Job cost sheets constitute the subsidiary ledger for

CHAPTER PREVIEW 

The Feature Story about Disney describes how important accurate costing is to movie studios. In order to submit accurate bids on new film projects and to know whether it profited from past films, the company needs a good costing system. This chapter illustrates how costs are assigned to specific jobs, such as the production of The Avengers 2. We begin the discussion in this chapter with an overview of the flow of costs in a job order cost accounting system. We then use a case study to explain and illustrate the documents, entries, and accounts in this type of cost accounting system.

A chart lists learning objectives and do it practices in this chapter. Learning objective 1: describe cost systems and the flow of costs in a job order system, covers process cost system, job order cost system, job order cost flow, and accumulating costs. Do it practice 1: accumulating manufacturing costs. Learning objective 2: use a job cost sheet to assign costs to work in process, covers raw materials costs and factory labor costs. Do it practice 2: work in process. Learning objective 3: demonstrate how to determine and use the predetermined overhead rate. Do it practice 3: predetermined overhead rate. Learning objective 4: prepare entries for manufacturing and service jobs completed and sold, covers finished goods, cost of goods sold, summary, job order for service companies, and pros and cons of job order costing. Do it practice 4: completion and sale of jobs. Learning objective 5: distinguish between under- and overapplied manufacturing overhead, covers under- or overapplied manufacturing overhead. Do it practice 5: applied manufacturing overhead. Go to the review and practice section at the end of the chapter for a targeted summary and exercises with solutions. Visit WileyPlus for additional tutorials and practice opportunities.

Profiting from the Silver Screen

Have you ever had the chance to tour a movie studio? There's a lot going on! Lots of equipment and lots of people with a variety of talents. Running a film studio, whether as an independent company or part of a major corporation, is a complex and risky business. Consider Disney, which has produced such classics as Snow White and the Seven Dwarfs and such colossal successes as Frozen. The movie studio has, however, also seen its share of losses. Disney's Lone Ranger movie brought in revenues of $260 million, but its production and marketing costs were a combined $375 million—a loss of $115 million.

Every time Disney or another movie studio makes a new movie, it is creating a unique product. Ideally, each new movie should be able to stand on its own, that is, the film should generate revenues that exceed its costs. And in order to know whether a particular movie is profitable, the studio must keep track of all of the costs incurred to make and market the film. These costs include such items as salaries of the writers, actors, director, producer, and production team (e.g., film crew); licensing costs; depreciation on equipment; music; studio rental; and marketing and distribution costs. If you've ever watched the credits at the end of a movie, you know the list goes on and on.

The movie studio isn't the only one with an interest in knowing a particular project's profitability. Many of the people involved in making the movie, such as the screenwriters, actors, and producers, have at least part of their compensation tied to its profitability. As such, complaints about inaccurate accounting are common in the movie industry.

In particular, a few well‐known and widely attended movies reported low profits, or even losses, once the accountants got done with them. How can this be? The issue is that a large portion of a movie's costs are overhead costs that can't be directly traced to a film, such as depreciation of film equipment and sets, facility maintenance costs, and executives' salaries. Actors and others often suggest that these overhead costs are overallocated to their movie and therefore negatively affect their compensation.

To reduce the risk of financial flops, many of the big studios now focus on making sequels of previous hits. This might explain why, shortly after losing money on the Lone Ranger, Disney announced plans to make The Avengers 2—a much safer bet.

LEARNING OBJECTIVE 1

Describe cost systems and the flow of costs in a job order system.

Cost accounting involves measuring, recording, and reporting product costs. Companies determine both the total cost and the unit cost of each product. The accuracy of the product cost information is critical to the success of the company. Companies use this information to determine which products to produce, what prices to charge, and how many units to produce. Accurate product cost information is also vital for effective evaluation of employee performance.

A cost accounting system consists of accounts for the various manufacturing costs. These accounts are fully integrated into the general ledger of a company. An important feature of a cost accounting system is the use of a perpetual inventory system. Such a system provides immediate, up‐to‐date information on the cost of a product.

There are two basic types of cost accounting systems: (1) a process cost system and (2) a job order cost system. Although cost accounting systems differ widely from company to company, most involve one of these two traditional product costing systems.

PROCESS COST SYSTEM

A company uses a process cost system when it manufactures a large volume of similar products. Production is continuous. Examples of a process cost system are the manufacture of cereal by Kellogg, the refining of petroleum by Exxon‐Mobil, and the production of ice cream by Ben & Jerry's. Process costing accumulates product‐related costs for a period of time (such as a week or a month) instead of assigning costs to specific products or job orders. In process costing, companies assign the costs to departments or processes for the specified period of time. Illustration 15-1 shows examples of the use of a process cost system. We will discuss the process cost system further in Chapter 16 .

