows:
o Cost of Goods Sold = Beginning Finished Goods Inventory + Cost
of Goods Manufactured - Ending Finished Goods Inventory

• Cost of Goods Manufactured includes three components:

o Direct materials used
o Direct labour
o Manufacturing overhead (indirect expenses such as indirect
labour and materials, utilities and rent for the plant, etc)

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 Cost of Goods Manufactured – Cost Flow
Cost of Goods Manufactured (COGM) =
Beginning work-in process inventory
+ Manufacturing Cost (DM used + DL + manufacturing OH)
- Ending work-in-process inventory

• To calculate direct materials used :

o Beginning raw materials + raw materials purchases – ending raw materials
• Direct labour: obtained from company’s general ledger
• Manufacturing overhead: obtained from company’s general ledger

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 Example of COGM Calculation
Raw Materials, Jan 1, 2012: $15,000
+Raw Materials Purchased in 2012: 105,000
− Raw Materials, Dec 31, 2012: (12,000)
= Direct Materials Used: $108,000
Direct Labour: $88,000
Manufacturing OH:
Indirect labour $24,000
Machine amortization 28,000
Utilities 32,000 Manufacturing costs incurred in 2012: $288,000

Plant insurance 8,000 + WIP, Jan 1, 2012 28,000

Total Manufacturing Overhead: $92,000 – WIP, Dec 31, 2012 (26,000)

Manufacturing Costs Incurred in 2012 $288,000 Cost of Goods Manufactured: $290,000

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 Job Costing vs. Process Costing
• Job costing is best used when
products can be distinguished from
one another. Assigns costs to custom
products or services.
• Process costing is best used when
similar products are mass-produced.
Allocates both direct and overhead
costs to continuous-flow processing
lines.
• In many companies, hybrid costing
systems are used that include
characteristics of both job and
process costing.

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Tracing and Allocating Costs to Jobs

EXHIBIT 5.7
Tracing and Allocating
Product Costs to Jobs

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 Job Cost Records
• Each job’s costs are maintained on a job cost record.
• The job cost records form the subsidiary ledger for Work in process inventory.

EXHIBIT 5.8
Job card Record for Aluminum Benders

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 Allocating Overhead Costs to Jobs
Allocating overhead to individual products is a two-
stage process:
STEP 1
1. In the first stage, a variety of overhead costs are
collected in an overhead cost pool, a group of
individual costs that are accumulated for a
particular purpose.
 Identify the relevant cost object first (In a job
costing system, the cost object is a job)
 Identify one or more overhead cost pools and
allocation bases next
STEP 2
2. In the second stage, costs are allocated from the
cost pool to individual jobs.

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 Allocating Overhead Costs to Jobs
Manufacturing job costing systems frequently allocate overhead using
one of the following allocation bases:
• Direct labour hours
• Direct labour costs
• Machine hours

Allocation base should be chosen because it is a good cost driver for total costs

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 Overhead Allocation Rates STEP 1

For each overhead cost pool, calculate an overhead allocation rate, the dollar
amount per unit of allocation base used to allocate overhead to each cost
object.
• Companies may use an actual or an estimated overhead allocation rate.
Actual overhead cost
Actual allocation rate =
Actual quantity of the allocation base

Estimated overhead cost

Estimated allocation rate =
Estimated quantity of the allocation base

• The actual allocation rate cannot be computed until the accounting period is over.
• The estimated allocation rate can be computed at the beginning of the accounting period.

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 Overhead Allocation Rates STEP 1 EXAMPLE

Chausse Manufacturing makes road paving equipment. At the beginning of the year,
overhead costs were estimated to be $450,000. However, the actual overhead was
$504,000. Chausse uses direct labour hours as the cost allocation base. At the
beginning of the year, total direct labour hours were estimated at 10,000 hours, but
actual direct labour hours for the year totaled 12,000 hours. Compute the actual
overhead rate and the estimated overhead rate.

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 Overhead Allocation Rates STEP 1 EXAMPLE

Chausse Manufacturing makes road paving equipment. At the beginning of the year,
overhead costs were estimated to be $450,000. However, the actual overhead was
$504,000. Chausse uses direct labour hours as the cost allocation base. At the
beginning of the year, total direct labour hours were estimated at 10,000 hours, but
actual direct labour hours for the year totaled 12,000 hours. Compute the actual
overhead rate and the estimated overhead rate.

$504,000
Actual allocation rate = $42/hr
12,000 hours

$450,000
Estimated allocation rate = $45/hr
10,000 hours

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 Allocating Overhead Costs to Jobs STEP 2

For each overhead cost pool, allocate costs to the cost object.
 Allocate overhead costs by multiplying the overhead allocation rate
by the quantity of the allocation base used by each job.

