CHAPTER 2

JOB COSTING

- Product costing is the process of accumulating and classifying costs and then assigning those
costs to products.
- Product cost information is used for various purposes.
- The choice of a product -costing system depends on many factors, including the type of
industry, the needs of management, and the nature of the product or service. Three basic
characteristics distinguish product-costing and service costing system
1. Whether actual or estimated costs are used:
• Actual costing― assigns actual DL, DM and FOH to cost objects.
• Normal costing― assigns actual DM, DL and estimated FOH to cost objects.
• Standard costing―assigns estimated cost of DM, DL, & FOH to cost objects
2. The treatment of fixed-overhead costs
• Absorption costing― all manufacturing costs are inventoried.
• Variable costing― only variable mfg costs are inventoried. Fixed FOH period cost.
3. The procedures by which costs are accumulated and assigned.
• Job-order costing― costs are accumulated and assigned individually on a per-job basis.
• Process costing―accumulates costs by department and processes.

From these points you can see that there are twelve possible costing systems
{actual, normal, standard} {absorption, variable} {job order, process }
3 × 2 × 2 = 12
Operation Costing is a hybrid-costing system. It is used in situations where products have
some common as well as individual characteristics. TVs, for example, have some common
characteristics in that all models must be assembled and tested following the same basic
steps. However, each model has different components with different costs. The costs of the
components (materials) would be charged to a batch of a particular model individually, as in
job-order costing, but the conversion costs may be assigned using process costing.

Cost Systems
- The two extremes of product costing are usually termed job costing and process costing
1. Job Costing
- It is used by entities that make relatively small quantities or distinct batches of identifiable
unique products (services).
- Businesses using job costing include: Printing jobs at a printing Co., Ship-builders, Custom
furniture manufacturers, Construction companies, Film-producing companies, Accounting
and law firms, Advertising agencies, Medical clinics, etc
- Here an individual job is considered as a cost object. Sometimes a job consists of an
individual product, and sometimes it consists of a batch of products.

Cost Accounting AAUCC 2009 Page 1 of 16

- Job cost information is used (a) to determine the profitability of individual jobs, (b) to assist
in bidding on future jobs, and (c) to evaluate professionals who are in charge of managing
individual jobs.
- Service organizations would most likely use job-order costing to assign and track costs to
each client’s job.

2. Process Costing
- Process costing is used for production processes that produce mass quantities of identical
units that use the same amounts and types of direct labor, direct materials, and overhead.
- All costs are accumulated by departments, operations, or processes. The accumulated costs
can be averaged over the entire production since each unit is essentially identical.
- Businesses using Process Costing: Chemical plants, Food processors, Household appliance
manufacturers, Textile companies, Petroleum products manufacturers, Paper, Lumber and
pulp mills, Glass factories, soft-drink industries, beverage companies, cement factories, food
processing, ceramics, oil, etc

Building–Block Concepts of Costing Systems

- Cost object (cost objective) - anything for which a measurement of cost is desired
e.g. product, department , branch ,a service, a job, a customer etc
- Cost Accumulation
• The collection of cost data in some organized way by means of an accounting system.
• We may collect costs by some natural classification such as materials or labor or by
activities performed such as order processing or machine processing costs.
- Cost Pool
• A group of individual costs that is allocated to cost objects using a single cost driver.
• Cost pools can range from broad, such as all costs of the manufacturing plant, to narrow,
such as the cost of operating metal-cutting machine.
- Cost Allocation
• The assignment of indirect costs to a cost object.
- Cost Allocation Base
• Indirect mfg costs are assigned to cost objects by allocation. Cost allocation base is the
factor that links in a systematic way an indirect cost or group of indirect costs to a cost
object.
• Companies often use the cost driver of indirect costs because of the existence of cause
and effect link.
• A cost allocation base can be financial (DL cost, material costs) or nonfinancial (number
of machine hours, DL hours, units of production). But it has to be one that can easily be
measured for each cost object.
• In machine intensive operations a large part of the FOH cost is associated with operating
the machinery making probably machine hour a proper base. For similarly reason, in
labor intensive operations the proper base is probably DL cost or DL hours. If OH is
mainly material oriented, dominated by costs associated with procuring and handling
material, then materials cost may be a suitable base.