Illustration of Process cost system which depicts production of Potato chips. The process include: Harvest; Clean; Slice; Fry; Bag - packaging. Below the illustration, a text reads, Similar products are produced over a specified time period. ILLUSTRATION 15-1 Process cost system

JOB ORDER COST SYSTEM

Under a job order cost system , the company assigns costs to each job or to each batch of goods. An example of a job is the manufacture of a jet by Boeing, the production of a movie by Disney, or the making of a fire truck by American LaFrance. An example of a batch is the printing of 225 wedding invitations by a local print shop, or the printing of a weekly issue of Fortune magazine by a high‐tech printer such as Quad Graphics.

An important feature of job order costing is that each job or batch has its own distinguishing characteristics. For example, each house is custom built, each consulting engagement by a CPA firm is unique, and each printing job is different. The objective is to compute the cost per job. At each point in manufacturing a product or performing a service, the company can identify the job and its associated costs. A job order cost system measures costs for each completed job, rather than for set time periods. Illustration 15-2 shows the recording of costs in a job order cost system for Disney as it produced two different films at the same time: an animated film and an action thriller.

Illustration depicts job order cost system for Disney involving two jobs, animated film and action thriller. Job Id #9501, pertaining to an animated film, deals with Computer programmers, Musical composers, voice-over talent, and Animation talent. Job id #9502, pertaining to Action thriller film, deals with Actors, Stunt people, set design, Food caterers, Stunt person insurance, and location fees. Each job has distinguishing characteristics and related costs ILLUSTRATION 15-2 Job order cost system for Disney

Can a company use both types of cost systems? Yes. For example, General Motors uses process cost accounting for its standard model cars, such as Malibus and Corvettes, and job order cost accounting for a custom‐made limousine for the President of the United States.

The objective of both cost accounting systems is to provide unit cost information for product pricing, cost control, inventory valuation, and financial statement presentation.

 MANAGEMENT INSIGHT 

Jobs Won, Money Lost

An engine pulling a train.

Many companies suffer from poor cost accounting. As a result, they sometimes make products they should not be selling at all, or they buy product components that they could more profitably make themselves. Also, inaccurate cost data leads companies to misallocate capital and frustrates efforts by plant managers to improve efficiency.

For example, consider the case of a diversified company in the business of rebuilding diesel locomotives. The managers thought they were making money, but a consulting firm found that the company had seriously underestimated costs. The company bailed out of the business and not a moment too soon. Says the consultant who advised the company, “The more contracts it won, the more money it lost.” Given that situation, a company cannot stay in business very long!

What type of costs do you think the company had been underestimating? (Go to WileyPLUS for this answer and additional questions.)

JOB ORDER COST FLOW

The flow of costs (direct materials, direct labor, and manufacturing overhead) in job order cost accounting parallels the physical flow of the materials as they are converted into finished goods. As shown in Illustration 15-3 (page 750), companies first accumulate manufacturing costs in the form of raw materials, factory labor, or manufacturing overhead. They then assign manufacturing costs to the Work in Process Inventory account. When a job is completed, the company transfers the cost of the job to Finished Goods Inventory. Later when the goods are sold, the company transfers their cost to Cost of Goods Sold.

The illustration shows multiple T-accounts depicting the Flow of costs in Job Order Costing. The First T-account is labeled as Manufacturing costs and has three segments: Raw materials; Factory labor; and manufacturing overhead. The second T-account is labeled as Work in Process inventory showing the picture of a Fire truck with its chassis alone. A red arrow labeled Assigned to is drawn from Manufacturing costs T-account to Work in Process Inventory. The third T-account is labeled as Finished Goods inventory showing the picture of a completed Fire truck. A red arrow labeled Completed is drawn from Work in Process inventory T-account to Finished Goods inventory.The fourth T-account is labeled as Costs of goods sold showing the picture of a sold Fire truck. A red arrow labeled Sold is drawn from Finished Goods inventory T-account to Costs of goods. ILLUSTRATION 15-3 Flow of costs in job order costing

Illustration 15-3 provides a basic overview of the flow of costs in a manufacturing setting for production of a fire truck. A more detailed presentation of the flow of costs is summarized near the end of this chapter in Illustration 15-15 . There are two major steps in the flow of costs: (1) accumulatingthe manufacturing costs incurred, and (2) assigning the accumulated costs to the work done. The following discussion shows that the company accumulates manufacturing costs incurred by debits to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead. When the company incurs these costs, it does not attempt to associate the costs with specific jobs. The company makes additional entries to assign manufacturing costs incurred to specific jobs. In the remainder of this chapter, we will use a case study to explain how a job order cost system operates.

ACCUMULATING MANUFACTURING COSTS

To illustrate a job order cost system, we will use the January transactions of Wallace Company, which makes custom electronic sensors for corporate safety applications (such as fire and carbon monoxide) and security applications (such as theft and corporate espionage).

Raw Materials Costs

When Wallace receives the raw materials it has purchased, it debits the cost of the materials to Raw Materials Inventory. The company debits this account for the invoice cost of the raw materials and freight costs chargeable to the purchaser. It credits the account for purchase discounts taken and purchase returns and allowances. Wallace makes no effort at this point to associate the cost of materials with specific jobs or orders.

