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Chapter 4 - Job Order Costing

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1 Chapter 4 - Job Order Costing
Group 9: Lin Wang Bichloan Nguyen Hank Liu Keye Su Jeff Tsai

Constructo is a manufacturer of furnishings for infants and children. The company uses a job cost system and employs a full absorption accounting method for cost accumulation.

3 Q1: Describe when it is appropriate for a company to use a job cost system?
Job cost system is used in situations where the organization offers many different products or services, such as in furniture manufacturing, commercial aircraft manufacturing, hospitals, and law firms. In a job cost system, costs are traced and allocated to jobs.

4 Flow of Documents in a Job-Order Costing System
Materials requisition form Job cost sheet Sales order Production order Direct labor time ticket Predetermined overhead rates

5 A General Model of Cost Flows in Job-order Costing System
Raw Materials Direct materials Cost of materials purchased Work in Process Indirect materials Direct materials Direct labor Overhead applied Cost of goods manufactured Salaries and Wages Payable Direct labor Indirect labor Finished Goods Manufacturing Overhead Cost of goods manufactured Cost of goods sold Actual overhead Applied overhead Cost of Goods Sold Underapplied overhead cost Overapplied overhead cost Cost of goods sold

6 Constructo’s work in process inventory on April 30, 2001
Job No Items Units Accumulated Cost CBS102 Cribs 20,000 $900,000 PLP086 Playpens 25,000 $420,000 DRS114 Dressers $250,000 TOTAL $1,570,000

7 The Company’s finished goods inventory, using the FIFO method on April 30, 2001

8 Materials Inventory on April 30,2001
At the end of April, the balance in Constructo’s Materials Inventory account, which includes both raw materials and purchased parts, was $668,000

9 Additions to and requisitions from the inventory during the month of May

10 Labor costs during the month of May

11 Jobs completed for May

12 Unit sales for May

13 OVERHEAD COST Constructo applies factory overhead on the basis of direct labor hours. The company’s factory overhead budget for the fiscal year ending May 31, 2001 total $4,500,000 The company plans to expend 600,000 Direct Labor Hours (DLH) during the period Predetermined overhead rate = $4,500,000 / 600,000 DHL = $7.5 per DLH

14 The flow of costs through the accounts presented in T-account form (1)
Raw Materials Requisitions: Cribs: 51, ,000=155,000 Playpens: 3,000+10,800=13,800 Dressers: 124,000+87,000=211,000 Strollers: 62,000+81,000=143,000 Carriages: 65, ,000=252,000 Bal ,000 Raw Materials additions ,000 Purchased Parts additions 396,000 Bal ,200

15 The flow of costs through the accounts presented in T-account form (2)
Work in Process Finished Goods: Cribs: 1,267, ,000+51, , ,400+12,000*7.5 Playpens: 336,480 (420,000+3,000+10,800)*15,000/25,000+43,200+4,400*7.5 Strollers: 199,250 62,000+81,000+30,000+3,500*7.5 Carriages: 495,000 65, , ,000+14,000*7.5 Bal ,570,000 Direct Materials: 774,800 (155,000+13, , , ,000) Direct labor: 534,100 (621,100-29,400-57,600) Overhead Applied: 400,500 ((12,000+4,400+19,500+3, ,000)*7.5) Bal ,270 (Answer to Q2)

16 The flow of costs through the accounts presented in T-account form (3)
Finished Goods Bal ,755,400 Cribs: 1,267,400 Playpens: 336,480 Strollers: 199,250 Carriages: 495,000 Cost of Goods Sold: Cribs: 1,113,700 7,500*64+(17,500-7,500)*1,267,400/20,000 Playpens: 714,891 19,400*35+(21,000-19,400)*336,480/15,000 Strollers: 318,925 13,000*23+(14,000-13,000)*199,250/10,000 Dressers: 990,000 18,000*55 Carriages: 612,000 6,000*102 Bal ,304,014

17 The flow of costs through the accounts presented in T-account form (4)
Cost of Goods Sold 3,749,516 (1,113, , , , ,000)

