Topic 1: Job-order and service department costing (C4, L3)

Question 1

What is job-order costing, and where is it used?

Answer 1

Job-order costing is a system that assigns costs to specific jobs or orders, used in industries like custom furniture, large-scale construction, service industries (hospitals, consulting etc.) etc., where many different products are produced each period.

Question 2

How are costs determined for job-order costing?

Answer 2

Costs are traced and allocated to jobs, and then the costs of the job are divided by the number of units in the job. Thus, the result is arrive an average cost per unit.

Question 3

How should cost records be kept for job-order costing? And why?

Answer 3

Cost records must be maintained for each distinct product or job.

Because the record-keeping and cost assignment problems are more complex when a company sells many different products and services, since the products are different and therefore the costs are typically different.

Question 4

What documents are essential in a job-order costing system?

Answer 4

Key documents include:

1. Job Cost Sheet: Tracks costs for each job.
2. Materials Requisition Form: Requests materials for specific jobs.
3. Bill of Materials (BOM): Lists materials and quantities needed.
4. Time Tickets: Record direct labor hours worked on jobs.

Question 5

What are the three primary cost components in job-order costing?

Answer 5

1. Direct Materials
2. Direct Labor
3. Manufacturing Overhead

Question 6

How are costs recorded and accumulated using direct materials cost?

Answer 6

Tracked via production orders, materials requisition form and job cost sheet.

Steps:
0. An agreement has been reached with the customer concerning the quantities, prices and shipment date for the order. If this were a standard product, there would be a bill of materials for the product.

1. Issuing the production order.
2. Preparing the materials requisition form.
3. Preparing a job cost sheet (automatically generated following the production order).
4. After direct materials are issued, the Accounting Department records their costs directly on the job cost sheet.

Question 7

What is a Bill of Materials (BOM)?

Answer 7

A document that lists the type and quantity of each item of materials needed to complete a unit of product.

Question 8

What is a production order?

Answer 8

A document that tells which specific quantity of material is to be produced within a certain timeframe.

Question 9

What is a materials requisition form?

Answer 9

A detailed source document that (1) specifies the type and quantity of materials, and (2) identifies the job to which the costs of the materials are to be charged.

Question 10

What is a job cost sheet?

Answer 10

A form prepared for each separate job that records the materials, labour and overhead costs charged to the job (automatically generated following the production order).

Question 11

What is the purpose of a Job Cost Sheet?

Answer 11

Tracks all costs (direct materials, direct labor, and applied overhead) associated with a specific job, helping managers analyze costs and profitability.

Question 12

How are costs recorded and accumulated using direct labour cost?

Answer 12

Measured through time logs (time tickets) and predetermined rates.

Where the employee scans follow bar codes before and after the job:
1. The first indicates that a job is being started/finished.
2. The second is the unique bar code on the employee’s identity badge.
3. The third is the unique bar code of the job itself.

Since all of the source data is already in computer files,
the labour costs can be automatically posted to job cost sheets.

Question 13

What is a time ticket?

Answer 13

A completed ticket is an hour-by-hour summary of the employee’s activities throughout the day (today these are computerized using handheld scanners and bar codes).

Question 14

What should one do with labour charges that cannot easily be traced directly to any job?

Answer 14

These are treated as part of manufacturing overhead.

These are called indirect labour costs, and include maintenance, supervision and clean up.

Question 15

What are the problems associated with assigning overhead costs to products?

Answer 15

1. Manufacturing overhead is an indirect cost (difficult to trace to a product or job).
2. Manufacturing overhead consists of many different items.
3. Total manufacturing overhead costs tend to remain relatively constant (due to fixed costs), which causes the average cost per unit to vary.

(NB! This applies for companies using an absorption costing approach manufacturing overhead must be included with direct materials and direct labour on the job cost sheet since manufacturing overhead is also a product cost.)

Question 16

How are costs applied using direct manufacturing overhead?

Answer 16

Allocated using the POHR.