Cost Accounting AAUCC 2009 Page 2 of 16

 Job Costing in Manufacturing Firms
- Let us examine the basic records (documents) used in a job costing system.
Job-cost sheet
- It is a document that records and accumulates all costs assigned to a specific job, starting
when work begins. The job may be a product, service, or batch of products.
- The job-cost sheet can be in paper or electronic form. A simplified job-cost sheet follows:
ABC Co. Job Cost Record
Job No. 160 Customer: X Co.
Date Started: May5,09 Date Finished: May 9, 09
Description: Office Eqt.
Machining Assembly Total
DM xx xx xxx
DL xx xx xxx
FOH xx xx xxx
Total xxx xxx xxx
- DM and DL costs are
traced to the job, and FOH costs are allocated to the job.
- A file of job cost sheets for partially completed jobs makes up the subsidiary ledger for the
WIP control.
- The output of a job can be a single unit or multiple similar or dissimilar units. With multiple
outputs, a unit cost can be computed only if the units are similar or if costs are accumulated
for each separate unit (such as through an ID no.).
- Costs entered onto the job cost sheet are obtained from:
Materials Requisition:
• It is a form which enables each department to take the material they want from stores and
is the basis for recording the amount of material used by each department for a job.
• This form identifies the job to which the materials are to be charged. Care must be taken
when charging materials to distinguish between direct and indirect materials. An example
of a materials requisition form is shown below.

Time Cards and Time Tickets

• Time cards collects data on how many hours have been worked by each hourly rate
employee. Manual system requires a time card for each individual, who would manually
record time. Electronic system uses magnetic cards, swiped through a card reader
• Each employee records the amount of time he or she spends on each job and each task on
a time ticket (time sheet).
• Periodically (e.g every week) an analysis (summary) of the time tickets is prepared. The
time spent on a particular job is considered direct labor and its cost is traced to that job.
The cost of time spent on other tasks, not traceable to any particular job, is usually
considered part of manufacturing overhead. Any time spent in nonmanufacturing areas is
charged to marketing or adm. Expense. An example of an employee time ticket is shown
below.

Cost Accounting AAUCC 2009 Page 3 of 16

 Job No.160 DMs Requisition No. ___
Job No. 160 Date ___
Name ________________
Dept _____
Department ___________
Wage rate ___________ Description Quantity Unit cost Amount
Time started _________
Time finished ________

Departmental Overhead Analysis Sheet

• FOH cost is accumulated, without distinction as to job, for each department in

departmental OH analysis sheet. Then, departmental OH costs are allocated to each job
using a cost allocation base.
Departmental Overhead Analysis Sheet
Department ___________
Date Ind. Mater. Ind. Labor Prop. Tax Depr. Rep.&Maint Utilities Insurance Others Total

• Departmentalizing FOH allows departments to have different FOH rate resulting in

improved product costing. It also facilities responsibility accounting and control of OH
costs in a department.

General Approaches to Job costing

- There are seven steps to assigning costs to an individual job. They are equally applicable to
assigning costs to a job in manufacturing, merchandising and service sectors.

Step1. Identify the cost object which is a job.

Step2. Identify the direct costs. DMs and DLs can be traced to each job using materials
requisition and time tickets respectively and entered on the job-cost sheet.
Step3. Identify the indirect cost pools
• Overhead costs are accumulated in one or more cost pools. Accountants use
judgment in choosing the number and type of overhead cost pools for a given
organization.
• Some organizations use a single cost pool for all fixed and variable overhead
costs. Other organizations use separate cost pools for fixed and variable overhead
costs.
• If work is performed in separate departments or work areas, separate overhead
cost pools may be designated for each department or activity. All FOH are
determined for each department using departmental overhead analysis sheet.
Step 4. Select the cost allocation base
• The crucial quality of an allocation base is that it be a cost driver of the costs in the
pool to be allocated. The base must be easily measurable for each job.

