Andrews University Management accounting Readings

Job order costing system

Job order costing system is generally used by companies that manufacture a

number of different products. It is a widely used costing system in manufacturing as
well as service industries.

Manufacturing companies using job order costing system usually receive orders for
customized products and services. These customized orders are known
as jobs or batches. A clothing factory, for example, may receive an order for men shirts
with particular size, color, and design.

When companies accept orders or jobs for different products, the assignment of cost to
products becomes a difficult task. In these circumstances, the cost record for each
individual job is kept because each job have a different product and, therefore, different
cost associated with it.

The per unit cost of a particular job is computed by dividing the total cost allocated to
that job by the number of units in the job. The per unit cost formula is given below:

Per unit cost = Total cost applicable to job/Number of units in the job

Job order costing is extensively used by companies all over the world. According to a
survey, 51.1% of manufacturing companies in United States use job order costing.

Examples of manufacturing businesses that use job order costing system include
clothing factories, food companies, air craft manufacturing companies etc.

Examples of service businesses that use job order costing system include movie
producers, accounting firms, law firms, hospitals etc.

Job cost sheet is a document used to record manufacturing costs and is prepared by
companies that use job-order costing system to compute and allocate costs to products
and services.

The accounting department is responsible to record all manufacturing costs (direct

materials, direct labor, and manufacturing overhead) on the job cost sheet. A separate
job cost sheet is prepared for each individual job.

All necessary details about the job and costs incurred to complete the job are written on
the job cost sheet.

The information about a job or order that is shown on job cost sheet usually includes
job number, product name, starting date, completing date, number of units completed
etc.

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Andrews University Management accounting Readings

The information about manufacturing costs that is shown on job cost sheet usually
includes materials requisition number, cost of direct materials issued, time tickets, direct
labor hours, direct labor rate per hour and total cost, manufacturing overhead rate per
direct labor or machine hour and total cost etc.

Job cost sheet is not only used to charge cost to jobs but is also a part of the
company’s accounting record. It is used as a subsidiary ledger to the work in process
account because it contains all details about the job in process.

Example:

An example of a complete job cost sheet is given below

After accepting a job or order, the first step in a job order costing system is to
determine the direct materials requirement to complete the job. The type and quantity
of direct materials required to manufacture a product can be determined either by using
a bill of materials or by production staff.

Bill of materials is a document that lists the type and quantity of direct materials
required to manufacture a standard product. But companies using job order
costing system frequently receive orders that require customization in design, size and
color etc. In such circumstances, the bill of materials cannot be used to determine the
type and quantity of materials required to complete the job. Therefore the production
department determines materials requirement using the information provided by
customers.

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Andrews University Management accounting Readings

After direct materials requirement has been determined, the production process starts
with issuance of direct materials. For this purpose, production department prepares a
document known as ‘materials requisition form‘. An authorized person from production
department writes the type, quantity, and job number (to which the materials cost is to
be charged) on materials requisition form. A signed copy of this form is then sent to the
storeroom clerk who completes the form by entering on it per unit and total cost of
materials to be issued. After necessary verification, storeroom clerk issues direct
materials to production department.

A complete materials requisition form is also used by accounting department to record

direct materials cost on the job cost sheet of the related job order.

An example/sample of materials requisition form is given below:

Use of computer technology for materials requisition:

The procedure described above is the manual procedure of issuing materials. In today’s
business world, many companies are replacing manual procedure with computer
technology. In computer technology, automated information processing systems are
used to send the requisition information to storeroom. The material is transferred from
storeroom to the production department on the basis of this information. An
entry about each requisition is made in a computer that automatically updates the
subsidiary materials record.

Journal entries to record the flow of materials:

Normally two types of journal entries are made for direct materials cost. One at the
time of purchase of direct materials from suppliers and one at the time of issuance of
direct materials from storeroom to production department. These two entries are given
below:

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Andrews University Management accounting Readings

When materials are purchased:

When materials are issued:

In job order costing system, the method of measuring and recording direct labor cost is
similar to measuring and recording direct materials cost.

Direct labor hours worked, direct labor rate per hour, and total amount in dollars for
each individual job or task is recorded on a document known as time ticket or employee
time ticket. A separate time ticket is prepared by each worker for every working day.

Accounting department collects all time tickets at the end of the day. These time tickets
are used to enter direct labor cost on the job cost sheet of each individual job order. An
example/sample of complete time ticket is given below:

Employee Time Ticket

In job order costing system, any labor charges that are not directly traceable to a
particular job are known as indirect labor cost. In example of time ticket given above
“maintenance” is indirect labor. Other examples of indirect labor are cleanup costs and
supervision etc. Indirect labor is not included in direct labor cost and, therefore,
becomes a part of the manufacturing overhead.

These days, many companies have replaced the manual process of recording direct
materials cost with the computerized approaches. They use a bar code technology to

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Andrews University Management accounting Readings

enter data into a computer. This technology increases the speed and accuracy of the
whole process.

Journal entry to record direct labor cost:

After collecting time tickets by accounting department, wages of workers are computed
and labor costs are classified as direct or indirect on the basis of information provided
by time tickets. As discussed earlier, indirect labor is a part of manufacturing overhead
and its accounting treatment has been discussed in “measuring and recording
manufacturing overhead” article. The journal entry of direct labor cost is made as
follows:

Manufacturing costs other than direct materials and direct labor are known as
manufacturing overhead (also known as factory overhead). It usually consists of both
variable and fixed components. Examples of manufacturing overhead cost
include indirect materials, indirect labor, depreciation, salary of production manager,
property taxes, fuel, electricity, grease used in machines, and insurance etc.

Unlike direct materials and direct labor, manufacturing overhead is an indirect cost that
cannot be directly assigned to each individual job. This problem is solved by using a
rate that is computed at the beginning of each period. This rate is known
as predetermined overhead rate.

Application of manufacturing overhead:

As stated earlier, the predetermined overhead rate is computed at the beginning of the
period and is used to apply manufacturing overhead cost to jobs throughout the period.

Manufacturing overhead cost is applied to jobs as follows:

Overhead applied to a particular job = Predetermined overhead rate × Amount of the

allocation base incurred by the job

Example:

Suppose the GX company has completed a job order. The time tickets show that the
workers have worked for 27 hours to complete the job. The predetermined overhead
rate computed at the beginning of the year is $8 per direct labor hour. The
manufacturing overhead cost would be applied to this job as follows:

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Andrews University Management accounting Readings

Overhead applied to a particular job = Predetermined overhead rate × Amount of the

allocation base incurred by the job

= $8.00 × 27 DLH

= $216

The manufacturing overhead cost assigned to the job is recorded on the job cost
sheet of that particular job.

Journal entry to record manufacturing overhead cost:

The manufacturing overhead cost applied to the job is debited to work in process
account. The journal entry for the applied manufacturing overhead cost, computed in
the above example, would be made as follows:

The reason of using a predetermined overhead rate rather than actual

overhead costs:

Notice that the procedure of manufacturing overhead application described above is

based on an estimated overhead rate (predetermined overhead rate). The
manufacturing overhead cost applied to the job is, therefore, not actual manufacturing
overhead cost incurred by the job. The reason is that the total actual manufacturing
overhead costs are usually not known to managers before the end of the year.
The application of manufacturing overhead based on a predetermined overhead rate
helps in computing cost of goods sold of a particular job before it is shipped to the
customer.

The use of predetermined overhead rate to apply manufacturing overhead cost to

products or job orders is known as normal cost system.

Predetermined overhead rate is used to apply manufacturing overhead to products

or job orders and is usually computed at the beginning of each period by dividing
the estimated manufacturing overhead cost by an allocation base (also known
as activity base or activity driver). Commonly used allocation bases are direct labor
hours, direct labor dollars, machine hours, and direct materials.