Following the allocation process by selecting an allocation base that is common to all of the company’s products and services, and using a predetermined overhead rate to applicate overhead.

Question 17

What is an allocation base? And what are the most common?

Answer 17

A measure that is used to assign overhead costs to products and services.

The most common:
- Direct labour-hours
- Direct labour cost
- Machine-hours
- Units of product (only when producing one type)

Question 18

What is a Predetermined Overhead Rate (POHR)?

Answer 18

The predetermined overhead rate is computed before the period begins, and is used to apply overhead cost to jobs throughout the period. Thus, it is based on estimates rather than actual figures.

Question 19

How is a POHR calculated?

Answer 19

POHR = Estimated total manufacturing overhead cost / Estimatedtotalunits in the allocationbase(e.g.,laborhours)

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Question 20

What is overhead application?

Answer 20

The process of assigning overhead cost to jobs.

Question 21

How is overhead applied to a job?

Answer 21

Overhead Applied = POHR × Amount of allocation base incurred by the job

Question 22

What is a normal cost system?

Answer 22

When a company applies overhead cost to jobs by multiplying actual activity by the predetermined overhead rate.

Question 23

A company could wait until the end of the accounting period to compute an actual overhead rate based on the actuals - why don’t companies do this?

Answer 23

1. Timeliness: A predetermined rate allows overhead costs to be applied to jobs during the period, enabling timely job cost updates without waiting until the end of the period.
2. Stability: Actual overhead rates can fluctuate due to seasonal factors or changes in the allocation base (e.g., labor hours), which can mislead managers. Predetermined rates ensure consistent cost allocation.
3. Simplified record keeping: Using a predetermined rate simplifies accounting by avoiding frequent recalculations of actual overhead costs, making the process more efficient.

Question 24

How is the allocation base for overhead costs chosen?

Answer 24

The allocation base should be a cost driver of overhead cost.

Question 25

What is a cost driver?

Answer 25

A factor, such as machine-hours, beds occupied, computer time or flight hours, that causes overhead costs.

Question 26

Why is direct labor becoming less relevant as an allocation base for manufacturing overhead, and what alternatives are being used?

Answer 26

Direct labor is becoming less relevant because:

1. Automation has replaced many direct labor tasks, increasing overhead costs while reducing direct labor usage.
2. Products are becoming more complex and require highly skilled indirect labor, like engineers, increasing the share of overhead costs.

As a result, many companies are shifting to activity-based costing, which better reflects the actual drivers of overhead costs by aligning them with specific activities and demands.

Question 27

Based on the allocations of the three cost types, unit costs are computated - how?

Answer 27

1. The totals for direct materials, direct labour and manufacturing overhead are transferred to the Cost Summary section of the job cost sheet and added together to obtain the total cost for the job.
2. The total cost is divided by the number of units to obtain the unit cost.

NB! This unit cost is an average cost, and should not be interpreted as the cost that would actually be incurred.

Then the completed job cost sheet is ready to be transferred to the Finished Goods inventory account, where it will serve as the basis for valuing unsold units in ending inventory and determining cost of goods sold.

Question 28

What is the flow of documents in a job-order costing system, and how do they contribute to cost calculation?

Answer 28

The flow of documents in a job-order costing system is as follows:

1. Sales order: Initiates the process by defining the customer order details.
2. Production order: Authorizes the start of production and tracks associated costs.

3a. Materials requisition form: Records the raw materials used for the job.

3b. Direct labor time ticket: Tracks labor hours worked on the job.

3c. Predetermined Overhead Rates: Applies overhead costs based on a predefined formula.

4- Job Cost Sheet: Accumulates all production costs (materials, labor, overhead) and is used to calculate product costs, value inventories, and determine the cost of goods sold.

Question 29

How are raw material costs recorded and allocated in a job-order costing system?

Answer 29

Raw materials are recorded as an asset when purchased.
Raw material costs are recorded and allocated as follows:

1. Materials requisition form: Tracks the total materials requisitioned.

2a. Direct materials: Raw materials and Work in Progress (WIP). The total amount is divided between WIP and manufacturing overhead, and allocated to specific jobs - recorded in both the WIP account and individual job cost sheets.

