UNIT FOUR: THE COSTING OF RESOURCE OUTPUTS

3. Introduction
Purpose of product costs-Product costs are needed for a variety of purpose in both financial
accounting and managerial accounting.
In financial accounting, product costs are needed to value inventory on the balance sheet and
to compute cost of goods sold (expense) on the income statement.
In managerial accounting, product costs are needed for planning, for cost control, and to
provide managers with data for decision making. Decisions about product price, the mix of
products to be produced, and the quantity of output to be manufactured are among those
decisions for which product cost information is needed by management.
The need for product costs is not limited to manufacturing firms. Merchandising firms
include the costs of buying and transporting merchandise in their product costs. Service firms
and nonprofit organizations also need to know the cost of their services.
3.1 Types of Product Costing Systems
Companies may use one or more of the following product costing systems:- Job order costing
system, Process costing system, Batch costing system, Contract costing system and Activity
based costing system.
Job-Order Costing System
A job order costing system provides a separate record of the cost of each particular batch of
product that passes through the factory. The system accumulates costs for a particular batch
of production, commonly referred to as a job. A job has a definite starting and completion
time as would, for example, the production of 10 pieces of windows, or 50 coffee tables.
As the name implies, job order means, the units are produced as per the order of a customer,
each customer order is different in terms of specification. Whether for customer or stock,
jobs are not similar, and their costs are also different. In job order costing system, costs are
accumulated by job. For each job, the firm maintains a separate job cost sheet, which is a
record on which manufacturing costs of the job are accumulated.
For example, job order costing is used for construction projects, government contracts,
shipbuilding, automobile repair, printing jobs, wood furniture, office machines, machine
tools, and luggage. Accumulating the cost of professional services such as lawyers, doctors
and CPA's also falls into this category.

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Process Costing System - is a costing system used for manufacturing processes which
produce a single/identical product or single mix of products continuously for an extended
period of time. In process costing, costs are accumulated by departments. For example,
process costing is used by companies that produce appliances, alcoholic beverages, tires,
sugar, breakfast cereals, leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber,
cigarettes, shoes, typewriters, cement, gasoline, steel, baby foods, flour, glass, men's suits,
pharmaceuticals and automobiles. Process costing is also used in meat packing and for public
utility services such as water, gas and electricity.
Batch Costing - This is another form of job-order costing which is adopted in case of
manufacturing a large number of components of machines or of other articles. Since a
large number of them are manufactured together and pass through the same process of
manufacture, it is convenient to collect their cost together. Each batch is treated as a job.
Separate cost sheets are maintained for each batch of products. Each batch is given a number.
Material requisitions are prepared batch-wise, and overheads are also allocated batch-wise.
Cost of each component is then determined by dividing the total cost by the number of
articles manufactured.
Contract Costing - also known as terminal costing, is a variant of job costing. Contract
means a big job in which work is done at site and not in factory premises. The cost of each
contract is ascertained. Thus, in this method of costing, each contract is a cost unit and an
account is opened for each contract in the books of the contractor to ascertain profit/loss
thereon.

3.3 Accounting for Job-Order Costing System

Source Documents in Job-Order Costing System
1. Measuring Direct Materials Cost in Job Order Costing System:

At the beginning of a production process, a document known as bill of materials is used for
standard products. "A bill of materials is a document that lists the type and quantity of each
item of materials needed to complete a unit of standard product". In case where it is not
possible to use a bill of materials, the production staff determines the material requirements
from the blueprints submitted by the customer.

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When an agreement is reached with the customer concerning the quantities, price and
shipment date for the order, a production order is issued. The production department then
prepares a materials requisition form. Materials requisition form is a detailed source
document that specifies the type and quantity of materials to be drawn from the storeroom,
and identifies the job to which the costs of the materials are to be charged. The form is used
to control the flow of materials into production and also for making entries in the
accounting records. The completed form is presented to the storeroom clerk who then issues
the necessary raw materials. The storeroom clerk is not allowed to release materials without
such a form bearing an authorized signature. The following is a sample material requisition
form for job 2B47.
Sample Materials Requisition Form:
Materials Requisition Number14873 Date March 2 ,2009
Job Number to Be Charged 2B47
Department Milling
Description Quantity Unit Cost Total Cost
M46 Housing 2 Br.124 Br.248
G7 Connector 4 103 412
Br.660
Authorized Signature __________________

After being notified that the production order has been issued, the accounting department
prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that
records the materials, labor and overhead costs charged to the job. After direct materials are
issued, the accounting department records their costs directly on the job cost sheet. In
addition to serving as a means for charging costs to jobs, the job cost sheet also serves as a
key part of a firm's accounting records. The job cost sheets form a subsidiary ledger to the
work in process (WIP) account. They are detailed records for the jobs in process that add up
to the balance in the work in process (WIP). The raw material cost Br.660 for job 2B47 is
accumulated on a job cost sheet as follows:

JOB COST SHEET

Job Number 2B47 Date Initiated March 2 ,2009
Department Milling Date Completed
Item Units Completed
For Stock

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 Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660

2. Measuring Direct Labor Cost under Job Order Costing System:

Direct labor cost is handled in much the same way as direct materials cost. Direct labor
consists of labor charges that are easily traced to a particular job. Labor charges that cannot
be easily traced directly to any job are treated as part of manufacturing overhead. The later
category of labor cost is known as indirect labor and includes tasks such as maintenance,
supervision, and cleanup. Workers use time tickets to record the time they spend on each job
and task. A completed labor time ticket is an hour by hour summary of the employees
activities throughout a specific job. The employee enters the job number on the time ticket
and notes the amount of time spent on that job. When not assigned to a particular job, the
employee records the nature of the indirect labor task (such as cleanup and maintenance) and
the amount of time spent on the task. The daily time tickets are also used as the basis for
labor cost entries into the accounting records. Following is an example of employees’ time
ticket.

Time Ticket No. 843 Date March 3 ,2009

Employee : Jaleta Bulli Station 4

Started Ended Time Rate Amount Job Number

Completed
7:00 12:00 5.0 Br.9 Br.45 2B47
12:30 2:30 2.0 9 18 2B50
2:30 3:30 1.0 9 9 Maintenance

At the end of the day, the time tickets are gathered and accounting department enters the
direct labor hours and costs on individual job cost sheets. The following is how to do that for
job 2B47.

JOB COST SHEET

Job Number 2B47 Date Initiated March 2 ,2009
Department Milling Date Completed
Item Units Completed
For Stock

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 Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660 843 5 Br.45

3. Application of Manufacturing Overhead Cost in Job Order Costing:

Manufacturing overhead must be included with direct labor on the job cost sheet since
manufacturing overhead is also a product cost. However, assigning manufacturing overhead
to units of products can be a difficult task. There are two reasons for this:

1. Manufacturing overhead is an indirect cost. This means that it is either impossible or

difficult to trace these costs to a particular product or job.
2. Manufacturing overhead consists of many different items ranging from the grease
used in machines to the annual salary of production manager.
Given these problems, the only way to assign overhead costs to production is to use an
allocation process. This allocation of overhead cost is accomplished by selecting an
allocation base that is common to all of the company's products and services. An allocation
base is a measure such as direct labor hours or machine hours that is used to assign overhead
costs to products and services. The most widely used allocation bases are direct labor hours,
direct labor cost, machine hours and even units of product can also be used to some extent.
The allocation base is used to compute "predetermined overhead rate" in the following
formula or equation.

Predetermined Overhead Rate = Estimated total MOH cost

Estimated total allocation base

For example, if a company has estimated that its total manufacturing overhead cost will be
Br.320, 000 for the year and its total direct labor hour will be 40, 000 hour, its predetermined
overhead rate (POR) for the year will be Br.8 per direct labor hour, calculated as follows:

Br. 320,000 / 40,000 = Br.8 per direct labor hour

Predetermined overhead rate is based on estimates rather than actual result. This is because
the predetermined overhead rate is computed before the period begins and is used to apply

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overhead cost throughout the period. The process of assigning overhead costs to jobs is
called overhead application. The formula for determining the amount of overhead cost to
apply to a particular job is:

Overhead applied to a particular job = POR × Amount of allocation base consumed by the job

Note that the job cost sheet in the example below indicates that 27 labor hours have been
worked. Therefore a total of Br.216 of manufacturing overhead cost would be applied to the
job.
Overhead applied to Job 2B47 = Predetermined overhead rate × Actual direct labor hours
= Br.8 per DLH × 27 DL Hrs = Br.216
In addition to direct material and direct labor cost, the applied manufacturing overhead cost
will be entered in the job cost sheet and the total estimated cost to complete the job will be
summarized as shown below.
JOB COST SHEET

Job Number 2B47 Date Initiated March 2 ,2009

Department Milling Date Completed March 8 ,2009

Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660 843 5 Br.45 27 Br.8/DLH Br.216
14875 506 846 8 60
14912 238 850 4 21
--------- 851 10 54
Br.1,404 -------- --------
===== 27 Br.180
===== =====
Cost Summary Units Shipped
Direct Materials Br.1,404 Date Number Balance
Direct Labor 180 March 8 -- 2
Manufacturing Overhead 216
Total Cost Br.1800
Unit Product Cost 900

The amount of overhead cost entered in the job cost sheet is not the actual amount of
overhead caused by the job. There is no attempt to trace actual overhead costs to jobs. If that

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could be done, the costs would be direct costs, not overhead costs. Overhead assigned to the
job is simply a share of the total overhead that was estimated at the beginning of the year.
When a company applies overhead cost to jobs as we have done, it is called normal
costing system. The overhead may be applied as direct labor-hours are charged to jobs, or all
of the overhead can be applied at once when the job is completed. The choice is up to the
company. If a job is not completed at the year-end, however, overhead should be applied to
value the work in process inventory.