To illustrate, assume that Wallace purchases 2,000 lithium batteries (Stock No. AA2746) at $5 per unit ($10,000) and 800 electronic modules (Stock No. AA2850) at $40 per unit ($32,000) for a total cost of $42,000 ($10,000+$32,000)$42,000 ($10,000+$32,000). The entry to record this purchase on January 4 is:

Raw Materials Inventory

42,000

(1) 1

Jan. 4

Raw Materials Inventory

 42,000

 Accounts Payable

 42,000

  (Purchase of raw materials on account)

At this point, Raw Materials Inventory has a balance of $42,000, as shown in the T‐account in the margin. As we will explain later in the chapter, the company subsequently assigns direct raw materials inventory to work in process and indirect raw materials inventory to manufacturing overhead.

Factory Labor Costs

Some of a company's employees are involved in the manufacturing process, while others are not. As discussed in Chapter 14 , wages and salaries of nonmanufacturing employees are expensed as period costs (e.g., Salaries and Wages Expense). Costs related to manufacturing employees are accumulated in Factory Labor to ensure their treatment as product costs. Factory labor consists of three costs: (1) gross earnings of factory workers, (2) employer payroll taxes on these earnings, and (3) fringe benefits (such as sick pay, pensions, and vacation pay) incurred by the employer. Companies debit labor costs to Factory Labor as they incur those costs.

To illustrate, assume that Wallace incurs $32,000 of factory labor costs. Of that amount, $27,000 relates to wages payable and $5,000 relates to payroll taxes payable in February. The entry to record factory labor for the month is:

Factory Labor

32,000

(2)

Jan. 31

Factory Labor

 32,000

 Factory Wages Payable

 27,000

 Employer Payroll Taxes Payable

5,000

  (To record factory labor costs)

At this point, Factory Labor has a balance of $32,000, as shown in the T‐account in the margin. The company subsequently assigns direct factory labor to work in process and indirect factory labor to manufacturing overhead.

Manufacturing Overhead Costs

A company has many types of overhead costs. If these overhead costs, such as property taxes, depreciation, insurance, and repairs, relate to overhead costs of a nonmanufacturing facility, such as an office building, then these costs are expensed as period costs (e.g., Property Tax Expense, Depreciation Expense, Insurance Expense, and Maintenance and Repairs Expense). If the costs relate to the manufacturing process, then they are accumulated in Manufacturing Overhead to ensure their treatment as product costs.

Using assumed data, the summary entry for manufacturing overhead in Wallace Company is:

Manufacturing Overhead

13,800

(3)

Jan. 31

Manufacturing Overhead

13,800

 Utilities Payable

4,800

 Prepaid Insurance

2,000

 Accounts Payable (for repairs)

2,600

 Accumulated Depreciation

3,000

 Property Taxes Payable

1,400

  (To record overhead costs)

At this point, Manufacturing Overhead has a balance of $13,800, as shown in the T‐account in the margin. The company subsequently assigns manufacturing overhead to work in process.

DO IT! 1

Accumulating Manufacturing Costs

During the current month, Ringling Company incurs the following manufacturing costs:

(a) Raw material purchases of $4,200 on account.

(b) Factory labor of $18,000. Of that amount, $15,000 relates to wages payable and $3,000 relates to payroll taxes payable.

(c) Factory utilities of $2,200 are payable, prepaid factory insurance of $1,800 has expired, and depreciation on the factory building is $3,500.

Prepare journal entries for each type of manufacturing cost.

Action Plan

✓ In accumulating manufacturing costs, debit at least one of three accounts: Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

✓ Manufacturing overhead costs may be recognized daily. Or, manufacturing overhead may be recorded periodically through a summary entry.

SOLUTION

(a)

Raw Materials Inventory

 4,200

 Accounts Payable

 4,200

  (Purchases of raw materials on account)

(b)

Factory Labor

18,000

 Factory Wages Payable

15,000

 Employer Payroll Taxes Payable

3,000

  (To record factory labor costs)

(c)

Manufacturing Overhead

7,500

 Utilities Payable

2,200

 Prepaid Insurance

1,800

 Accumulated Depreciation

3,500

  (To record overhead costs)

Related exercise material: BE15-1, BE15-2, E15-1, E15-7, E15-8, E15-11, and DO IT! 15-1.

LEARNING OBJECTIVE 2

Use a job cost sheet to assign costs to work in process.

Assigning manufacturing costs to work in process results in the following entries.

1. Debits made to Work in Process Inventory.

2. Credits made to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

An essential accounting record in assigning costs to jobs is a job cost sheet, as shown in Illustration 15-4 . A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.

Companies keep a separate job cost sheet for each job. The job cost sheets constitute the subsidiary ledger for the Work in Process Inventory account. A subsidiary ledger consists of individual records for each individual item—in this case, each job. The Work in Process account is referred to as a control account because it summarizes the detailed data regarding specific jobs contained in the job cost sheets. Each entry to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets.