Direct labour hours times the estimated overhead rate would be used
in the previous example.

# of labor hours actually spent on each job $45 per hour

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 Actual and Normal Costing
Actual costing is when overhead is allocated using the actual volume
of the allocation base multiplied by the actual allocation rate.
Normal costing is when the estimated allocation rate and actual
quantity of the allocation base are used to allocate overhead.

Actual Costing Normal Costing

Direct costs Actual costs Actual costs

Indirect costs Actual rate x actual usage of cost Estimated rate x actual usage of
allocation base cost allocation base

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 Job Costing Example (Service Sector)
Serena-Sturm is an architectural firm with a professional staff of 5 architects and a support staff of 7. Some
projects are done for a fixed fee, while others are billed for the actual hours spent on the project. You are
given the following information for Serena-Sturm (SS) for 2012. What is the estimated indirect cost rate if #
of projects is used as the cost allocation base? Is this a good choice for the cost allocation base?
BUDGETED ACTUAL
Direct Costs:
Professional labor costs $400,000 $420,000
Professional labor hours 10,000 12,000 Estimated indirect cost rate =
Professional labor rate/hour $40 $35
Remember:
$450,000/1,000 projects = good allocation
Indirect Costs:
base = cost
Designers, drafters $360,000 $360,000 $450/project driver
Office costs 40,000 80,000
Office salaries & wages 45,000 56,800
Travel & entertainment 5,000 7,200 Terrible choice for a cost
Total indirect costs $450,000 $504,000 allocation base; ignores
Other Information:
resource consumption of
Number of projects 1,000 1,200 the projects.
Number of blueprints prepared 3,600 4,000

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 Job Costing Example (Service Sector)
SS has a costing system with a single direct cost pool. If SS uses a single indirect cost pool,
determine both the estimated and actual indirect cost rates using (a) the number of professional
labour hours and (b) the number of blueprints prepared as cost allocation bases.
BUDGETED ACTUAL
Direct Costs:
Professional labor costs $400,000 $420,000
Potential Cost Actual Rate Estimated Rate
Professional labor hours 10,000 12,000 Allocation Base
Professional labor rate/hour $40 $35
$504, 000 $450, 000
Indirect Costs: Professional labor
hours 12, 000 hrs 10, 000 hrs
Designers, drafters $360,000 $360,000 $42 / hr $45 / hr
Office costs 40,000 80,000
Office salaries & wages 45,000 56,800 $504, 000 $450, 000
Travel & entertainment 5,000 7,200
Number of blueprints 4, 000 bpts 3, 600 bpts
$126 / hr $125 / bpt
Total indirect costs $450,000 $504,000

Other Information:
Number of projects 1,000 1,200

Number of blueprints prepared 3,600 4,000

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 Job Costing Example (Service Sector)
SS was asked to prepare a fixed fee bid for an out-of-town project called The Culebra Complex. The
budgeted professional hours for this project was 400, and the job is expected to require the
preparation of 7 blueprints. Compute the budgeted project cost using (a) professional labour
hours and (b) the number of blueprints prepared as a cost driver for indirect costs.

Costs Cost Allocation Base: Cost Allocation Base:

Potential Cost Estimated Professional labor hours Number of blueprints
Allocation Base Rate
Professional labor Direct costs $40/hr x 400 hrs = $16,000 $40/hr x 400 hrs = $16,000
$45/hr
hours
Indirect costs $45/hr x 400 hrs = $18,000 $125/bpt x 7 bpts = $875
Number of
$125/bpt
blueprints Total $34,000 $16,875

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 Why Are Costs so Different?
Why do the different cost allocation bases yield vastly different project costs?
BUDGETED

Direct Costs:
Costs Cost Allocation Base: Cost Allocation Base:
Professional labor Number of blueprints
Professional labor costs $400,000 hours
Professional labor hours 10,000
Direct costs $16,000 $16,000
Professional labor rate/hour $40
Indirect costs $18,000 $875
Indirect Costs:

Designers, drafters $360,000 Total $34,000 $16,875

Office costs 40,000

Office salaries & wages 45,000

If professional labour hours is a good measure
Travel & entertainment 5,000
of activity, then this project is expected to be
Total indirect costs $450,000
400 hrs/10,000 hrs, or 4% of the year’s activity.
Other Information: If # of blueprints is a good measure of activity,
Number of projects 1,000 then this project is expected to be 7
bpts/3,600 bpts, or less than 0.2% of the year’s
Number of blueprints prepared 3,600
activity.
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 Journal Entries in Job Costing

• Flow of costs matches the flow of the goods through the factory
• Source documents used to update accounts for direct costs
• Normal costing is used, so overhead is charged to jobs based on
estimated overhead rates
• Overhead cost control is a temporary account used in normal
costing
o Debit overhead cost control for actual overhead costs
o Credit overhead cost control when overhead allocated to WIP

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 Job Costing in Manufacturing
EXAMPLE: Logo Lamps makes desk lamps stamped with the customer’s logo.

