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Job order costing.

In the April column, we discussed the essentials of cost or managerial accounting. This month we'll continue with a discussion of the specific methods of cost accumulation using job order costing.

We characterized job order costing as generally appropriate when large, unique or special-order items are produced--for instance, airplanes, grand pianos or a special order for fifty tractors. A job order system can be identified by the following characteristics: 1) all costs are collected and assigned to a specific batch or job; 2) costs are assigned for each completed job, rather than for set time periods; 3) only one Work-in-Process inventory account is required; and 4) the cost of completed goods is transferred to the Finished Goods inventory until the units are sold.

Cost is recorded on a job order cost sheet, which can be either a paper record or an electronic one. Three elements of cost must be combined to determine the final total cost of the items produced and the cost per unit. Those costs are raw materials, labor and factory overhead costs.

When raw materials are purchased, they are recorded as Inventory. As a job is begun, the materials are requisitioned into production. Direct materials are recorded as a debit to the Work-in-Process account and a credit to the materials Inventory. Indirect materials (those that aren't easily traced to finished goods but are necessary for production) are debited to the Factory Overhead account.

Labor costs are treated in two stages. First, labor costs must be collected. Time cards, payroll reports, factory time sheets are all used to collect data on hours worked and associated payroll expense. The time worked is analyzed to determine how many hours were spent working directly on the job, what time was indirect labor and how much time was not production-related. Once this analysis is completed, the direct labor is assigned to Work-in-Process while the indirect labor is charged to Factory Overhead. The non-production wages remain classified as Wages Expense or Payroll.

Factory overhead costs are applied to the job using the predetermined overhead rate (see the National Public Accountant, April, 1993, "Accounting Scene" article for a discussion of this rate). The predetermined overhead rate will be stated as some dollar amount per some measure of activity which should be the principal cost driver. For instance, overhead might be closely related to machine hours used, material cost or direct labor and could be expressed as "$5 per machine hour." Factory overhead may be assigned as soon as the activity base is known, but must be assigned no later than the completion of the job.

To assign factory overhead, the Work-in-Process account is debited and the Factory Overhead account is credited. At the end of the period, a balance in the Factory Overhead account indicates the estimates used to compute the predetermined overhead rate were not quite accurate, and the factory overhead was over- or underapplied. If this over- or underapplied amount is relatively small, it is usually closed to Cost of Goods Sold at the end of the period. If the amount is significant or most of the goods remain unsold, it is more reasonable to distribute the discrepancy to the goods by prorating it between the Work-in-Process, Finished Goods and Cost of Goods Sold accounts.

Greater control over factory overhead costs can be achieved if two accounts are used, one to record the actual factory overhead costs incurred (Factory Overhead Control) and another to record the amount applied to products (Factory Overhead Applied). At period end, these two accounts are netted. If control |is greater than~ applied, costs have been underapplied; if applied |is greater than~ control, costs have been overapplied. The over- or underapplied amount is then closed as discussed above.

When the job is done, the material, labor and factory overhead on the cost sheet are totaled. The total cost is divided by the total number of items produced to determine unit cost. This unit cost is a valuable control figure and can be used as part of the pricing decision. The total cost is transferred to the Finished Goods Inventory, to await the sale of the items. Once sold, the cost is transferred from Finished Goods to Cost of Goods Sold.

While our discussion has focused on manufacturing firm activities, job order costing is a valuable management tool for planning and control of costs for service firms as well. Imagine a tax practitioner or consultant who is considering accepting a new client. In order to quote a fair fee, the consultant must know the direct and indirect costs to the firm, must monitor those costs as the job is done and must use the total cost to evaluate whether a change in price is appropriate for the next engagement. A sound understanding of these costing techniques will assist the manager--whether service or manufacturing oriented--in running the firm efficiently.

The following problems will give you practice in using these job order costing techniques. Answers will be available in the June NPA, or call the Education Department for clues!

Quiz on Job Order Costing Techniques

1. George's Good Stuff uses a job order costing system to track costs in his hunting equipment shop in Texas. Since he has no one in the family who understands financial matters, he has asked you to prepare the journal entries for February.

(a) Purchased materials on account for $25,000.

(b) Requisitioned $8,000 of direct materials and $2,000 of indirect materials.

(c) Factory payroll totalling $9,400 had been recorded as Wages Expense but not assigned to manufacturing accounts. The payroll consisted of $7,600 direct labor and $1,800 indirect labor.

(d) Depreciation of $1,200 on factory equipment should be recorded.

(e) A batch of hunting vests was completed with $1,830 of direct labor and $1,450 of materials having been previously recorded. Factory overhead must be applied at 2/3 of direct labor cost.

(f) Miscellaneous factory overhead of $1,250 was incurred.

(g) The hunting vests were shipped to Raygun Associates, who were billed for $5,400.
2. The following information refers to the Magic Company:

 Account Balances

 Beginning Ending
Finished Goods $80,000 $ ?
Work in Process 20,000 ?
Materials 15,000 23,000
Accounts Payable 7,000 5,000
Accrued Payroll 11,000 14,000
Accounts Receivable 45,000 65,000

(a) All sales are on account with a 28% markup above cost.

(b) The accounts payable was used for materials purchases only.

(c) Factory overhead was applied at 150% of direct labor cost.

(d) Miscellaneous factory overhead cost totalled $60,000.

(e) Direct materials issued to production cost $80,000.

(f) Payment on accounts payable totalled $102,000.

(g) There was only one job in process at the end of the period, with charges to date of materials costing $10,000 and direct labor of $8,000.

(h) Collection of accounts receivable totalled $440,800.

(i) Cost of goods manufactured was $320,000.

(j) Payroll payment totalled $172,000.

Using T-accounts, compute:

(1) Materials purchased. (2) Cost of goods sold. (3) Finished goods ending inventory. (4) Work in process ending inventory. (5) Direct labor cost. (6) Applied factory overhead. (7) Over- or underapplied factory overhead.

Answers to April Quiz

The predetermined overhead rate would be $574,584/61,450 machine hours, or $9.35 per machine hour. If 62,000 machine hours were experienced, we would have applied $579,700 of overhead costs, or $5,116 overapplied. Under direct costing, fixed overhead costs (most likely factory supervision, depreciation, insurance and property taxes) would not be included, nor would we be calculating a predetermined overhead rate. As overhead costs were incurred, they would be charged to the products.
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Article Details
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Title Annotation:Accounting Scene
Author:Winicur, Barbara
Publication:The National Public Accountant
Article Type:Column
Date:May 1, 1993
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