1. Distinguish between process costing and
job-order costing and identify companies that would use
each costing method.
2. Identify the documents used in a job-order costing
3. Compute predetermined overhead rates and explain why
estimated overhead costs (rather than actual overhead
costs) are used in the costing process.
4. Prepare journal entries to record costs in a job-order
5. Apply overhead cost to Work In Process using a
predetermined overhead rate.
6. Prepare T-accounts to show the flow of costs in a
job-order costing system, and prepare schedules of cost
of goods manufactured and cost of goods sold.
7. Compute under- or overapplied overhead cost and
prepare the journal entry to close the balance in
Manufacturing Overhead to the appropriate accounts.
A. Costing Systems. Two major types of
costing systems are used in manufacturing and many service
firms: process costing and job-order costing.
1. Process Costing. A process costing
system is used where a single, homogeneous product or
service is produced. In a process costing system, total
manufacturing costs are divided by total number of units
produced during a given period. The unit cost that
results is a broad, average figure. Examples of
industries in which process costing is used include
cement, flour, brick, and oil refining.
2. Job-Order Costing. Job-order costing is used
when different types of products, jobs, or batches are
produced, typically over a rather short period of time.
In a job-order costing system, direct materials costs and
direct labor costs are usually "traced" directly to jobs.
Overhead is applied to jobs using a predetermined rate.
Actual overhead costs are not "traced" to jobs. Examples
of industries in which job-order costing is used include
special order printing, shipbuilding, construction,
hospitals, professional services such as law firms, and
Note that there are many situations where either
job-order costing or process costing could be selected,
depending upon the level of detail needed and the desires
B. Job-Order Costing-An Overview. The
discussion in the text and below assumes that a paper-based
manual system is used for recording costs. Cost and other
data are recorded on materials requisition forms, time
tickets, and job cost sheets. Of course, many companies now
enter cost and other data directly into computer databases
and have dispensed with these paper documents. Nevertheless,
the data residing in the computer typically consists of a
"virtual" version of the manual system. Since a manual
system is easy for students to understand, we continue to
rely on it when describing a job-order costing system.
1. Job Cost Sheet. Each job has its own
job cost sheet on which are recorded the costs that have
been charged to the job. The job cost sheet will have
some code or descriptive data to identify the particular
job and will contain spaces to collect costs of
materials, labor, and overhead. Exhibit 3-4 provides an
illustration of a job cost sheet.
2. Materials Costs. When a job is started,
materials that will be required to complete the job are
withdrawn from the storeroom. The document that
authorizes these withdrawals and that specifies the types
and amounts of materials withdrawn is called the
materials requisition form. The materials requisition
form identifies the job to which the materials are to be
charged. Care must be taken when charging materials to
distinguish between direct and indirect materials. An
example of a materials requisition form is shown in
Exhibit 3-1 in the text.
3. Labor. Labor costs are recorded on a
document called a time ticket or a time sheet. Each
employee records the amount of time he or she spends on
each job and each task on a time ticket. The time spent
on a particular job is considered direct labor and its
cost is "traced" to that job. The cost of time spent on
other tasks, not traceable to any particular job, is
usually considered part of manufacturing overhead. An
example of an employee time ticket is shown in Exhibit
3-3 in the text.
4. Manufacturing Overhead. Manufacturing
overhead includes all of those costs incurred in the
manufacturing process which are not "traced" to a
particular job. In practice, manufacturing overhead
usually consists of all manufacturing costs other than
direct materials and direct labor. Since manufacturing
overhead costs are not traced to jobs, they must be
allocated to jobs if absorption costing is used.
a. We do not dwell on the reasons for
allocating all manufacturing overhead to jobs in
Chapter 3. There is, of course, a great deal of
controversy concerning what costs should or should not
be allocated to jobs and to products. In the chapter
we confine discussion to absorption costing since that
is what is used in the vast majority of organizations
for both external and internal reporting.
b. In order to allocate overhead costs, some type
of allocation base common to all products being
produced must be identified. The most widely used
allocation bases are direct labor-hours, direct labor
costs, and machine-hours. (These bases have been
severely criticized in recent years since allegedly
there is little relationship between machine-hours or
direct labor-hours and overhead.) In the costing
system illustrated in the chapter, a predetermined
overhead rate is computed by dividing the estimated
total overhead for the upcoming period by the
estimated total amount of the allocation base.
c. Ideally overhead cost should be strictly
proportional to the allocation base; in other words,
an x% change in the allocation base should cause an x%
change in the overhead cost. Only then will the
allocated overhead costs be useful in decision-making
and in performance evaluation. However, much of the
overhead typically consists of costs that are not
proportional to any allocation base that could be
devised for products and hence any scheme for
allocating such costs will inevitably lead to costs
that are biased and unreliable for decision-making and
performance evaluation. In practice, the overriding
concern is to select some basis or bases for
allocating all overhead costs and scant attention is
paid to questions of causality.
d. At any rate, the actual amount of the allocation base incurred
by a job is recorded on the job cost sheet. The actual amount of
the allocation base is then multiplied by the predetermined overhead
rate to determine the amount of overhead that is applied
to the job.
SUGGESTION: Remember that job costs consist of actual
direct materials costs, actual direct labor costs, but applied
C. Job Order Costing-The Flow of Costs.
Exhibit 3-14 in the text provides a model for the cost flows
in a job-order costing system.
1. Overview of Cost Flows. The basic flow
of costs in a job-order system begins by recording the
costs of material, labor, and manufacturing overhead.
a. Direct material and direct labor costs are
debited to the Work In Process account. Any indirect
material or indirect labor costs are debited to the
Manufacturing Overhead control account, along with any
other actual manufacturing overhead costs incurred
during the period. Manufacturing overhead is applied
to Work In Process using the predetermined rate. The
offsetting credit entry is to the Manufacturing
Overhead control account.
b. The cost of finished units is credited to Work
In Process and debited to the Finished Goods inventory
c. When units are sold, their costs are credited to
Finished Goods and debited to Cost of Good Sold.
2. The Manufacturing Overhead Control Account.
Manufacturing Overhead is a temporary control
a. As stated above, actual overhead costs are
recorded on the debit side of the Manufacturing
Overhead control account. Overhead costs applied to
Work in Process using predetermined rates are recorded
on the credit side of the account.
b. Any discrepancy between overhead costs incurred
and overhead costs applied shows up as a balance in
the Manufacturing Overhead control account at the end
of the period. A debit balance is called underapplied
overhead and a credit balance is called overapplied
D. Under- and Overapplied Overhead. Since
the predetermined overhead rate is based entirely on
estimated data, there will almost always be a difference
between the actual amount of overhead cost incurred and the
amount of overhead cost that is applied to the Work In
Process account. This difference is termed underapplied or
overapplied overhead, and as discussed above, can be
determined by the ending balance in the Manufacturing
Overhead control account. An underapplied balance occurs
when more overhead cost is actually incurred than is applied
to the Work In Process account. An overapplied balance
results from applying more overhead to Work In Process than
is actually incurred.
1. Cause of Under- and Overapplied
Overhead. When a predetermined overhead rate is used,
it is implicitly assumed that the overhead cost is
variable with (i.e., proportional to) the allocation
base. For example, if the predetermined overhead rate is
$20 per direct labor-hour, it is implicitly assumed that
the actual overhead costs will increase by $20 for each
additional direct labor-hour that is incurred. If,
however, some of the overhead is fixed with respect to
the allocation base, this will not happen and there will
be a discrepancy between the actual total amount of the
overhead and the overhead that is applied using the $20
rate. In addition, the actual total overhead can differ
from the estimated total overhead because of poor
controls over overhead spending or because of inability
to accurately forecast overhead costs.
2. Disposition of Under- and Overapplied
Overhead. Two approaches to dealing with an under- or
overapplied overhead balance in the accounts are
illustrated in the text.
a. The simplest approach is to close out the
under- or overapplied overhead to Cost of Goods Sold.
This is the method that is used in most of the
exercises and problems because it is easiest for
students to understand and master.
b. The second approach is to allocate the under- or
overapplied balance to Cost of Goods Sold and to the
Work In Process and Finished Goods inventory accounts.
The basis of allocation is the amount of overhead
applied during the period in the ending balance of
each of these accounts. This method is equivalent to
waiting until the end of the period to allocate the
actual overhead costs based on the actual amount of
the allocation base incurred.
3. The Effect of Under- and Overapplied Overhead on
a. If overhead is underapplied, less overhead
has been applied to inventory than has actually been
incurred. Enough overhead must be applied
retroactively to Cost of Goods Sold (and perhaps
ending inventories) to eliminate this discrepancy.
Since Cost of Goods Sold is increased, underapplied
overhead reduces net income.
b. If overhead is overapplied, more overhead has
been applied to inventory than has actually been
incurred. Enough overhead must be removed
retroactively from Cost of Goods Sold (and perhaps
ending inventories) to eliminate this discrepancy.
Since Cost of Goods Sold is decreased, overapplied
overhead increases net income.