Illustration showing the Job Cost Sheet. The Job Cost Sheet is a form consisting of fields such as Job no, Item, For, Quantity, Date Requested, a and Date Completed. Below is a four-column table with headings: Date, Direct materials, Direct labor, and manufacturing overhead. Below are a series of fields: Cost of Completed Job comprising of Direct materials, Direct labor, and Manufacturing overhead, Total cost and Unit cost, total dollars divided by quantity. ILLUSTRATION 15-4 Job cost sheet

DECISION TOOLS Decision Tool

A completed job cost sheet helps managers to compare costs to both those of previous periods and of competitors to ensure that costs are in line.

▼ HELPFUL HINT

Companies typically maintain job cost sheets as computer files.

RAW MATERIALS COSTS

Companies assign raw materials costs to jobs when their materials storeroom issues the materials in response to requests.Requests for issuing raw materials are made on a prenumbered materials requisition slip . The materials issued may be used directly on a job, or they may be considered indirect materials. As Illustration 15-5 shows, the requisition should indicate the quantity and type of materials withdrawn and the account to be charged. The company will charge direct materials to Work in Process Inventory, and indirect materials to Manufacturing Overhead.

ETHICS NOTE

Approvals are an important internal control feature of a requisition slip because they establish individual accountability over inventory.

Illustration showing the Materials requisitions slips. Shown is a hand-written Material requisition ship of Wallace Company. The form consists of fields such as Deliver to, Charge to, Reg. no., and Date. Below is a five-column table with headings: Quantity, Description, Stock No., and Cost per unit and Total. Below are a series of fields: Requested by, Approved by, Received by and Costed by. ILLUSTRATION 15-5 Materials requisition slip

▼ HELPFUL HINT

Note the specific job (in this case, Job No. 101) to be charged.

ETHICS NOTE

The internal control principle of documentation includes prenumbering to enhance accountability.

The company may use any of the inventory costing methods (FIFO, LIFO, or average‐cost) in costing the requisitions to the individual job cost sheets.

Periodically, the company journalizes the requisitions. For example, if Wallace uses $24,000 of direct materials and $6,000 of indirect materials in January, the entry is:

(4)

Jan. 31

Work in Process Inventory

24,000

Manufacturing Overhead

6,000

 Raw Materials Inventory

30,000

  (To assign materials to jobs and overhead)

This entry reduces Raw Materials Inventory by $30,000, increases Work in Process Inventory by $24,000, and increases Manufacturing Overhead by $6,000, as shown below.

Illustration shows multiple T-accounts: one on the left side and two on the right side. The left-hand side T-account is labeled as Raw Materials Inventory and has amount 42,000 and 30,000 on debit and credit sides, where latter is marked red. The top T-account at the right-hand side is labeled as Work in Process Inventory and has 24,000 on debit side, marked in red. The bottom T-account at the right-hand side is labeled as Manufacturing Overhead and has amounts 13,000 and 6,000 as debit values where the latter is marked red. Amount 30,000 from first account is split into 24,000 and 6,000 of next two accounts

Illustration 15-6 shows the posting of requisition slip R247 to Job No. 101 and other assumed postings to the job cost sheets for materials. The requisition slips provide the basis for total direct materials costs of $12,000 for Job No. 101, $7,000 for Job No. 102, and $5,000 for Job No. 103. After the company has completed all postings, the sum of the direct materials columns of the job cost sheets (the subsidiary account amounts of $12,000, $7,000, and $5,000) should equal the direct materials debited to Work in Process Inventory (the control account amount of $24,000).

Illustration of Job cost sheets–posting of direct materials. Illustration is a Flow chart summary showing accounting involved in filling Job cost sheets. Shown at the top is a T-account labeled as General Ledger of Work in Process Inventory. An amount of $24,000 is shown on debit side. The right-hand side has three tables labeled collectively as Subsidiary Ledger: Job costs sheets under which three tables containing specific job numbers and comprising of columns labeled: Date, Direct materials, Direct labor, and Manufacturing overhead, are shown.At the bottom a box reads, Source documents for posting to job cost sheets and Work in Process Inventory: Material requisition slips. A red arrow from this box leads to General ledger. An arrow containing text, $24,000 assigned to specific jobs, starts from general ledger and splits into three that points to the three tables of the subsidiary ledge. ILLUSTRATION 15-6 Job cost sheets–posting of direct materials

▼ HELPFUL HINT

Companies post to control accounts monthly, and post to job cost sheets daily.

▼ HELPFUL HINT

Prove the $24,000 direct materials charge to Work in Process Inventory by totaling the charges by jobs:

101

$12,000

102

7,000

103

 5,000

$24,000

 MANAGEMENT INSIGHT  iSuppli

The Cost of an iPhone? Just Tear One Apart

Screenshot of a snippet with one-line heading Management Insight.© TommL/iStockphoto

All companies need to know what it costs to make their own products—but a lot of companies would also like to know the cost of their competitors' products as well. That's where iSuppli steps in. For a price, iSuppli will tear apart sophisticated electronic devices to tell you what it would cost to replicate. In the case of smartphones, which often have more than 1,000 tiny components, that is no small feat. As shown in the chart to the right, the components of a recent iPhone model cost about $170. Assembly adds only about another $6.50. However, the difference between what you pay (about double the total component cost) and the “cost” is not all profit. You also have to consider the additional nonproduction costs of research, design, marketing, patent fees, and selling costs.