2b. Indirect materials: Charged to the manufacturing overhead account.

The WIP account summarizes total costs across all jobs in progress (carries over) and aligns with the balances on the individual job cost sheets.

(See exhibit 4.6)

Question 30

How are labor costs recorded and allocated in a job-order costing system?

Answer 30

1. Various time tickets: Tracks the total activities completed.

2a. Direct labor: Wages payable and Work in Progress (WIP). The total amount is divided from wages payable between WIP and manufacturing overhead, and allocated to specific jobs.

2b. Indirect Labor: Charged to the manufacturing overhead account.

(See exhibit 4.7)

Question 31

How are manufacturing overhead costs recorded and tracked in a job-order costing system?

Answer 31

Overhead costs are directly entered into the manufacturing overhead account and credited to accounts payable.

Other costs like accrued property taxes, expired prepaid insurance, and depreciation on factory equipment are also debited to the manufacturing overhead account and credited to their respective accounts.

The manufacturing overhead account serves as a control for multiple subsidiary accounts, including indirect materials, indirect labor, and factory utilities, ensuring all costs are captured systematically.

Question 32

How is manufacturing overhead applied to jobs using a predetermined overhead rate, and how does it flow into the Work in Progress account?

Answer 32

Manufacturing overhead is applied using a predetermined overhead rate calculated at the beginning of the year. The process is as follows:

1. The predetermined overhead rate is determined by dividing the estimated total manufacturing overhead cost by the estimated total allocation base (e.g., machine-hours or direct labor-hours).
   Example: £6 per machine-hour.
2. Overhead is applied by multiplying the predetermined rate by the actual allocation base used.
   Example: For 15,000 machine-hours (10,000 for Job A and 5,000 for Job B), the applied overhead is £90,000 (£6 × 15,000).
3. Applied overhead is debited to the Work in Progress account and credited to the manufacturing overhead account.
4. The applied overhead is distributed to individual job cost sheets.
   Example: £60,000 for Job A and £30,000 for Job B.

(See exhibit 4.8)

Question 33

How does the manufacturing overhead account function as a clearing account, and how are overhead costs applied to jobs?

Answer 33

Actual overhead costs (e.g., utilities, equipment rent) are debited to this account as they are incurred throughout the period.

Applying overhead to jobs: Overhead is applied to the Work in Progress (WIP) account using the predetermined overhead rate, based on an allocation base such as machine-hours or labor-hours.

Only the applied overhead cost (using the predetermined rate) is charged to jobs and appears on the job cost sheets and WIP account. Actual overhead costs remain in the manufacturing overhead account until reconciled.

Question 34

How are non-manufacturing costs recorded and treated differently from manufacturing costs?

Answer 34

Non-manufacturing costs, such as selling and administrative expenses, are treated as period expenses and charged directly to the statement of profit or loss.

Salaries expense and depreciation expense are debited, reflecting their period expense nature.

Accounts such as salaries and wages payable or accumulated depreciation are credited.

Distinction: Non-manufacturing costs are not added to the manufacturing overhead account because they do not relate to production. This contrasts with manufacturing costs like factory equipment depreciation, which is treated as a product cost.

Question 35

How is the cost of goods manufactured recorded when a job is completed, and what happens to incomplete jobs?

Answer 35

When a job is completed, the total costs for the job (direct materials, direct labor, and applied overhead) are transferred from the Work in Progress (WIP) account to the Finished Goods account.

The total transferred amount represents the cost of goods manufactured for the period.

For incomplete jobs, the costs remain in the WIP account and are carried forward to the next period. On the balance sheet, these costs are classified as Work in Progress Inventory under assets.

Question 36

How are the cost of goods sold recorded when finished goods are sold in a job-order costing system?

Answer 36

The sales revenue is recorded by debiting Accounts Receivable and crediting Revenue for the sales amount.