18 The flow of costs through the accounts presented in T-account form (5)
Manufacturing Overhead Actual Overhead Costs: Indirect materials: ? Indirect labor: 29,400 Supervision: 57,600 Utilities: ? Rent on factory equipment: ? Miscellaneous factory costs: ? Depreciation on factory equipment: ? Applied Overhead Costs: 400,500 (12,000+4,400+19,500+3, ,000)*7.5 ? (overapplied overhead) Bal. ? (underapplied overhead)

19 Price per unit of finished goods for May
Job No. Item Quantity Finished Finished goods cost Price Per unit CBS102 Cribs 20,000 1,267,400 $63 PLP086 Playpens 15,000 336,480 $22.4 DRS114 Dressers STR077 Strollers 10,000 199,250 $20 CRG098 Carriages 5,000 495,000 $99 Total 2,298,130

20 Q3: The dollar amount related to the playpens in Constructo’s finished goods inventory as of May 31,2001 Playpens in Finished Goods 714,891 Bal ,000 336,480 Bal ,589 Answer to Q3: The dollar amount related to the playpens in Constructo’s finished goods inventory as of May 31,2001 was $300,589.

21 Another method for calculating the answer to Q3
Beginning Inventory + Quantity Added = Quantity shipped + Ending Inventory 19, ,000 = 21,000 + Ending Inventory Ending Inventory = 34,400 – 21,000 = 13,400 Dollar amount = 13,400 * = $300,589

22 Overapplied or underapplied overhead can be treated in two ways:
Closed out to Cost of Goods Sold. Unadjusted Cost of goods sold + Underapplied overhead  Adjusted Cost of goods sold Unadjusted Cost of goods sold - Overapplied overhead  Adjusted Cost of goods sold 2. Allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the current period in the ending balances of these accounts.

23 Underapplied or Overapplied overhead can be disposed of in 2 ways
Q4: Explain the proper accounting treatment for overapplied or underapplied overhead balances when using a job cost system Since actual production costs should be reported in the period they were incurred, total product costs at the accounting period should be based on actual rather than applied overhead. Underapplied or Overapplied overhead can be disposed of in 2 ways

24 Closed out to Cost of Goods Sold : the more expedient of the two methods for disposing of overhead discrepancies: For Example: Suppose… Unadjusted Cost of Goods Sold = 3,749,516 Manufactory Overhead Applied = 4,500,000 Actual Manufactory Overhead = 4,674,000 Underapplied Overhead = 4,674,000 – 4,500,000 = 174,000 Then the adjusted cost of goods sold = 3,749, ,000 = 3,923,516

25 Ending W-I-P Inventory $20,000 Ending Finished goods Inventory $30,000
Proration: the process of allocating Underapplied or overapplied overhead to Work-In-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts at the end of period. For Example: Assume that a company’s accounts has the following applied overhead balances for the end of period: Ending W-I-P Inventory $20,000 Ending Finished goods Inventory $30,000 Cost of Goods Sold $150,000 Total Manufactory Overhead applied $200,000 Actual Manufactory Overhead $205,000

26 The proration of the $5,000 underapplied factory overhead among the W-I-P Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts is computed as follows:

27 The appropriate adjusting entry is:
Factory Overhead Applied 200,000 W-I-P Inventory 500 Finished Goods Inventory 750 Cost of Goods Sold 3,750 Factory Overhead 205,000

28 Case 4-2 Power Services Industries
Three plants in the U.S. East River Plant 1 2 3 4 5 6 7 8 9 Industrial manufacturer of power-generating equipment since 1907 PSI also produces after market and original-equipment parts East River Plant – one of three manufacturing firms, located in Illinois Major products: coal-fired boilers

29 Competitive Environment
Pre-1980s era high demand for electricity low # of competitors low # of manufacturers for OEM and replacement parts low fuel price Original-equipment market (OEM) made up 60% of East River’s revenues Replacement orders made up about 40% of revenues Early 1990s constant growth for electricity, significant decrease in orders government regulations – environmental concerns more manufacturers of replacement parts, raising market standard: a. faster delivery b. lower prices c. higher quality fuel price/interest rate increase