Components

Apple iPhone a

Integrated circuits

$ 91.38    

Display/touchscreen

34.65    

Mechanical b

17.80    

Camera

9.35    

Battery

5.07    

Other

 11.82    

Total

$170.07    

a Latest data available.

b Includes electromechanical.

Source: iSuppli.

Source: “The Business of Dissecting Electronics: The Lowdown on Teardowns,” The Economist.com (January 21, 2010).

What type of costs are marketing and selling costs, and how are they treated for accounting purposes? (Go to WileyPLUS for this answer and additional questions.)

FACTORY LABOR COSTS

Companies assign factory labor costs to jobs on the basis of time tickets prepared when the work is performed. The time ticket indicates the employee, the hours worked, the account and job to be charged, and the total labor cost. Many companies accumulate these data through the use of bar coding and scanning devices. When they start and end work, employees scan bar codes on their identification badges and bar codes associated with each job they work on. When direct labor is involved, the time ticket must indicate the job number, as shown in Illustration 15-7 . The employee's supervisor should approve all time tickets.

Illustration showing the Materials requisitions slip. Shown is a hand-written Material requisition ship of Wallace Company. The form consists of fields such as Deliver to, Charge to, Reg. no., and Date. Below is a five-column table with heads: Quantity, Description, Stock No., and Cost per unit and Total. Below are a series of fields: Requested by, Approved by, Received by and Costed by. ILLUSTRATION 15-7 Time ticket

The time tickets are later sent to the payroll department, which applies the employee's hourly wage rate and computes the total labor cost. Finally, the company journalizes the time tickets. It debits the account Work in Process Inventory for direct labor and debits Manufacturing Overhead for indirect labor. For example, if the $32,000 total factory labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the entry is:

(5)

Jan. 31

Work in Process Inventory

28,000

Manufacturing Overhead

4,000

 Factory Labor

32,000

  (To assign labor to jobs and overhead)

As a result of this entry, Factory Labor is reduced by $32,000 so it has a zero balance, and labor costs are assigned to the appropriate manufacturing accounts. The entry increases Work in Process Inventory by $28,000 and increases Manufacturing Overhead by $4,000, as shown below.

Illustration shows multiple T-accounts: one on left side and two on right side. The left-hand side T-account is labeled as Factory Labor and has 32,000 and 32,000 on debit and credit sides, where latter is marked red. The top T-account at the right-hand side is labeled as Work in Process Inventory and has amounts 24,000 and 28,000 on debit side where the latter is marked red. The bottom T-account at the right-hand side is labeled as Manufacturing Overhead and has amounts 13,800, 6,000, and 4,000 on debit side where the latter is marked red. Amount 32,000 from first account is split into 28,000 and 4,000 of next two accounts.

Let's assume that the labor costs chargeable to Wallace's three jobs are $15,000, $9,000, and $4,000. Illustration 15-8 shows the Work in Process Inventory and job cost sheets after posting. As in the case of direct materials, the postings to the direct labor columns of the job cost sheets should equal the posting of direct labor to Work in Process Inventory.

Illustration of Job cost sheets–posting of direct materials. Illustration is a Flow chart summary showing accounting involved in filling Job cost sheets. Shown at the top is a T-account labeled as General Ledger of Work in Process Inventory. An amount of $24,000 and $28,000 are shown on debit side. The right-hand side has three tables labeled collectively as Subsidiary Ledger: Job costs sheets under which three tables containing specific job numbers and comprising of columns labeled: Date, Direct materials, Direct labor, and Manufacturing overhead, are shown.At the bottom a box reads, Source documents for posting to job cost sheets and Work in Process Inventory: Time tickets. A red arrow from this box leads to General ledger. An arrow containing text, $28,000 assigned to specific jobs, starts from general ledger and splits into three that points to the amounts in direct labor column of the three tables of the subsidiary ledge. ILLUSTRATION 15-8 Job cost sheets–direct labor

▼ HELPFUL HINT

Prove the $28,000 direct labor charge to Work in Process Inventory by totaling the charges by jobs:

101

$15,000

102

9,000

103

 4,000

$28,000

DO IT! 2

Work in Process

Danielle Company is working on two job orders. The job cost sheets show the following:

· Direct materials—Job 120 $6,000; Job 121 $3,600

· Direct labor—Job 120 $4,000; Job 121 $2,000

· Manufacturing overhead—Job 120 $5,000; Job 121 $2,500

Prepare the three summary entries to record the assignment of costs to Work in Process from the data on the job cost sheets.

Action Plan

✓ Recognize that Work in Process Inventory is the control account for all unfinished job cost sheets.

✓ Debit Work in Process Inventory for the materials, labor, and overhead charged to the job cost sheets.

✓ Credit the accounts that were debited when the manufacturing costs were accumulated.

