# Calculate Cost of Goods Sold and Ending Overhead Balance

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Calculate Cost of Goods Sold and Ending Overhead Balance
Principles of Cost Analysis and Management © Dale R. Geiger 2011

Terminal Learning Objective

If Unit Cost is misstated, how might that affect these decisions?
On which products and services should we expend our limited resources? Do user fees cover Unit Cost? Are we competitive in providing this service? Should we increase user fees? Introduction If Unit Cost is misstated, how might that affect these decisions? Are we competitive in providing this service? If we don’t have an accurate unit cost, we can’t even answer this question Do user fees cover Unit Cost? This is a very important question for revolving funds. If we set our user fees based on erroneous information, then we might not break even. On which products and services should we expend our limited resources? If our resources are limited, we want to channel those resources toward the products and services where we are most cost-effective (or most profitable). Should we increase user fees? Again, we can’t even begin to answer this question without good cost information. © Dale R. Geiger 2011

Job Order Costing Provides a methodology for calculating the cost of a job Assumes that each job is unique and has identifiable direct costs Assumes that all jobs consume indirect resources in a similar manner Activity Step 1 Overview of Job Order Costing Provides a methodology for calculating the cost of a job. Job order costing is a way to get that unit cost information that we need. It is a method of cost measurement that is useful given the following assumptions: Assumes that each job is unique and has identifiable direct costs. Each job is unique: If all jobs are the same then some sort of average cost method would probably be more useful. Each job has identifiable costs: There must be some direct costs such as materials and labor that are clearly identifiable to individual jobs. That is, when a worker is working, he or she is only working on one job at a time. Materials are used on only one job. The “parts and labor” method of pricing that your auto mechanic uses is a type of job order costing. Assumes that all jobs consume indirect resources in a similar manner. The materials, labor and other overhead costs that are not identifiable to specific jobs are consumed by jobs in a similar manner. Most job order cost systems assume that jobs consume overhead resources in direct proportion to Direct Labor. © Dale R. Geiger 2011

Job Order Costing Records Direct Materials and Labor for each individual job Work in Process consists of all jobs still in process Cost of job = Direct Materials + Direct Labor + Applied Overhead Activity Step 1 Overview of Job Order Costing Records Direct Materials and Labor for each individual job. Job order costing keeps detailed records of materials and labor that are directly identified to individual jobs. Some job order costing systems keep paper records. More sophisticated systems have barcode scanners to track materials as they are added to jobs. Workers scan their ID badges as they move from job to job and the system tracks the time worked on each job, as well as the hourly rate for each worker. Under job order costing, Work in Process consists of all jobs still in process. The Work in Process inventory account is the summary of all of the individual jobs in process. Cost of job = Direct Materials + Direct Labor + Applied Overhead The Direct Materials and Direct Labor are calculated from the detailed records. The Overhead is “Applied” or assigned. © Dale R. Geiger 2011

Overhead Rate * Direct Labor \$

Job Order Costing Lends itself readily to service applications:
Legal services Repair and maintenance services Contract services Others? Activity Step 1 Overview of Job Order Costing Job order costing lends itself readily to service applications: Legal services (direct labor for a particular case or “job” can be measured) Repair and maintenance services (parts and labor can be measured) Contract services (labor on a particular contract can be measured) Others? See if the students can suggest other services where job order costing would be appropriate. © Dale R. Geiger 2011

Activity Step 1 Overview of Job Order Costing Review of the inventory chain. Remember that resources flow from left to right: inputs on the left, outputs on the right. The input to raw materials is purchases. The output is Direct Materials Used. The inputs to Work in process are labor, Direct Materials Used, and overhead. The output is Cost of Goods Manufactured, which is also the input to Finished goods. The output from Finished goods is Cost of Goods Sold. Overhead © Dale R. Geiger 2011

Job Order Cost Flow Raw Materials Job A Finished Goods Job B Materials
Purchased Materials Used DL OH DM Goods Mfd Goods Sold Work in Process Activity Step 1 Overview of Job Order Costing The same cost flow applies to Job Order Costing. We still have the raw materials inventory account. The materials used are identified with two separate jobs. Some of the materials go to Job A, some go to Job B. Direct Labor and Overhead are added individually to Job A and Job B. Together Job A and Job B comprise Work in Process Inventory. When Job A and Job B are finished, they will be transferred to Finished goods as “Cost of goods manufactured.” © Dale R. Geiger 2011

