Topic Three (i)

1. Systems Design: Job-Order, Process & AB Costing Topic Three (i)

2. A company produces many units of a single product. • One unit of product is indistinguishable from other units of product. • The identical nature of each unit of product enables assigning the same average cost per unit. Types of Product Costing Systems ProcessCosting Job-orderCosting

3. Many different products are produced each period. • Products are manufactured to order. • The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job. Types of Product Costing Systems ProcessCosting Job-orderCosting

4. Comparing Process and Job-Order Costing Example products: Process order costing: paper manufacturing, mixing and bottling beverages. Job-order costing: aircraft manufacturing, movie production.

5. Similarities Between Job-Order and Process Costing • Both systems assign material, labor and overhead costs to products and they provide a mechanism for computing unit product cost. • Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods. • The flow of costs through the manufacturing accounts is basically the same in both systems.

6. Differences Between Job-Order and Process Costing • Process costing is used when a single product is produced on a continuing basis or for a long period of time. Job-order costing is used when many different jobs are worked on each period. • Process costing systems accumulate costs by department. Job-order costing systems accumulated costs by individual jobs. • Process costing systems use department production reports to accumulate costs. Job-order costing systems use job cost sheets to accumulate costs. • Process costing systems compute unit costs by department. Job-order costing systems compute unit costs by job.

7. FinishedGoods Work inProcess Cost of GoodsSold Normal Costing Direct Materials Direct Labor ManufacturingOverhead

8. Job-Order Costing Costs are traced andapplied to individualjobs in a job-ordercost system. Direct Materials FinishedGoods Jobs Direct Labor ManufacturingOverhead Cost of GoodsSold

9. Process Costing Costs are traced and applied to departments in a process cost system. Direct Materials FinishedGoods Processing Department Direct Labor ManufacturingOverhead Cost of GoodsSold

10. Job-Order Costing:Direct Manufacturing Costs Charge direct material and direct labor costs to each job as work is performed. Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

11. Direct Manufacturing Costs Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job. Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

12. Why Use an Allocation Base? Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to individual jobs. • We use an allocation base because: • It is impossible or difficult to trace overhead costs to particular jobs. • Manufacturing overhead consists of many different items ranging from the grease used in machines to production manager’s salary. • Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

13. Estimated total manufacturingoverhead cost for the coming period POHR = Estimated total units in theallocation base for the coming period Ideally, the allocation base is a cost driver that causes overhead. Manufacturing Overhead Application The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.

14. The Need for a POHR Using a predetermined rate makes itpossible to estimate total job costs sooner. Actual overhead for the period is notknown until the end of the period. $

15. Overhead applied = POHR × Actual activity Application of Manufacturing Overhead Based on estimates, and determined before the period begins. Actual amount of the allocation based upon the actual level of activity.

16. Estimated total manufacturingoverhead cost for the coming period POHR = Estimated total units in theallocation base for the coming period $640,000 POHR = 160,000 direct labor hours (DLH) Overhead Application Rate POHR = $4.00 per DLH For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

17. Let’s summarize the document flow in a job-order costing system. Job-Order CostingDocument Flow Summary

18. Job-Order CostingDocument Flow Summary A sales order is the basis of issuing a production order. A production order initiates work on a job.

19. Direct materials Indirect materials Job-Order CostingDocument Flow Summary Materials usedmay be eitherdirect orindirect. Job Cost Sheets MaterialsRequisition Manufacturing Overhead Account

20. Direct Labor Indirect Labor Job-Order CostingDocument Flow Summary An employee’stime may be eitherdirect or indirect. Job Cost Sheets Employee Time Ticket Manufacturing Overhead Account

21. IndirectLabor AppliedOverhead IndirectMaterial Job-Order CostingDocument Flow Summary EmployeeTime Ticket OtherActual OHCharges Manufacturing Overhead Account Job Cost Sheets MaterialsRequisition

22. Defining Under- and Overapplied Overhead The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is termed either underapplied or overapplied overhead. Underapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period. Overapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.

23. Overhead Application Example PearCo’s actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour. Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

24. PearCo has overappliedoverhead for the yearby $30,000. What willPearCo do? Overhead Application Example PearCo’s actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour. Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

25. PearCo’s Method $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 Disposition of Under- or Overapplied Overhead OR

26. Allocating Under- or Overapplied Overhead Between Accounts Assume the overhead applied in ending Work in Process Inventory, ending Finished Goods Inventory, and Cost of Goods Sold is shown below:

27. Allocating Under- or Overapplied Overhead Between Accounts We would complete the following allocation of $30,000 overapplied overhead:

28. Allocating Under- or Overapplied Overhead Between Accounts

29. Overapplied and Underapplied Manufacturing Overhead - Summary PearCo’s Method