Instead of using a predetermined overhead rate, a company could wait until the end of the
accounting period to compute an actual overhead rate based on actual total manufacturing
costs and the actual total units in the allocation base for the period. However, managers cite
the following two reasons for using predetermined overhead rates instead of actual overhead
rates:
1. Managers would like to know the accounting system's valuation of completed jobs
before the end of the accounting period. Suppose, for example a company waits until
the end of the year to compute its overhead rate. Then there would be no way for
managers to know the cost of goods sold for a job until the close of the year because
the job may be completed and shipped before the end of the year.
2. The use of predetermined overhead rate simplifies the record keeping. To determine
the overhead cost to apply to a job, the accounting staff simply multiplies the direct
labor hours recorded for the job by the predetermined overhead rate.

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 The Flow of Documents in a Job Order Costing System
The job
Materials cost sheet
requisition is used to
A form
These compute
productio production unit
A sales
n order costs are Job product
Sales order is Production initiates Direct labor accumulated
→ → cost costs that
Order prepare Order work on a time ticket on a form,
d as a → sheet in turn are
job, prepared by used to
basis for
whereby the value
issuing
costs are accounting ending
a.....
charged department inventorie
through... Predetermined known as... s and to
overhead rates determine
cost of
goods sold

Illustration of Accounting Procedures for Job-order Costing System

Illustration 1: Ravsten Company uses a job-order costing system. The company applies
overhead cost to jobs on the basis of machine-hours. For the current year, the company
estimated that it would work 36,000 machine-hours and incur $153,000 in manufacturing
overhead cost. The following transactions were recorded for the year:
a. Raw materials purchased on account, $200,000.
b. Raw materials requisitioned for use in production, $190,000 (80% direct and 20%
indirect).
c. The following costs were incurred for employees’ services:
Direct labor . . . . . . . . . . . . . . . . $160,000
Indirect labor . . . . . . . . . . . . . . . $27,000
Sales commissions . . . . . . . . . . $36,000
Administrative salaries . . . . . . . $80,000
d. Heat, power, and water costs incurred in the factory, $42,000.
e. Prepaid insurance expired during the year, $10,000 (90% relates to factory operations, and
10% relates to selling and administrative activities).
f. Advertising costs incurred $52,000.

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g. Depreciation recorded for the year, $60,000 (85% relates to factory operations, and 15%
relates to selling and administrative activities).
h. Manufacturing overhead cost was applied to production. The company recorded 40,000
machine-hours for the year.
i. Goods that cost $480,000 to manufacture according to their job cost sheets were transferred
to the finished goods warehouse.
j. Sales for the year totaled $700,000 and were all on account. The total cost to manufacture
these goods according to their job cost sheets was $475,000.
Required:
1. Prepare journal entries to record the transactions given above.
2. Is MOH under-applied or over-applied for the year? Prepare a journal entry to close
any balance in the Manufacturing Overhead account to Cost of Goods Sold.
Exercise
Rock Star, Inc., which uses a job-costing system, began business on January 1, 2023 and
applies manufacturing overhead on the basis of direct-labour cost.
• The following information relates to 2023:
Budgeted direct labour and manufacturing overhead were anticipated to be $200,000 and
$250,000, respectively.
Job nos. 1, 2, and 3 were begun during the year and had the following charges for direct
material and direct labour:
Job# Direct Materials Direct Labour
1 $145,000 $35,000
2 320,000 65,000
3 55,000 80,000
• Job nos. 1 and 2 were completed and sold on account to customers at a profit of 60% of
cost. Job no. 3 remained in production.
• Actual manufacturing overhead by year-end totaled $233,000. Rock Star adjusts all under-
and over-applied overhead to cost of goods sold.
Required:
a) Compute the company's predetermined overhead application rate.
b) Compute Rock Star's ending work-in-process inventory.

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c) Determine Rock Star's sales revenue.
d) Was manufacturing overhead under- or over-applied during 2023? By how much?
e) Present the necessary journal entry to handle under- or over-applied manufacturing
overhead at year-end.

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