Check on Learning What is the goal of Job Order costing?
What is the equation for the cost of a job? What is the goal of Job Order costing? Provide a methodology to measure the cost of a job What is the equation for the cost of a job? Direct Materials + Direct Labor + Applied overhead © Dale R. Geiger 2011

Job Tickets Detailed information about each job is recorded on a Job Ticket: Direct Materials Direct Labor Overhead Applied Work in Process = Total of Job Tickets for unfinished jobs Cost of Goods Manufactured = Total of Job Tickets for jobs completed during the period Activity Step 2 Calculate cost of job given predetermined overhead rate Detailed information about each job is recorded on a Job Ticket: Direct Materials Direct Labor Overhead Applied The job ticket may be a literal paper record, or as, we described before, a record that is kept on a computer and updated using barcode scanning technology. (Some hospitals use barcode scanning technology so that the patient’s bracelet is scanned each time materials are issued to that patient. The computer uses this data to compile the patient’s itemized bill, which is essentially a job ticket.) © Dale R. Geiger 2011

Job Tickets Detailed information about each job is recorded on a Job Ticket: Direct Materials Direct Labor Overhead Applied Work in Process = Total of Job Tickets for unfinished jobs Cost of Goods Manufactured = Total of Job Tickets for jobs completed during the period Activity Step 2 Calculate cost of job given predetermined overhead rate Work in Process = Total of Job Tickets for unfinished jobs The dollar value reported as Work in process inventory would be equal to all of the materials, labor, and overhead currently invested into jobs in process. As jobs are completed, the job tickets are transferred out of Work in Process and into finished goods. © Dale R. Geiger 2011

Job Tickets Detailed information about each job is recorded on a Job Ticket: Direct Materials Direct Labor Overhead Applied Work in Process = Total of Job Tickets for unfinished jobs Cost of Goods Manufactured = Total of Job Tickets for jobs completed during the period Activity Step 2 Calculate cost of job given predetermined overhead rate Therefore, Cost of Goods Manufactured = Total of Job Tickets for jobs completed during the period The cost of the jobs completed is subtracted from Work in Process and added to Finished Goods. The costs will be carried as an asset until the job is sold. © Dale R. Geiger 2011

Job Order Cost Flow Total cost of direct materials used equals cost of materials for Job A plus cost of materials for Job B Raw Materials Job A Finished Goods Job B Materials Purchased DMU 4000 DL 2000 OH 1600 DM 1500 5100 DL 3000 OH 2400 DM 2500 7900 Goods Mfd Goods Sold Work in Process = 13,000 Activity Step 2 Calculate cost of job given predetermined overhead rate Total cost of direct materials used equals cost of materials for Job A plus cost of materials for Job B Two jobs are in process, Job A and Job B. A total of \$4000 in direct materials are issued from the raw materials inventory. \$1500 is put into Job A, \$2500 into Job B. Direct Labor is added (2000 to Job A, 3000 to Job B) and overhead is added at 80% of direct labor. OH to Job A = DL 2000 * .8 = OH to Job B = DL 3000 * .8 = 2400 The total cost of Job A is DL OH DM 1500 = 5100 The total cost of Job B is DL OH DM 2500 = 7900 © Dale R. Geiger 2011

Job Order Cost Flow Total cost of Work in Process equals cost of materials, labor and overhead for Job A plus cost of materials, labor and overhead for Job B Raw Materials Job A Finished Goods Job B Materials Purchased DMU 4000 DL 2000 OH 1600 DM 1500 5100 DL 3000 OH 2400 DM 2500 7900 Goods Mfd Goods Sold Work in Process = 13,000 Activity Step 2 Calculate cost of job given predetermined overhead rate Total cost of Work in Process equals cost of materials, labor and overhead for Job A plus cost of materials, labor and overhead for Job B The total cost of Job A is DL OH DM 1500 = 5100 The total cost of Job B is DL OH DM 2500 = 7900 The sum of the two jobs together = which is the total of Work in Process © Dale R. Geiger 2011

Job Order Cost Flow If Job B is completed and transferred to Finished Goods, Cost of Goods Manufactured equals cost of Job B. Work in Process consists of Job A, which is still unfinished. Raw Materials Job A Finished Goods Job B Materials Purchased DMU 4000 DL 2000 OH 1600 DM 1500 5100 DL 3000 OH 2400 DM 2500 Goods Mfd 7900 Goods Sold Work in Process = Activity Step 2 Calculate cost of job given predetermined overhead rate If Job B is completed and transferred to Finished Goods, Cost of Goods Manufactured equals cost of Job B. Work in Process consists of Job A, which is still unfinished. During the period Job B is completed and transferred to Finished Goods. Cost of Goods Manufactured is equal to the cost of Job B. Job A remains unfinished, and constitutes Work in Process. © Dale R. Geiger 2011

Check on Learning Work in Process inventory is equal to?
Cost of Goods Manufactured is equal to? Work in Process inventory is equal to? Total of all unfinished jobs Cost of Goods Manufactured is equal to? Total of all jobs completed during the period © Dale R. Geiger 2011

Demonstration Problem
The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Overhead is applied at 50% of Direct Labor Calculate the cost of each job Alpha Bravo Charlie Parts 5000 4200 3600 Labor 4500 6400 3200 Overhead ? Total Activity Step 3 Calculate cost of job given predetermined overhead rate Demonstration Problem The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Overhead is applied at 50% of Direct Labor Calculate the cost of each job Students will have the blank slide © Dale R. Geiger 2011

Demonstration Problem
The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Overhead is applied at 50% of Direct Labor Calculate the cost of each job Alpha Bravo Charlie Parts 5000 4200 3600 Labor 4500 6400 3200 Overhead 2250 1600 Total ? Activity Step 3 Calculate cost of job given predetermined overhead rate Demonstration Problem Overhead is 50% of direct labor for each job. For Alpha: 4500*.5=2250 For Bravo: 6400*.5=3200 For Charlie: 3200*.5=1600 © Dale R. Geiger 2011

Demonstration Problem
The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Overhead is applied at 50% of Direct Labor Calculate the cost of each job Alpha Bravo Charlie Parts 5000 4200 3600 Labor 4500 6400 3200 Overhead 2250 1600 Total 11750 13800 8400 Activity Step 3 Calculate cost of job given predetermined overhead rate Demonstration Problem Cost of a job is DM (parts) + DL + OH Alpha = = 11750 Bravo = = 13800 Charlie = = 8400 © Dale R. Geiger 2011

Demonstration Problem
Alpha and Bravo are completed and transferred out. Charlie remains in process Calculate Cost of Goods Manufactured and ending Work in Process inventory Alpha Bravo Charlie Parts 5000 4200 3600 Labor 4500 6400 3200 Overhead 2250 1600 Total 11750 13800 8400 Activity Step 3 Calculate cost of job given predetermined overhead rate Demonstration Problem Jobs Alpha and Bravo are completed. Job Charlie remains in process Calculate Cost of Goods Manufactured and ending Work in Process inventory Cost of Goods Manufactured = Alpha + Bravo (jobs transferred) 11, ,800 = 25,550 Work in Process inventory = Charlie 8,400 © Dale R. Geiger 2011

Check on Learning How is overhead applied to each job?
What is the underlying assumption in using direct labor as a basis for overhead application? How is overhead applied to each job? As a percentage of direct labor dollars What is the underlying assumption in using direct labor as a basis for overhead application? That overhead resources are consumed in direct proportion to labor. Or, at least, that there is a significant correlation between labor consumption and overhead consumption. © Dale R. Geiger 2011

The Contract Administration Department accounts for the cost of administering contracts using a job order cost system. The Department Manager estimates that Overhead for the year will be \$85,500 and Direct Labor on contracts will be \$95,000. Calculate the Predetermined Overhead Rate: Estimated Overhead: \$85,500 = 90% Estimated Direct Labor: \$95,000 Activity Step 4 Calculate predetermined overhead rate Estimated Overhead: \$85,500 = 90% Estimated Direct Labor: \$95,000 © Dale R. Geiger 2011