SOLUTION

The three summary entries are:

Work in Process Inventory ($6,000 + $3,600)

 9,600

 Raw Materials Inventory

 9,600

  (To assign materials to jobs)

Work in Process Inventory ($4,000 + $2,000)

6,000

 Factory Labor

6,000

  (To assign labor to jobs)

Work in Process Inventory ($5,000 + $2,500)

7,500

 Manufacturing Overhead

7,500

  (To assign overhead to jobs)

Related exercise material: BE15-3, BE15-4, BE15-5, E15-2, E15-7, E15-8, and DO IT! 15-2.

LEARNING OBJECTIVE 3

Demonstrate how to determine and use the predetermined overhead rate.

Companies charge the actual costs of direct materials and direct labor to specific jobs. In contrast, manufacturing overhead relates to production operations as a whole. As a result, overhead costs cannot be assigned to specific jobs on the basis of actual costs incurred. Instead, companies assign manufacturing overhead to work in process and to specific jobs on an estimated basis through the use of a predetermined overhead rate.

The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. The company may state the activity in terms of direct labor costs, direct labor hours, machine hours, or any other measure that will provide an equitable basis for applying overhead costs to jobs. Companies establish the predetermined overhead rate at the beginning of the year. Small companies often use a single, company‐wide predetermined overhead rate. Large companies often use rates that vary from department to department. The formula for a predetermined overhead rate is as follows.

Estimated AnnualOverhead Costs÷Expected AnnualOperating Activity=PredeterminedOverhead RateEstimated AnnualOverhead Costs÷Expected AnnualOperating Activity=PredeterminedOverhead RateILLUSTRATION 15-9 Formula for predetermined overhead rate

Overhead relates to production operations as a whole. To know what “the whole” is, the logical thing is to wait until the end of the year's operations. At that time, the company knows all of its costs for the period. As a practical matter, though, managers cannot wait until the end of the year. To price products effectively as they are completed, managers need information about product costs of specific jobs completed during the year. Using a predetermined overhead rate enables a cost to be determined for the job immediately. Illustration 15-10 indicates how manufacturing overhead is assigned to work in process.

Flowchart-like illustration used to describe predetermined overhead rates. Actual Activity base Used multiplied by Predetermined Overhead Rate is assigned to T-accounts for work in progress under which t-accounts for three specific jobs are shown. ILLUSTRATION 15-10 Using predetermined overhead rates

Wallace Company uses direct labor cost as the activity base. Assuming that the company expects annual overhead costs to be $280,000 and direct labor costs for the year to be $350,000, the overhead rate is 80%, computed as follows.

Estimated Annual Overhead Costs÷Expected Direct Labor Cost=Predetermined Overhead Rate$280,000÷$350,000=80%Estimated Annual Overhead Costs÷Expected Direct Labor Cost=Predetermined Overhead Rate$280,000÷$350,000=80%ILLUSTRATION 15-11 Calculation of predetermined overhead rate

This means that for every dollar of direct labor, Wallace will assign 80 cents of manufacturing overhead to a job. The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when it completes the job.

Historically, companies used direct labor costs or direct labor hours as the activity base. The reason was the relatively high correlation between direct labor and manufacturing overhead. Today, more companies are using machine hours as the activity base, due to increased reliance on automation in manufacturing operations. Or, as mentioned in Chapter 14 (and discussed more fully in Chapter 17 ), many companies now use activity‐based costing to more accurately allocate overhead costs based on the activities that give rise to the costs.

A company may use more than one activity base. For example, if a job is manufactured in more than one factory department, each department may have its own overhead rate. In the Feature Story, Disney might use two bases in assigning overhead to film jobs: direct materials dollars for indirect materials, and direct labor hours for such costs as insurance and supervisor salaries.

Wallace Company applies manufacturing overhead to work in process when it assigns direct labor costs. It also applies manufacturing overhead to specific jobs at the same time. For January, Wallace applied overhead of $22,400 in response to its assignment of $28,000 of direct labor costs (direct labor cost of $28,000 × 80%). The following entry records this application.

(6)

Jan. 31

Work in Process Inventory

22,400

 Manufacturing Overhead

22,400

  (To assign overhead to jobs)

This entry reduces the balance in Manufacturing Overhead and increases Work in Process Inventory by $22,400, as shown below.

Illustration shows multiple T-accounts: one to the left side and one to the right side. The left-hand side T-account is labeled as Manufacturing Overhead and has 13,800, 6,000, and 4,000 displayed on debit side and 22,400 displayed on credit sid. The right-hand side T-account is labeled as Work in Process Inventory and has 24,000, 28,000 and 22,400 displayed on debit side. A red arrow is drawn from 22,400 of Manufacturing Overhead to 22,400 of Work in Process Inventory.

The overhead that Wallace applies to each job will be 80% of the direct labor cost of the job for the month. Illustration 15-12 shows the Work in Process Inventory account and the job cost sheets after posting. Note that the debit of $22,400 to Work in Process Inventory equals the sum of the overhead applied to jobs: Job No. 101 $12,000+Job No. 102 $7,200+Job No. 103 $3,200Job No. 101 $12,000+Job No. 102 $7,200+Job No. 103 $3,200.

