1. Job-Order Cost Accounting
3-1
Job-Order Cost
Accounting
Chapter Two
Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach (also called a full cost approach) to calculating product costs known as job-order costing.

2. 3-2
Learning Objective 1
Distinguish between process costing and job-order costing and identify companies that would use each costing method.
Learning objective number 1 is to distinguish between process costing and job-order costing and identify companies that would use each costing method.

3. Types of Product Costing Systems
3-3
Types of Product Costing Systems
Process Costing
Job-order Costing
A company produces many units of a single product.
The identical nature of each unit of product enables assigning the same average cost per unit.
A process costing system is best used by companies that produce many units of a single product. Because the units of output are identical, the company will probably use an average cost system to determine product cost.

4. Types of Product Costing Systems
3-4
Types of Product Costing Systems
Process Costing
Job-order Costing
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.

5. Identify the documents used in a job-order costing system.
3-5
Learning Objective 2
Identify the documents used in a job-order costing system.
Learning objective number 2 is to identify the documents used in a job-order costing system.

6. Job-Order Costing – An Overview
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Job-Order Costing – An Overview
Charge direct material and direct labor costs to each job as work is performed.
Direct Materials
Job No. 1
Direct Labor
Job No. 2
In a job-order costing system, direct materials and direct labor are traced directly to each job as the work is preformed.
Manufacturing Overhead
Job No. 3

7. Direct Manufacturing Costs
3-7
Direct Manufacturing Costs
Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.
Direct Materials
Job No. 1
Direct Labor
Job No. 2
Manufacturing overhead (including indirect materials and indirect labor) represents other manufacturing costs like the power used to run the machinery in the factory. Manufacturing overhead cannot be traced directly to specific jobs. Rather, it is allocated to jobs on the basis of a predetermined rate.
Manufacturing Overhead
Job No. 3

8. 3-8
Learning Objective 3
Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.
Learning objective number 3 is to compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

9. Manufacturing Overhead Application
3-9
Manufacturing Overhead Application
The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.
Estimated total manufacturing overhead cost for the coming period
Estimated total units in the allocation base for the coming period
POHR =
To facilitate the allocation of manufacturing overhead to each job, we calculate a predetermined overhead rate before the period begins. The rate is calculated by dividing the total estimated manufacturing overhead for the coming period by the estimated total units of the allocation base. If our allocation base is machine hours, we would estimate the total number of machine hours used in production in the coming period.
Ideally, the allocation base should be a cost driver, that is, it causes overhead to be incurred.
Ideally, the allocation base is a cost driver that causes overhead.

10. 3-10
The Need for a POHR
Using a predetermined rate makes it possible to estimate total job costs sooner.
Actual overhead for the period is not known until the end of the period. $
Predetermined overhead rates that rely upon estimated data are often used because (1) actual overhead costs for the period are not known until the end of the period, thus inhibiting the ability to estimate job costs during the period; (2) actual overhead costs can fluctuate seasonally, thus misleading decision makers; and (3) it simplifies record keeping.

11. Application of Manufacturing Overhead
3-11
Application of Manufacturing Overhead
Based on estimates, and determined before the period begins.
Overhead applied = POHR × Actual activity
We calculate the predetermined overhead rate before the period begins. As we work on a particular job, we apply overhead by multiplying the predetermined rate times the actual level of activity. If overhead is applied on the basis of machine hours, we would apply overhead by multiplying the predetermined rate times the actual number of machine hours used on a particular job.
Actual amount of the allocation based upon the actual level of activity.

12. Overhead Application Rate
3-12
Overhead Application Rate
Estimated total manufacturing overhead cost for the coming period
Estimated total units in the allocation base for the coming period
POHR =
$640,000
160,000 direct labor hours (DLH)
POHR =
POHR = $4.00 per DLH
Part I
Here is our equation for calculating the predetermined manufacturing overhead rate.
Part II
PearCo’s predetermined overhead rate is $4 per direct labor hour. Part III
So, at PearCo, each job will be charged $4 of overhead for each hour of direct labor worked.
Let’s see how this works.
For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

13. 3-13
Quick Check 
Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
This problem may take a while to solve, but it will be well worth your time to work it carefully.

14. 3-14
Quick Check 
Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
The correct answer is $730. You can see the costs incurred for direct materials, direct labor and manufacturing overhead applied to job WR53 in the blue box.

15. Compute underapplied or overapplied overhead
3-15
Learning Objective 8
Compute underapplied or overapplied overhead
cost.
Learning objective number 8 is to compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.

16. Problems of Overhead Application
3-16
Problems of Overhead Application
The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is referred to as 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.
When we apply overhead on the basis of a predetermined overhead rate, there is always the chance that the amount of overhead applied will be different from the amount of overhead actually incurred during the period. When there is a difference we refer to the amount as either underapplied overhead 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.