Formula:

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Andrews University Management accounting Readings

The formula of predetermined overhead rate is written as follows:

Example:

Suppose GX company uses direct labor hours to assign manufacturing overhead cost to
job orders. The budget of the GX company shows an estimated manufacturing
overhead cost of $8,000 for the forthcoming year. The company estimates that 1,000
direct labors hours will be worked in the forthcoming year.

Using the above information, we can compute the predetermined overhead rate as
follows:

Predetermined overhead rate = Estimated manufacturing overhead cost/Estimated total

units in the allocation base

Predetermined overhead rate = $8,000/1,000 hours = $8.00 per direct labor hour

Notice that the formula of predetermined overhead rate is entirely based on estimates.
The overhead applied to products or job orders would, therefore, be different from the
actual overhead incurred by jobs or products. This difference is eliminated at the end of
the period. The elimination of difference between applied overhead and actual
overhead is known as disposition of over or under applied overhead.

Multiple Predetermined overhead rate:

The predetermined overhead rate computed above is known as single predetermined

overhead rate or plant-wide overhead rate. It is mostly used by small companies. In
large companies, each production department computes its own predetermined
overhead rate. The use of multiple predetermined overhead rates may be complex and
time consuming but is considered more accurate than a single plant-wide overhead
rate.

According to a survey 34% of the manufacturing businesses use a single plant wide
overhead rate, 44% use multiple predetermined overhead rates and rest of the
companies use activity based costing (ABC) system.

The over or under-applied manufacturing overhead is defined as the difference

between manufacturing overhead cost applied to work in process and manufacturing
overhead cost actually incurred during a period.

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Andrews University Management accounting Readings

If the manufacturing overhead cost applied to work in process is more than the
manufacturing overhead cost actually incurred during a period, the difference is known
as over-applied manufacturing overhead. On the other hand; if the manufacturing
overhead cost applied to work in process is less than the manufacturing overhead cost
actually incurred during a period, the difference is known as under-applied
manufacturing overhead.

The occurrence of over or under-applied overhead is normal in manufacturing

businesses because overhead is applied to work in process using a predetermined
overhead rate. A predetermined overhead rate is computed at the beginning of the
period using estimated information and is used to apply manufacturing overhead cost
throughout the period.

The procedure of computing predetermined overhead rate and its use in applying
manufacturing overhead has been described in “measuring and recording
manufacturing overhead cost” article.

Recording actual and applied overhead cost in manufacturing overhead

account:

Over or under-applied manufacturing overhead is actually the debit or credit balance

of manufacturing overhead account (also known as factory overhead account).

Actual manufacturing overhead costs are debited and applied manufacturing overhead
costs are credited to manufacturing overhead account. Actual overhead costs are
debited as they are incurred and applied overhead costs are credited as they are
applied to work in process. At the end of a period, if manufacturing overhead account
shows a debit balance, it means the overhead is under-applied. On the other hand; if it
shows a credit balance, it means the overhead is over-applied. For further explanation
of the concept, consider the following example:

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Andrews University Management accounting Readings

The debit or credit balance in manufacturing overhead account at the end of a month is
carried forward to the next month until the end of a particular period – usually one
year.

Disposition of over or under-applied manufacturing overhead:

At the end of the year, the balance in manufacturing overhead account (over or under-
applied manufacturing overhead) is disposed off by either allocating it among work in
process, finished goods and cost of goods sold accounts or transferring the entire
amount to cost of goods sold account. These two methods have been discussed below:

Allocation among work in process, finished goods and cost of goods sold
account:

Under this method, the amount of over or under-applied overhead is disposed off by
allocating it among work in process, finished goods and cost of goods sold accounts on
the basis of overhead applied in each of the accounts during the period. The following
journal entry is made to dispose off an over or under-applied overhead:

When overhead is under-applied:

When overhead is over-applied:

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This method is more accurate than second method. The only disadvantage of this
method is that it is more time consuming.