Check on Learning How is the predetermined overhead rate calculated?
Why is perpetual overhead application used in Job Order costing? How is the predetermined overhead rate calculated? Estimated OH\$ / Estimated DL\$ Why is perpetual overhead application used in Job Order costing? Because jobs are completed throughout the period and it’s not practical to wait until the end of the period. © Dale R. Geiger 2011

The Training and Education contract requires \$3,000 of direct Contract Administration labor. How much Overhead should be added to the cost of administering the contract? \$3,000 * 90% = \$2,700 Direct Contract Administration Labor incurred on all other contracts during June totaled \$6,800 How much Overhead was applied to other contracts? \$6,800 * 90% = \$6,120 Activity Step 5 Calculate over-/ under-applied overhead How much Overhead was applied to other contracts? \$6,800 * 90% = \$6,120 © Dale R. Geiger 2011

Check on Learning How is actual overhead calculated?
How is applied overhead calculated? How is actual overhead calculated? Actual overhead is the sum of all indirect costs incurred. How is applied overhead calculated? Applied overhead is the predetermined OH application rate times the actual DL incurred © Dale R. Geiger 2011

Over-applied vs. Under-applied

Over-applied vs. Under-applied
Think of the overhead account as a bank account Actual overhead cost incurred is like a deposit Overhead applied to jobs is like a withdrawal If more overhead is applied jobs than incurred, the account is overdrawn, or over-applied Activity Step 6 Explain causes of over-/under-applied overhead Think of the overhead account as a bank account Actual overhead costs incurred are like deposits Overhead applied to jobs are like withdrawals If more overhead is applied jobs than incurred, the account is overdrawn, or over-applied (+) (-) OH incurred 8500 OH applied 8820 320 © Dale R. Geiger 2011

Over-applied vs. Under-applied

Is this a Serious Problem?

Under- or Over-costing
How might under-costing Contract Administration affect decisions? How might over-costing Contract Administration affect decisions? Activity Step 6 Explain causes of over-/under-applied overhead [Students will have the blank slide] How might under-costing Contract Administration affect decisions? How might over-costing Contract Administration affect decisions? © Dale R. Geiger 2011

Under- or Over-costing
How might under-costing Contract Administration affect decisions? If contract administration costs are significantly under-costed (think underpriced), the demand for contract administration resources will increase and they will be over-consumed. How might over-costing Contract Administration affect decisions? Activity Step 6 Explain causes of over-/under-applied overhead How might under-costing Contract Administration affect decisions? If contract administration costs are significantly under-costed (think underpriced), the demand for contract administration resources will increase and they will be over-consumed. © Dale R. Geiger 2011

Under- or Over-costing
How might under-costing Contract Administration affect decisions? If contract administration costs are significantly under-costed (think underpriced), the demand for contract administration resources will increase and they will be over-consumed. How might over-costing Contract Administration affect decisions? If contract administration costs are significantly over-costed, it may make outsourcing appear attractive. Activity Step 6 Explain causes of over-/under-applied overhead How might over-costing Contract Administration affect decisions? If contract administration costs are significantly over-costed, it may make outsourcing appear attractive. We will discuss this more in the next lesson, and also on Day 8. © Dale R. Geiger 2011

Demonstration Problem – Part 2
The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Alpha and Bravo are completed and transferred out. Charlie remains in process. Alpha Bravo Charlie Parts 5000 4200 3600 Labor 4500 6400 3200 Overhead 2250 1600 Total 11750 13800 8400 Activity Step 7 Prove ending balances in inventory accounts The Repair Depot has no jobs in process at the beginning of the period. During the period the following jobs are started: Alpha and Bravo are completed and transferred out. Charlie remains in process © Dale R. Geiger 2011