Illustration of Job cost sheets–posting of direct materials. Illustration is a Flow chart summary showing accounting involved in filling Job cost sheets. Shown at the top is a T-account labeled as General Ledger of Work in Process Inventory. An amount of $24,000, $28,000 and 22,400 are shown on debit side. The right-hand side has three tables labeled collectively as Subsidiary Ledger: Job costs sheets under which three tables containing specific job numbers and comprising of columns labeled: Date, Direct materials, Direct labor, and Manufacturing overhead, are shown.At the bottom a box reads, Source documents for posting to job cost sheets: predetermined overhead rate, 80 % of direct labor cost. A red arrow from this box leads to General ledger. An arrow containing text, $22,400 assigned to specific jobs, starts from general ledger and splits into three that points to the amounts in Manufacturing Overhead column of the three tables of the subsidiary ledge. ILLUSTRATION 15-12 Job cost sheets–manufacturing overhead applied

At the end of each month, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. Illustration 15-13 presents proof of the agreement of the control and subsidiary accounts in Wallace. (It assumes that all jobs are still in process.)

Illustration shows multiple T-accounts: one to the left side and one to the right side. The right-hand side T-account is labeled as Work in Process Inventory and has 24,000, 28,000 and 22,400 as values; the values are totaled as 74,400 at the bottom and highlighted in red. A red arrow is drawn from 22,400 to 22,400.The left-hand side T-account is labeled as Job costs sheets and has $39,000, 23,200 and 12,200 as values; the values are totaled as 74,400 at the bottom and highlighted in red. A red arrow is drawn from $74,400 to $74,400. ILLUSTRATION 15-13 Proof of job cost sheets to work in process inventory

DO IT! 3

Predetermined Overhead Rate

Stanley Company produces specialized safety devices. For the year, manufacturing overhead costs are expected to be $160,000. Expected machine usage is 40,000 hours. The company assigns overhead based on machine hours. Job No. 302 used 2,000 machine hours.

Compute the predetermined overhead rate, determine the amount of overhead to allocate to Job No. 302, and prepare the entry to assign overhead to Job No. 302 on March 31.

Action Plan

✓ Predetermined overhead rate is estimated annual overhead cost divided by expected annual operating activity.

✓ Assignment of overhead to jobs is determined by multiplying the actual activity base used by the predetermined overhead rate.

✓ The entry to record the assignment of overhead transfers an amount out of Manufacturing Overhead into Work in Process Inventory.

SOLUTION

Predetermined overhead rate=$160,000÷40,000 hours=$4.00 per machine hourPredetermined overhead rate=$160,000÷40,000 hours=$4.00 per machine hour

Amount of overhead assigned to Job No. 302=2,000 hours×$4.00=$8,000Amount of overhead assigned to Job No. 302=2,000 hours×$4.00=$8,000

The entry to record the assignment of overhead to Job No. 302 on March 31 is:

Work in Process Inventory

 8,000

 Manufacturing Overhead

 8,000

  (To assign overhead to jobs) 

Related exercise material: BE15-6, BE15-7, E15-5, E15-6, and DO IT! 15-3.

LEARNING OBJECTIVE 4

Prepare entries for manufacturing and service jobs completed and sold.

ASSIGNING COSTS TO FINISHED GOODS

When a job is completed, Wallace Company summarizes the costs and completes the lower portion of the applicable job cost sheet. For example, if we assume that Wallace completes Job No. 101, a batch of electronic sensors, on January 31, the job cost sheet appears as shown in Illustration 15-14 .

Illustration showing the Job Cost Sheet. The Job Cost Sheet is a form consisting of fields such as Job no., Item, For, Quantity, Date Requested, a and Date Completed. Below is a four-column table with heads: Date, Direct materials, Direct labor, and manufacturing overhead. Below are a series of fields: Cost of Completed Job, Total cost and Unit cost (total dollars ÷ quantity). Below the Cost of completed job are three values slightly intended to the right: Direct materials, Direct labor, and Manufacturing overhead. ILLUSTRATION 15-14 Completed job cost sheet

When a job is finished, Wallace makes an entry to transfer its total cost to finished goods inventory. The entry is as follows.

(7)

Jan. 31

Finished Goods Inventory

 39,000

 Work in Process Inventory

 39,000

  (To record completion of Job No. 101) 

This entry increases Finished Goods Inventory and reduces Work in Process Inventory by $39,000, as shown in the T‐accounts below.

Illustration shows multiple T-accounts: one on the left side and one on the right side. The left-hand side T-account is labeled as Work in Process Inventory and has amounts 24,000, 28,000 and 22,400 on debit side and amount 39,000 on credit side where the last amount is highlighted in red. The right-hand side T-account is labeled as Finished Goods Inventory and has 39,000 on debit side highlighted in red. A red arrow is drawn from 39,000 of Work in process inventory to 39,000 of Finished goods inventory.

Finished Goods Inventory is a control account. It controls individual finished goods records in a finished goods subsidiary ledger.