Transferring the entire amount of over or under-applied to cost of goods

sold:

Under this method the entire amount of over or under applied overhead is transferred
to cost of goods sold. The following entry is made for this purpose:

When overhead is under-applied:

When overhead is over-applied:

Example:

During the year 2012, Beta company started two jobs – job A and job B . Job A
consisted of 1,000 units and job B consisted of 500 units. At the end of the year 2012,
job A was completed but job B was in process. The information about manufacturing
overhead cost applied to job A and B was as follows:

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The actual manufacturing overhead cost incurred by the company during 2012 was
$108,000. Out of 1,000 units in job A, 750 units had been sold before the end of 2012.

Required: Calculate over or under applied manufacturing overhead and make journal
entries required to dispose off over or under applied manufacturing overhead assuming:

1. It is disposed off by allocating between inventory and cost of goods sold

accounts.
2. It is disposed off by transferring to cost of goods sold.

Solution:

Calculation of over or under-applied manufacturing overhead:

In our example, manufacturing overhead is under-applied because actual overhead is

more than applied overhead. The under-applied overhead has been calculated below:

Under-applied manufacturing overhead = Total manufacturing overhead cost actually

incurred – Total manufacturing overhead applied to work in process

= $108,000 – $100,000

= $8,000

Journal entries to dispose off under-applied overhead:

(i). Allocation of under-applied overhead among work in process, finished goods, and
cost of goods sold accounts:

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(ii). Transfer of entire under-applied overhead to cost of goods sold account:

Treatment of non-manufacturing costs

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Non-manufacturing expenses have no effect on the production cost of the company

because they are treated as period costs.

Non-manufacturing costs are not included in manufacturing overhead account but

are charged directly to income statement. Examples of non-manufacturing expenses are
sales commission, advertising expenses, rent of office building, and depreciation on the
equipment used in office etc.

Journal entries to record non-manufacturing costs:

To understand how entries for non-manufacturing costs are made, consider the
following example:

GX company uses job order costing system and has incurred the following non-
manufacturing expenses for the most recent period:

1. Selling and administrative salary: $60,000

2. Depreciation on office expenses furniture: $14,000
3. Advertising expenses: $84,000
4. Other selling and administrative expenses: $16,000

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Required: make journal entries from the information provided above.

Journal entries:

Note: In entry 2, the depreciation on office furniture have been debited to depreciation
expense because depreciation on office furniture or equipment is treated as period cost.
If it were a depreciation on factory equipment, it would have been debited to
manufacturing overhead because depreciation on factory equipment is treated as
manufacturing or product cost.

Recording finished goods and cost of goods manufactured:

In a job order costing system, all manufacturing costs (i.e., direct materials, direct
labor, and applied manufacturing overhead) of the job are debited to work in process
account. When a job is completed, its cost (as shown by job cost sheet) is transferred
from the work in process account to the finished goods account.

After completion, the job becomes finished goods and is, therefore, transferred from
the production department to the finished goods storeroom (also called warehouse).

The following journal entry is made to transfer the cost of a completed job from work in
process account to finished goods account:

The total cost transferred from the work in process account to the finished goods
account during a period is equal to the cost of goods manufactured for that period.

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At the end of a period, the cost of incomplete jobs remain in the work in process
account and is shown as “work in process inventory” in assets section of the balance
sheet. Next period, this cost represents the opening balance of the work in process
account.

Cost of goods sold:

When finished goods are shipped to customers, the cost of finished goods are
transferred from finished goods account to cost of goods sold account. If a job is
completed according to specification of a particular customer, the complete job is
shipped to the customer immediately and the manufacturing cost associated with the
job (as shown by the job cost sheet) is charged to the cost of goods sold. But in some
cases, the complete job is not shipped but only a portion of the job is sold to
customers. In such circumstances, the manufacturing cost per unit is computed and the
cost of the units that have been shipped to customers is charged to cost of goods sold
account.

Sales and the transfer of cost from finished goods to cost of goods sold account are
recorded by making the following journal entries:

(1). When sales are made:

i. If sales are made on account:

ii. If sales are made on cash

(2). When cost is transferred to cost of goods sold account:

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(See BBB Company attached)

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