The total cost of the job (from the job cost sheet) is debited as Cost of Goods Sold and credited as Finished Goods.
From this, the unit product cost can be determined by dividing the total cost (above) by the number of units produced.

Question 37

What is Cost of Goods Sold (COGS)?

Answer 37

The cost of the sold units is transferred from the Finished Goods account to Cost of Goods Sold.

Question 38

How does job-order costing handle the flow of costs?

Answer 38

Summary of journal entries:

1. Record materials in the Raw Materials account.
2. Transfer materials to WIP for production.
3. Add direct labor and applied overhead to WIP (including taxes, insurance, depreciation and S&A).
4. Transfer completed jobs to Finished Goods.
5. Transfer sold jobs to Cost of Goods Sold.

(See exhibit 4.9, 4.10 and 4.11)

Question 39

How can cost flows be illustrated besides a summary of cost flows in T-accounts?

Answer 39

As a schedule of cost of goods manufactured and cost of goods sold.

(See exhibit 4.11)

Question 40

How does a manager finalize job costing?

Answer 40

1. Review direct materials, labor hours, and overhead applied.
2. Compare estimated vs. actual costs.
3. Analyze variances (under- og overapplied) to improve efficiency.

Question 41

What happens when actual overhead differs from applied overhead?

Answer 41

Underapplied Overhead: Actual > Applied (requires a debit adjustment to Cost of Goods Sold).

Overapplied Overhead: Actual < Applied (requires a credit adjustment to Cost of Goods Sold).

Question 42

What are the methods for disposing of underapplied or overapplied overhead balances, and when is each used?

Answer 42

At the end of a period, the balance in the Manufacturing Overhead account can be disposed of using two methods:

Close out to Cost of Goods Sold:
The entire underapplied or overapplied overhead is added to or subtracted from the Cost of Goods Sold account.

Allocate among accounts:
The balance is proportionally allocated to Work in Progress, Finished Goods, and Cost of Goods Sold based on the overhead applied to each account during the period.

Question 43

What are the benefits of the two methods of disposing underapplied or overapplied overhead balances?

Answer 43

1. Close out to Cost of Goods Sold:
   This method is simpler and typically used when the amount is immaterial.
2. Allocate among accounts:
   This method is more accurate and is preferred when the amount is material, as it better reflects the actual distribution of costs.

Question 44

How is manufacturing overhead estimated, applied, and adjusted in a job-order costing system?

Answer 44

Manufacturing overhead is managed in three steps:

1. At the beginning of the period:

The predetermined overhead rate is calculated by dividing the estimated total manufacturing overhead cost by the estimated total units in the allocation base.

2. During the period:

The total manufacturing overhead applied is determined by multiplying the predetermined overhead rate by the actual units of the allocation base incurred.

3. At the end of the period:

The actual total manufacturing overhead cost is compared with the total manufacturing overhead applied to identify if the overhead is underapplied (actual > applied) or overapplied (applied > actual).

Question 45

What are the steps in the job-order costing process?

Answer 45

1. Receive and approve sales order.
2. Create BOM.
3. Requisition materials.
4. Create a job sheet.
5. Begin production and allocate costs.
6. Track and compare actual vs. estimated costs.
7. Complete job and prepare the final cost report.

Question 46

What are some key accounts used in job-order costing?

Answer 46

1. Raw Materials Account: Records material purchases and withdrawals.
2. Work-in-Process (WIP) Account: Tracks all production costs.
3. Manufacturing Overhead Account: Records incurred and applied overhead.

Question 47

What industries benefit from job-order costing? And why?

Answer 47

Industries with unique or customized projects, such as:

1. Custom furniture manufacturers
2. Shipbuilders
3. Construction companies
4. Movie production studios
5. Consulting firms

Because they produce unique or customized products or services, which makes it necessary to track costs individually.

Question 48

What are some advantages of using job-order costing?

Answer 48

1. Precise cost tracking for individual jobs.
2. Insight into job profitability.
3. Helps identify inefficiencies and variances.