ASSIGNING COSTS TO COST OF GOODS SOLD

Companies recognize cost of goods sold when each sale occurs. To illustrate the entries a company makes when it sells a completed job, assume that on January 31 Wallace Company sells on account Job No. 101. The job cost $39,000, and it sold for $50,000. The entries to record the sale and recognize cost of goods sold are:

(8)

Jan. 31

Accounts Receivable

 50,000

 Sales Revenue

 50,000

  (To record sale of Job No. 101) 

31

Cost of Goods Sold

39,000

 Finished Goods Inventory

39,000

  (To record cost of Job No. 101)

This entry increases Cost of Goods Sold and reduces Finished Goods Inventory by $39,000, as shown in the T‐accounts below.

Illustration shows multiple T-accounts: one on the left side and one on the right side. The left-hand side T-account is labeled as Finished Goods Inventory and has amount 39,000 on debit side and amount 39,000 on credit side where the latter is highlighted in red. The right-hand side T-account is labeled as Cost of goods sold and has 39,000 on debit side highlighted in red. A red arrow is drawn from 39,000 of Finished goods inventory to 39,000 of Cost of goods sold.

SUMMARY OF JOB ORDER COST FLOWS

Illustration 15-15 (page 762) shows a completed flowchart for a job order cost accounting system. All postings are keyed to entries 1–8 in the example presented in the previous pages for Wallace Company.

The cost flows in the diagram can be categorized as one of four types:

· Accumulation. The company first accumulates costs by (1) purchasing raw materials, (2) incurring labor costs, and (3) incurring manufacturing overhead costs.

· Assignment to jobs. Once the company has incurred manufacturing costs, it must assign them to specific jobs. For example, as it uses raw materials on specific jobs (4), the company assigns them to work in process or treats them as manufacturing overhead if the raw materials cannot be associated with a specific job. Similarly, the company either assigns factory labor (5) to work in process or treats it as manufacturing overhead if the factory labor cannot be associated with a specific job. Finally the company assigns manufacturing overhead (6) to work in process using a predetermined overhead rate. This deserves emphasis: Do not assign overhead using actual overhead costs but instead use a predetermined rate.

· Completed jobs. As jobs are completed (7), the company transfers the cost of the completed job out of work in process inventory into finished goods inventory.

· When goods are sold. As specific items are sold (8), the company transfers their cost out of finished goods inventory into cost of goods sold.

Illustration shows multiple T-accounts used to explain the Flow of costs in a job order cost system. The T-accounts in the left side include Raw materials inventory, Factory labor, and manufacturing overhead. The T-account in the middle include: Work in process inventory. The T-account in the right side include: Finished goods inventory and Cost of goods sold. Costs flow from Raw materials inventory, Factory labor, and manufacturing overhead to Work in process inventory to Finished goods inventory and Cost of goods sold. A table depicts key entries with columns labeled Accumulation and Assignment. Accumulation includes purchasing of raw materials, incurring factory labor and manufacturing overhead. Assignment includes using raw materials, factory labor, applying overhead, recognizing completed goods and cost of goods sold. ILLUSTRATION 15-15 Flow of costs in a job order cost system

Illustration 15-16 summarizes the flow of documents in a job order cost system.

Illustration shows the Flow of documents in a job order cost system. The flowchart depicts three source documents: Material requisition slips, labor time tickets, and Predetermined overhead rate. The three documents are pointed to Job cost sheet which summarizes the cost of jobs completed and not completed at the end of the accounting period. Jobs completed are transferred finished goods to await sale. ILLUSTRATION 15-16 Flow of documents in a job order cost system

JOB ORDER COSTING FOR SERVICE COMPANIES

Our extended job order costing example focuses on a manufacturer so that you see the flow of costs through the inventory accounts. It is important to understand, however, that job order costing is also commonly used by service companies. While service companies do not have inventory, the techniques of job order costing are still quite useful in many service‐industry environments. Consider, for example, the Mayo Clinic (healthcare), PriceWaterhouseCoopers (accounting), and Goldman Sachs (investment banking). These companies need to keep track of the cost of jobs performed for specific customers to evaluate the profitability of medical treatments, audits, or investment banking engagements.

Many service organizations bill their customers using cost‐plus contracts. Cost‐plus contracts mean that the customer's bill is the sum of the costs incurred on the job, plus a profit amount that is calculated as a percentage of the costs incurred. In order to minimize conflict with customers and reduce potential contract disputes, service companies that use cost‐plus contracts must maintain accurate and up‐to‐date costing records. Up‐to‐date cost records enable a service company to immediately notify a customer of cost overruns due to customer requests for changes to the original plan or unexpected complications. Timely recordkeeping allows the contractor and customer to consider alternatives before it is too late.

A service company that uses a job order cost system does not have inventory accounts. It does, however, use an account similar to Work in Process Inventory, referred to here as Service Contracts in Process, to record job costs prior to completion. To illustrate the journal entries for a service company under a job order cost system, consider the following transactions for Dorm Decor, an interior design company. The entry to record the assignment of $9,000 of supplies to projects ($7,000 direct and $2,000 indirect) is: