Chapter 2:

1. Job Order Costing and Modern Manufacturing Practices Chapter 2:

2. Product Costing System • An integrated set of documents, ledgers, accounts, and accounting procedures used to measure and record the cost of manufactured products.

3. Types of Costing Systems Companies use product costing systems to measure and record the cost of manufactured products. Two types: • Job-Order Costing System. • Process Costing System.

4. Job-Order Costing • Companies that produce individual products or batches of products that are unique use a job-ordering costing system. • Goods are made to a customer’s unique specifications. • A job is an individual product or batch for which a company needs cost information. • Examples: Construction companies, producers of equipment and tools, ship-building companies, printing companies, consulting firms.

5. Sequence of Events in a Job-Order Costing System Receive orders from customers Begin production Schedulejobs Ordermaterials

6. Why Businesses Need to Know the Cost of Its Products • To set prices • To calculate profit when products are sold • To prepare financial statements in accordance with GAAP • To assess the reasonableness of the cost incurred in purchasing or manufacturing products • For management decision-making

7. Product Costs and Period Costs are Synonymous with Manufacturing and Nonmanufacturing costs, respectively. Product and Period Costs

8. Classification of Costs • Manufacturing Costs (also called Product Costs). • Associated with the production of goods. • Recorded into asset (inventory) accounts and reported on the Balance Sheet. They stay on the balance sheet until the goods are sold. • When goods are sold, the costs are transferred to income statement and are reported as Cost of Goods Sold • Non-manufacturing costs (also called period costs) • Associated with the period in which they are incurred. • Recorded in expense accounts and reported in income statement.

9. Assigning Costs to Jobs: A Summary

10. Cost Classifications for Manufacturing Firms Manufacturing Costs (product costs): all costs associated with the production of goods. • Direct Material • Direct Labor • Manufacturing Overhead

11. Manufacturing Costs (Also Called Product Costs) • All costs associated with the production of goods and services. • Includes Direct Material, Direct Labor, and Manufacturing Overhead (indirect costs) • Product costs are assigned to products and recorded in asset accounts

12. Nonmanufacturing Costs Nonmanufacturing Costs (period costs): all costs not associated with the production of goods. • Selling Costs • General and Administrative Costs

13. Definitions • Direct Material Cost: All materials and parts that are directly traced to items produced. • Indirect Material Cost: The cost of all material or parts that are not directly traced to a product. Examples: glue and screws used to make a boat.

14. Definitions • Direct Labor: Cost of labor that is directly traced to aproduct. • Indirect Labor Cost: The cost of labor that is not directly traced to a product. Examples: Cost of production supervisor, over-time.

15. Definitions: manufacturing Overhead • Cost of all manufacturing activities other than direct labor and direct material and direct labor. • Examples: Indirect material, indirect labor, supervisory salaries, tools, utilities.

16. Definitions: Full Cost • Product cost information used to prepare financial statements. • Includes direct labor, direct material, both variable and fixed manufacturing and overhead. • GAAP requires Cost of Goods Sold and Inventory to be presented using full cost information

17. Overview of Job Costs and Financial Statement Accounts In a Job-Order Costing System, the three product costs (materials, labor and overhead) are related to specific jobs.

18. Job-Order Costing System In Job-Order Costing Systems the primary document (likely electronic) is called a Job-Cost Sheet. It is used to accumulate or capture the following costs: • Direct Material Cost. • Direct Labor Cost. • Manufacturing Overhead.

19. Manufacturingoverhead (OH) Applied to eachjob using apredeterminedrate Accumulating Costs in aJob-Order Costing System Directmaterials Traced directly to each job THE JOB Traced directly to each job Direct labor

20. Accumulating Costs in aJob-Order Costing System Charge direct material and direct labor to each job as incurred. Direct Materials Job No. 1 Special documents are used to track costs for each job. Direct labor Job No. 2 Manufacturing Overhead Job No. 3 Apply overhead to each job using a predetermined rate.

21. Example of the type of document used in manufacturing companies

22. GAAP (Generally Accepted Accounting Principles) requires that inventory on balance sheets and cost of goods sold on income statements be disclosed (reported) using Full Costinformation. Product Cost Information in Financial Reporting and Decision Making

23. Raw Materials Inventory. Work in Process Inventory. Finished Goods Inventory. Balance Sheet Presentation of Product Costs

24. Flow of Product Costs in Accounts Current Manufacturing Costs Cost of Direct Materials Used Work in Process Inventory Beginning WIP Inventory + Cost of Goods Manufactured Cost of Direct Labor used Current Manfacturing Costs + Ending WIP Inventory Cost of Manufacturing Overhead Applied to Jobs Finished Goods Inventory Cost of Goods Sold

25. Flow of Product Costs in Accounts

26. Current Manufacturing Costs • Current manufacturing cost is the amount spent on production in the current accounting period • Includes • Cost of Direct Materials used in current period • Cost of Direct Labor used in current period. • Manufacturing overhead applied to jobs in current period.

27. Direct Labor Time Tickets are used to associate Direct Labor with specific Jobs.

28. Direct Labor

29. Direct Materials A Materials Requisition Form is used to request the release of materials from stores inventory into production.

30. Direct Materials

31. General Flow of Direct Materials Costs Beginning Direct Materials Inventory $1,000 Purchases of Direct Materials $5,000 = + Direct Materials Available for Use $6,000 Ending Inventory $2,000 Direct Materials Used $4,000 – =

32. Manufacturing Overhead Unlike Direct Costs(Direct Materials and Direct Labor) Manufacturing Overhead is indirectly traced (allocated) to jobs using an Overhead Allocation Rate.

33. Manufacturing Overhead

34. Cost of Goods Manufactured includes all costs of goods completed during the period. Cost of Goods Manufactured

35. Cost of Goods Sold Cost of Goods Sold.

36. Income Statement Presentation of Product Costs When finished goods are sold they are moved from Finished Goods to Cost of Goods Sold.

37. Job Costs and Financial Statement Accounts

38. How to distribute overhead costs to different jobs Now Let’s calculate the pre-determined overheads rate (POHR)

39. Identify the items to be included as indirect overhead costs. Estimate the costs for each of the indirect overhead items. Select the cost-driver (allocation base). Estimate the amount of the cost-driver rate (allocation base). Compute the predetermined overhead rate. Use of Predetermined Overhead Rates

40. Estimated total manufacturing overhead cost POHR = Estimated total amount of cost driver (or activity base) Manufacturing Overhead Costs • Manufacturing Overhead is applied to jobs using a pre-determined overhead rate (POHR) Overhead applied = POHR × Actual activity Based on estimates, and determined before the period begins Actualamount of the allocation base, such as direct labor hours, incurred during the period

41. Overhead Rate: Example Sterling Company applies overhead based on direct- labor hours. Total estimated overhead for the year is $640,000. Total estimated labor cost is $1,400,000 and total estimated labor hours are 160,000.What is Sterling Company’s predetermined overhead rate?

42. Estimated total manufacturing overhead cost $640,000 POHR = POHR= Estimated total amount of cost driver (or activity base) 160,000 direct-labor hours (DLH) Overhead Application Example POHR = $4.00 per DLH For each direct labor hour worked on a job, $4.00 of factory overhead will be applied to the job.

43. Overhead Rate Example

44. SOLUTION Overhead applied = POHR × Actual Direct labor Hours Overhead applied = $4.00 per DLH × 26 DLH = $104 Overhead Rate Example

45. More than 1 cost driver - Example ?

46. More than 1 cost driver - Example

47. Overhead Application Example Sterling Co’s actual overhead for the yearwas $650,000 and a total of 170,000 direct labor hours were worked. Using Sterling Co’s predetermined overhead rate of $4.00 per direct labor hour, how much overhead was appliedto all of Sterling Co’s jobs during the year? SOLUTION Applied Overhead = POHR × Actual Direct labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH =$680,000

48. Over-Applied Overhead • Sterling Company over-applied overhead to jobs during the year in the amount of $30,000. • What should Sterling Company do to bring applied overhead in line with actual overhead?

49. $30,000may be allocatedto these accounts. $30,000 may beclosed directly to cost of goods sold. Work inProcess FinishedGoods Cost of Goods Sold Cost of Goods Sold Treatments of Over/Underapplied Overheads OR Sterling Co’s Method

50. Sterling Co’s Cost of Goods Sold ______________________________________ Treatments of Over/Underapplied Overheads Manufacturing Overhead ActualOverheadCosts $650,000 OverheadAppliedto jobs $680,000 Unadjusted Balance $30,000 overapplied