Job Order Costing

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Job-order costing is used to cost products in situations where the organization offers many different products or services, such as in furniture manufacturing, hospitals, and legal firms.

Materials requisition forms and labor time tickets are used to assign direct materials and direct labor costs to jobs in a job-order costing system. Manufacturing overhead costs are assigned to jobs using a predetermined overhead rate. All of the costs are recorded on a job cost sheet.

The predetermined overhead rate is determined before the period begins by dividing the estimated total manufacturing cost for the period by the estimated total amount of the allocation base for the period. The most frequently used allocation bases are direct labor-hours and machine-hours. Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base recorded for the job.

Because the predetermined overhead rate is based on estimates, the actual overhead cost incurred during a period may be more or less than the amount of overhead cost applied to production. Such a difference is referred to as underapplied or overapplied overhead. The underapplied or overapplied overhead for a period can be either closed out to Cost of Goods Sold or allocated between Work in Process, Finished Goods, and Cost of Goods Sold. When overhead is underapplied, manufacturing overhead costs have been understated and therefore inventories and/or expenses must be adjusted upwards. When overhead is overapplied, manufacturing overhead costs have been overstated and therefore inventories and/or expenses must be adjusted downward.

Job-order costing is used in situations where many different products, each with individual and unique features, are produced each period. A job cost sheet records the materials, labor, and manufacturing overhead costs charged to that job.

In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs. A bill of materials is a document that lists the type and quantity of each type of direct material needed to complete a unit of product. The materials requisition form is a document that specifies the type and quantity of materials to be drawn from the storeroom and identifies the job that will be charged for the cost of the materials. The form is used to control the flow of materials into production and also for making entries in the accounting records.

cost driver is a factor, such as machine-hours, beds occupied, computer time, or flight-hours, that causes overhead costs. If the base in the predetermined overhead rate does not “drive” overhead costs, product costs will be distorted. For example, if direct labor-hours is used to allocate overhead, but in reality overhead has little to do with direct labor-hours, then products with high direct labor-hour requirements will be overcosted.

Raw materials include any materials that go into the final product. When raw materials are used in production, their costs are transferred to the Work in Process inventory account as direct materials.2 Work in process consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer. Notice that direct labor costs are added directly to Work in Process—they do not flow through Raw Materials inventory. Manufacturing overhead costs are applied to Work in Process by multiplying the predetermined overhead rate by the actual quantity of the allocation base consumed by each job.3 When goods are completed, their costs are transferred from Work in Process to Finished Goods. Finished goods consist of completed units of product that have not yet been sold to customers. The amount transferred from Work in Process to Finished Goods is referred to as the cost of goods manufactured. The cost of goods manufactured includes the manufacturing costs associated with the goods that were finished during the period.

The difference between the manufacturing overhead cost applied to jobs and the actual manufacturing overhead costs of a period is called either underapplied or overapplied overhead.