17. Overhead Application Example
3-17
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.
Part I
Let’s assume that PearCo incurred actual overhead of $650,000 during the period and worked a total of 170,000 direct labor hours. PearCo applies overhead at the rate of $4 per direct labor hour worked. How much overhead did PearCo apply to jobs during the period? Part II
PearCo would have applied $680,000 of overhead during the period. That is $4 per direct labor hour times the 170,000 direct labor hours actually worked. Can you see our problem?
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

18. Overhead Application Example
3-18
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.
PearCo has overapplied overhead for the year by $30,000. What will PearCo do?
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. PearCo incurred actual overhead of $650,000 and applied $680,000, so the company overapplied $30,000 of overhead for the year. How do we dispose of this overapplied overhead?
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

19. 3-19
Quick Check 
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is
a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied.
In this question, we ask you to calculate the overapplied or underapplied overhead. Be careful with your intermediate computations.

20. 3-20
Quick Check 
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tiger’s manufacturing overhead is
a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied.
Overhead Applied $4.00 per hour × 290,000 hours = $1,160,000
Underapplied Overhead $1,210,000 - $1,160, = $50,000
The correct answer is $50,000 underapplied overhead. Tiger incurred $1,210,000 of actual overhead but applied only $1,160,000, thus the company underapplied its overhead costs during the period.

21. 3-21
Quick Check 
What effect will the overapplied overhead have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.
Give this question some thought before deciding on your answer.

22. 3-22
Quick Check 
What effect will the overapplied overhead have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.
How did you do?

23. Job-Order Costing in Service Companies
3-23
Job-Order Costing in Service Companies
Job-order costing is used in many different types of service companies.
In a law firm, each client represents a job. Legal forms and similar inputs represent direct materials. The time expended by attorneys represents direct labor. The costs of secretaries, clerks, rent, depreciation, and so forth, represent the overhead.

24. The Predetermined Overhead Rate & Capacity
3-24
The Predetermined Overhead Rate & Capacity
Appendix 3A
Appendix 3A: The Predetermined Overhead Rate and Capacity

25. Learning Objective 9 (Appendix 3A)
3-25
Learning Objective 9
(Appendix 3A)
Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.
Learning objective is to understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

26. Capacity-Based Overhead Rates
3-26
Capacity-Based Overhead Rates
Criticisms can be overcome by using estimated total units in the allocation base at capacity in the denominator of the predetermined overhead rate calculation.
Let’s look at the difference!
We can minimize the criticisms by basing estimated total units in the allocation base at capacity levels of activity.

27. 3-27
An Example
Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate?
Here is a rather simple example where a company leases a piece of equipment for $100,000 per year. Full capacity at the company is 50,000 units of output. Management estimates that 40,000 units will be produced and sold in the coming year. Let’s calculate the predetermined overhead rate.

28. 3-28
An Example
Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate?
Traditional Method
= $2.50 per unit
$100,000
40,000 =
Part I
Under the traditional method we have used in this chapter, the predetermined overhead rate will be $2.50. We divide the total cost of $100,000 by the estimated level of activity, 40,000 units.
Part II
Under the capacity approach, the predetermined overhead rate is $2.00 per unit. We divide the total cost of $100,000 by production at capacity, 50,000 units.
Capacity Method
= $2.00 per unit
$100,000
50,000 =

29. 3-29
Quick Check 
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
Based on the information given, what is the predetermined overhead rate using the traditional method?

30. 3-30
Quick Check 
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
The correct answer is $2.50 per case. How did you do?

31. 3-31
Quick Check 
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
Now calculate the predetermined overhead rate using the capacity approach.

32. 3-32
Quick Check 
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
Did you get the correct answer of $2.00 per case?

33. 3-33
Quick Check 
When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?
a. The predetermined overhead rate goes up when activity goes down.
b. The predetermined overhead rate stays the same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down when activity goes down.
Recall your answers to the previous questions and answer this question about changes in the predetermined overhead rate.

34. 3-34
Quick Check 
When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?
a. The predetermined overhead rate goes up when activity goes down.
b. The predetermined overhead rate stays the same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down when activity goes down.
The predetermined overhead rate stays the same and is not affected by changes in the level of activity.

35. 3-35
Quick Check 
When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?
a.The predetermined overhead rate goes up when activity goes down.
b.The predetermined overhead rate stays the same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down when activity goes down.
Now, take that same information and answer this questions assuming the traditional approach is used by the company.

36. 3-36
Quick Check 
When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases?
a.The predetermined overhead rate goes up when activity goes down.
b.The predetermined overhead rate stays the same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down when activity goes down.
Now we know that the predetermined overhead rate goes up when activity goes down.

37. Income Statement Preparation
3-37
Income Statement Preparation
Critics suggest that the underapplied overhead that results from idle capacity should be disclosed on the income statement as the cost of unused capacity  a period expense. Look carefully at the income statement on this slide prepared using the capacity approach to calculate the predetermined overhead rate. Notice the disclosure of the $20,000 cost of idle capacity that is recorded as a period expense. This cost is incurred because we were not able to fully utilize our capacity. Using a measure of capacity in the denominator of the predetermined overhead rate enables this type of disclosure.