Demonstration Problem – Part 2

Demonstration Problem – Part 2
Use the inventory template to: Calculate Raw Materials Purchases Calculate Cost of Goods Sold Prove the ending balances in the inventory accounts Calculate Gross Profit and Operating Income Activity Step 7 Prove ending balances in inventory accounts Use the inventory template to: Calculate Raw Materials Purchases Calculate Cost of Goods Sold Prove the ending balances in the inventory accounts Calculate Gross Profit and Operating Income © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Beg DL OH DMU End. COGM Finished Goods Raw Materials Beg Purchases ? End Beg. COGM End. COGS  ? DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Students will have the blank slide Alpha Bravo Charlie DL OH DM . . © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Total of materials for the three jobs equals Direct Materials Used Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg. COGM End. COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Total of materials for the three jobs equals Direct Materials Used Direct Materials Used = Alpha Bravo Charlie 3600 = 12800 Alpha Bravo Charlie DL OH DM 6400 3200 4200 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Ending is 1000 more than Beginning; Inputs must be 1000 more than Outputs Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg. COGM End. COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Thought process: since the ending balance is 1000 more than the beginning, the inputs must be 1000 more than the outputs. Using the input-output equation: Raw Materials Purchases = Beg ? – DMU = End 2500 Beg ? – DMU = End 2500 ? = – 1500 ? = 13800 Alpha Bravo Charlie DL OH DM 6400 3200 4200 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Total of labor for the three jobs equals Direct Labor Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg. COGM End. COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Total of labor for the three jobs equals Direct Labor Direct Labor = Alpha Bravo Charlie 3200 = 14100 Alpha Bravo Charlie DL OH DM 6400 3200 4200 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Total of Overhead applied to for the three jobs equals Overhead Applied Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg. COGM End. COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Total of Overhead applied to for the three jobs equals Overhead Applied Overhead Applied (50% of DL) = Alpha Brave Charlie 1600 = 7050 Alpha Bravo Charlie DL OH DM 6400 3200 4200 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Alpha and Bravo are completed. COGM equals total of Alpha and Bravo Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg. COGM 25550 End. COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Alpha and Bravo are completed. COGM equals total of Alpha and Bravo Alpha Bravo = COGM 25550 Alpha Bravo Charlie DL OH DM 11750 6400 3200 4200 13800 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary All jobs are sold when completed. COGS equals total of Alpha and Bravo Beg DL OH DMU 12800 End. COGM Finished Goods Raw Materials Beg Purchases End Beg COGM 25550 End COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Since all jobs are sold when completed, COGS = total of Alpha and Bravo. Beginning and ending inventory of Finished Goods are zero. Alpha Bravo Charlie DL OH DM 11750 6400 3200 4200 13800 =14100 = 7050 =12800 © Dale R. Geiger 2011

Demonstration Problem – Part 2
WIP - Summary Beg DL OH DMU 12800 End COGM Finished Goods Raw Materials Beg Purchases End Beg COGM 25550 End COGS  DMU Work in Process Activity Step 7 Prove ending balances in inventory accounts Ending Balance in WIP is equal to the cost of Charlie But we can also prove that using the input output equation. Beginning 0 (given) + inputs DL OH DMU – Outputs COGM = End 8400 Alpha Bravo Charlie DL OH DM 11750 6400 3200 4200 13800 =14100 = 7050 =12800 8400 Ending Balance in WIP is equal to the cost of Charlie © Dale R. Geiger 2011

Demonstration Problem – Part 2
Is overhead over- or under-applied? Actual > Applied, so under-applied Statement of Activities Revenue: User Fees \$28,105 Less: COGS 25,550 Gross Profit 2,555 Less: Admin cost 2,800 Net loss \$ 355 Overhead Utilities Supplies Ind. labor 7050 Applied End Activity Step 7 Prove ending balances in inventory accounts Is overhead over- or under-applied? Actual > Applied, so under-applied Statement of Activities Revenue: User Fees \$28,105 Less: COGS 25,550 Gross Profit 2,555 Less: Admin cost 2,800 Net loss \$ User fees are equal to Cost of Goods Sold * 1.1 = * 1.1 = (to account for the 10% markup to cover admin costs) Gross Profit = Revenues or User Fees less COGS Gross Profit less Admin Costs (given) = a net loss of 355. The Net loss is slightly above 1% of user fees. This may be acceptable if there is a small profit made in another period during the year to offset the loss. © Dale R. Geiger 2011

Practical Exercise © Dale R. Geiger 2011

Enter estimated overhead and estimated direct labor to calculate pre-determined overhead rate Enter estimated overhead and estimated direct labor to calculate pre-determined overhead rate Enter total direct labor for the period to automatically calculate overhead applied Enter total direct labor for the period to automatically calculate overhead applied © Dale R. Geiger 2011