30 East River Plant + +

31 Plant Management Problems
equipment > 29 years approx. machine downtime  bottlenecks plant usage = 45-50% equipment layout = unnecessary manual process 40% manhours  material handling High Inventory  $7 Million

32 Potential Problem as-sold cost estimates & actual contract cost
As-sold cost based on historical data which from early seventies Cost of material has been changed  the actual contract cost more than estimate As-sold cost estimation didn’t contain defects and other material waste

33 Current Cost System Contract Order Order Order Direct Costs Overhead
Direct materials Direct labor Product design engineering Machine set up Materials handling Headquarter support services General admin services (payroll, accounting)

34 Current Cost System cont.
Job cost system since 1950s Materials and labor costs charged directly to contracts Overhead costs applied with predetermined % of direct labor costs performance – compare monthly ratio – Estimate Man to Actual Man Hours (E/A) If E/A below 100% = not good

35 Labor-Based vs. Activity Based
Labor cost is not majority of costs Not all costs are driven by man hours Example – increase in man hours in welding one product does not equal increase in cost for testing (QA) ABC – yes! Why? Inaccurate costing structure, complex manufacturing process

36 Recommendations for Current Cost System
update historically determined overhead/burden rate Incorporate probability of machine downtime Use actual costs from previous jobs of similar size for estimates vs. querying by parts Remove period costs in product costing Implement ABC

37 General Framework for Costing Products
Direct materials, direct labor, and factory overhead are only costs involved in product costing All costs can be accurately traced to cost driver(s) Accounting software used to accurately track accumulation and classify costs


39 The Company James Street Fashions dba Latt-Greene
A Knitting and Converting Operation Located in Vernon, California Knits Textiles for the Women’s and Children’s Apparel Market Dyes and Prints Designs on the Textiles According to Customer Instructions Delivers the Product to the Customer Ready for Cutting and Sewing into Clothing Customers Consist of Clothing Manufacturers who Sell to Clothing Retailers

40 The Problems Severe Negative Cash Flow
A Belief that Not All Sales to Customers were being Billed or Collected A Paper-Heavy System that was being Crushed by its Own Weight A “One-Write” Accounting System No Computer or Data Processing

41 The Old System “One-Write” System
Only Prepares General Ledger, Cash Receipts Journal and Customer Ledgers, and a Cash Disbursement Journal. Does Not Attempt to Cost the Greige Goods. Customer were Billed as per the Purchase Order. Weaknesses Unable to Cost Goods Accurately. No Matching Print-Sales Invoices. Purchase Orders with No Shipment Record. Late Delivery of Orders. Over-Filling Goods and Under-Charging the Customers.

42 The New System – The Changes
Hardware Changes A PC as Central Server. 10 Stations Using Novell System. Software Changes Quattro Pro Spreadsheet Program. Develops Spreadsheet Automated Scripts. System Changes Manual Costing System Requires a Tremendous Amount of Time to Maintain and Keep Current. Computerized Costing System Refines Cost Data as They Becomes Available. Workforce Changes Trains Willing Employees and Dispatch Unwilling Employees.

43 The New System – The Effects
Operation Improved Services to Customers. Delivery Schedules were Met More Consistently. More Time Spent on Product Consistency and Quality. Less Time Spent on Paperwork and Trying to Track Down Product Location. Problem Uncovered and Fixed in a More Timely and Efficient Manner. Product Prices and Quality Improved Product Consistency and Quality. Raised Price Caused Some Customer to Leave but Covered the Cost of the Product.

44 The New System – Company Profit
Year Net Sales ROI 1985 16.5 11.3% 1986 19.8 (46%) 1987 24.8 (18%) 1988 33.6 33% 1989 39.2 11% 1990 54.8 / 31.3 (6%) / 63% 1991 54 61% 1992 30 7% 1993 32 41% 1994 38 53% 1995 31 28% 1996 30% 1997 36 43% 1998 24%

45 Conclusion - Lessons Learned
Be Open with All Employees Regarding the Reengineering Process. Solicit Input from All Employees. Involve Everyone in the Implementation of the New System. Understand the System Yourself because This Understanding is More Important than Bringing in Consultants and Helps to Ensure that Costs are Kept Under Control.

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