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Flow of Costs in Job Costing

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Flow of Costs in Job Costing

Temporary
Account

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Flow of Costs in Job Costing

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Flow of Costs in Job Costing

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Flow of Costs in Job Costing

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Example: Journal Entries in Job Costing

The materials storeroom receives a shipment of direct and indirect

materials that cost $12,500. Prepare the journal entry.
Raw materials inventory 12,500
Accounts payable 12,500

Materials are sent to the stamping and assembly areas. The cost of
the direct materials is $1,400 and the cost of the indirect materials
is $800. Prepare the journal entry.
Work in process inventory 1,400
Overhead cost control 800
Raw materials inventory 2,200

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Example: Journal Entries in Job Costing
Wages totaling $2,000 are accrued; 75% of these costs are direct
labour and 25% are indirect labour. Prepare the journal entry.
Work in process inventory 1,500
Overhead cost control 500
Wages Payable 2,000

Overhead costs are allocated to work in process using an allocation

rate of 200% of direct labour costs. Prepare the journal entry.
Work in process inventory 3,000

Overhead cost control 3,000

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Example: Journal Entries in Job Costing

Job #1208, with a total cost of $2,200 is completed. Prepare the

journal entry.
Finished goods inventory 2,200
Work in process inventory 2,200

Job #1208 is shipped to the customer, who is billed for $4,000.

Prepare the journal entry.
Accounts receivable 4,000
Cost of goods sold 2,200
Sales 4,000
Finished goods inventory 2,200

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 Overapplied or Underapplied Overhead
• Normal costing  actual overhead is different from allocated overhead.
ESTIMATE!
o Over or underapplied overhead is the difference between actual and allocated
overhead.
o Overapplied overhead occurs when actual costs are less than the total amount of
overhead allocated to inventory accounts.
o Underapplied overhead occurs when actual costs are more than the amount of
overhead allocated.

• At the end of the year, the Overhead cost control account is closed out to WIP,
FG & COGS.
• Over or underapplied overhead (if material) is prorated to the 3 accounts ADJUST to
based on a ratio of their account balances; if immaterial it is closed to COGS. CORRECT
MISESTIMATE!

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 Disposition of Misallocated Overhead
Suppose the budgeted overhead was $100,000 fixed overhead plus variable overhead of $10/DL
hour. Expected DL hours were 50,00, so that the estimated overhead rate was $12/DL hour.
Actual DL hours totaled 40,000 for the year and actual overhead was $550,000. At the end of the
year, WIP, FG & CGS had the account balances shown below. Prepare the year-end entry to close
the Overhead cost control account.

WIP $ 100,000 5% Work in process inventory 3,000

FG 200,000 10% Finished goods inventory 7,000

CGS 1,700,000 85% Cost of goods sold 59,500
$2,000,000 Overhead cost control 70,000

Overhead cost control

$550,000 $480,000 ($12/DL hr x 40,000 DL hrs)
$70,000
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Summary of Overhead Allocation

Normal Costing

EXHIBIT 5.13
Overview of Overhead
Allocation Using
Normal Costing

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What are the Uses and Limitations of Job Cost Information?

• Job Cost information is useful for:

o Reporting inventory and cost of goods sold values on financial statements and
income tax returns
o Developing cost estimates to assist in bidding on potential future jobs
o Measuring actual costs to compare to estimated costs
o Developing cost estimates for short-term or long-term decisions

• Limitations are:
o Managers need to consider whether their job cost information is relevant and
reliable.
o Overhead allocations may distort costs for financial statements, income tax returns,
cost-based customer contracts, or other uses.
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Allocated Overhead Costs and Decision Making

• Allocated overhead costs are not relevant information for most short-term
decisions, such as special orders or the use of constrained resources.
• Many overhead costs are fixed; they do not change with changes in the
allocation base or any other measure of activity. Managers may mistakenly
assume that these allocated costs are variable, particularly when the job
costing system uses several cost pools and allocation bases.
• Another problem occurs if the allocation base used to allocate variable
overhead costs is not a cost driver, which means it does not accurately reflect
the use of variable cost resources.

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Judgment/Uncertainties in Job Costing System Design

• Job costing systems are subject to uncertainties and require judgment

when deciding which costs to trace directly, the types of overhead cost
pools, and the allocation base for each overhead cost pool.
• Fixed overhead is not expected to vary with any allocation base, and it
is not always possible to identify or to accurately measure a cost driver
for variable overhead. An allocated overhead generally does not
accurately measure the overhead resources used by a job.

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 Job Costing and Spoilage - Terminology
• Spoilage: unacceptable units discarded or sold
for disposal costs
o Normal spoilage arises under regular operating
conditions & is treated as an inventoriable cost
o Abnormal spoilage is not part of normal
operations & is treated as a period cost

• Reworked units: unacceptable units that are

reprocessed and sold

• Scrap: leftover direct materials that are

discarded or sold for a minimal amount

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 Job Costing and Spoilage
• In job costing, spoilage could be normal spoilage that
coincidentally occurred on this job, but was not due to
any demanding aspects of this job:
 Spoilage costs removed (credit) from Work in process
inventory
 Spoilage costs are debited to Overhead cost control

In this case, a job without spoilage has the same

manufacturing cost per unit as a job where spoilage
occurred

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 Job Costing and Spoilage
• In job costing, spoilage could be abnormal spoilage
that coincidentally occurred on this job, but was not
due to any demanding aspects of this job
 Spoilage costs removed (credit) from Work in process
inventory
 Spoilage costs are debited to Loss from abnormal
spoilage

In this case, a job without spoilage has the same

manufacturing cost per unit as a job where spoilage
occurred

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 Job Costing and Spoilage

• In job costing, spoilage could be spoilage that occurred on this job

due to the job’s demanding specifications
 Spoilage costs are not removed from Work in process inventory

In this case, a job without spoilage has a lower manufacturing cost per
unit than a job where this type of spoilage occurred

EXCEPTION: DEMANDING JOB!

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 Job Costing and Spoilage Example
On January 1 Leia Corp. budgeted the following factory overhead:

Leia expected to use 28,000 DL hours this

Factory rent $40,000
year; overhead is allocated to WIP using DL
Utilities 10,000 hours. Job #3 shows total costs of $12,200.
Normal spoilage 6,000 An inspection reveals that 20% of Job #3 must
$56,000 be scrapped and sold for $100. Prepare the
journal entry to record the spoilage and the
sale of the scrap if the spoilage is considered
Overhead cost control 2,340 normal and is not due to the demanding
specifications of Job #3. If Job #3 was
Cash 100 originally a batch of 10,000 units, what is the
Work in process inventory 2,440 manufacturing cost per unit for the good units
in Job #3?

Mfg cost/unit = ($12,200 - $2,440)/8,000 good units = $1.22/unit.

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 Job Costing and Spoilage Example
On January 1 Leia Corp. budgeted the following factory overhead:

Factory rent $40,000 Leia expected to use 28,000 DL hours this year;
Utilities 10,000 overhead is allocated to WIP using DL hours.
Normal spoilage 6,000 Job #3 shows total costs of $12,200. An
inspection reveals that 20% of Job #3 must be
$56,000
scrapped and sold for $100. Prepare the journal
entry to record the spoilage and the sale of the
scrap if the spoilage is considered abnormal. If
Loss from abnormal spoilage 2,340 Job #3 was originally a batch of 10,000 units,
Cash 100 what is the manufacturing cost per unit for the
Work in process inventory 2,440 good units in Job #3?

Mfg cost/unit = ($12,200 - $2,440)/8,000 good units = $1.22/unit.

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 Job Costing and Spoilage Example
On January 1 Leia Corp. budgeted the following factory overhead:

Factory rent $40,000 Leia expected to use 28,000 DL hours this year;
Utilities 10,000 overhead is allocated to WIP usingDL hours. Job
#3 shows total costs of $12,200. An inspection
Normal spoilage 6,000
reveals that 20% of Job #3 must be scrapped
$56,000 and sold for $100. Prepare the journal entry to
record the spoilage and the sale of the scrap if
the spoilage occurred to the demanding
Cash 100 specifications of Job #3. If Job #3 was originally
a batch of 10,000 units, what is the
Work in process inventory 100
manufacturing cost per unit for the good units
in Job #3?

Mfg cost/unit = ($12,200 - $100)/8,000 good units = $1.5125/unit.

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 Spoilage Opportunity Costs
• Opportunity costs include:
 Forgone profit
 Loss of reputation and market share

• To improve quality, many organizations adopt a variety of business

practices, such as total quality management, Six Sigma, lean
manufacturing, and kaizen costing.

• Quality efforts can dramatically reduce spoilage, rework, and

related opportunity costs.
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Effect of Spoilage Accounting on Manager Behaviour

• Spoilage opportunity costs are not measured or recorded in the accounting

records, which discourages management attention.
• Normal spoilage may seem insignificant because it is often a relatively small
part of the total overhead cost pool.
• Judgment is used to determine normal spoilage, which influences the portion
of spoilage costs included in the overhead cost pool versus the portion
reported as a separate operating loss.
• Rework costs are not usually tracked, giving managers an incentive to
inappropriately rework units to avoid recognizing abnormal spoilage.

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