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 • Direct labor costs and hours are the two most popular allocation bases because this
information is already captured by the payroll system.
• In a job order cost system, the units produced cannot serve as the allocation base
because each unit, or group of units, tends to be different(i.e., there is lack cause-
and-effect relationship)

Step 5. Develop allocation rate

• The overhead allocation rate expresses the relationship between overhead costs and
some activity base that can be traced directly to specific cost objects(job)
Actual costing Actual OH Actual indirect cost rate
Actual allocation base

Normal costing Budgeted OH Budgeted indirect cost rate

Budgeted allocation base (predetermined OH rate)

• Some companies use separate rate for fixed and variable FOH. Variable factory
overhead per unit of the allocation base is assumed to be constant within the
relevant range of activity. However, fixed factory overhead is assumed to be
constant in total over the relevant range.
Level of complexity in OH allocation rate:
Plant-wide OH rate: the simplest form of OH allocation is to use a single OH rate
throughout all departments of a company. Here, we treat all annual OH for the company as a
single costs pool, and allocate is based on one allocation base.
Departmental OH rate: after OH costs have been departmentalized, a different OH
allocation rate for each department may be used to have a more accurate OH cost allocation
to each cost object in each department. Multiple OH rates should be used, for example, in
sanitations where on department is machine intensive and another department is labor
intensive.
Activity Based Costing (ABC Costing): it is a more complex OH allocation system. It
recognizes that many activities within a department drive OH costs and uses multiple cost
pools and multiple cost drivers within a department. For example, a portion of the
departmental costs may be allocated on the basis of direct labor hours, another portion on the
basis of machine hours, and the remainder on the basis of the number of machine setups. This
method results in more accurate product cost information.
Step 6. Compute indirect costs allocated to the job

Actual costing Actual indirect cost rate × Actual quantity of the

cost allocation base used
Normal costing Budgeted indirect cost rate × Actual quantity of the
cost allocation base used
Step 7. Compute total cost of the job

Actual costing = DM + DL + OH(actual)

Normal costing = DM + DL + OH(applied)

Cost Accounting AAUCC 2009 Page 5 of 16

 Example 1 (Actual Job Costing Systems in Manufacturing Firms)
Robinson Company uses a job costing system with two direct cost categories (DMs and
Direct manufacturing OH) and one manufacturing cost OH pool. The company allocates
manufacturing OH costs using direct manufacturing labor hours. The year 2003 budget and
actual results are given below
Budget for Year 3 Actual results for Year 3
Mfg OH $1,120,000 $1,215,000
DL cost 500,000 550,000
DL hrs 28,000 27,000
Machine hrs 10,000 11,000
The job-cost sheet for job WPP 298 lists the following:

DMs used --------------------- $4,606

DL cost ---------------------- 1,579
DL hrs --------------------- 88
Required: Determine the cost of Job WPP 298 using actual costing
Solution
The real part of the computation starts from step 5 .
Step 5. FOH allocation rate?

Actual FOH rate = Actual OH = $1,215,000 = $45 per DL hr

Actual allocation base 27,000
Step 6. Compute OH cost allocated to the Job

FOH allocated = Actual rate x Actual quantity

to Job wpp298 $45 x 88 DL hrs
= $3,960
Step 7. Compute total cost of the Job
Cost of Job wpp298:
DMs ---------------------- $4606
DL cost ---------------- 1579
FOH ---------------- 3960
Total cost of the Job $10,145
Time Period Used To Compute Indirect-Cost Rates
- Most manufacturers use an annual period as a basis for determining FOH rates. A shorter
period for averaging costs is not satisfactory.
- There are two reasons for using longer periods to calculate indirect cost rates.
a) The numerator reason (indirect-cost pool)

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- A shorter period for averaging costs is not satisfactory because wide variation can occur in
the amount of FOH costs from periods to period as a result of seasonal and nonseasonal
costs.
• Seasonal costs - for example heating costs, air conditioning costs in hot seasons, which
are part of FOH costs, are incurred only during the cold season and hot season
(months). So if monthly rate is used this cost will be charged to only units produced in
these seasons.
• Nonseasonal costs - for example repair costs may be extremely high in certain months of
the year and low in others. The fact that the repair costs were actually incurred in
certain months does not mean that products manufactured during that time should bear
all repair costs. The same is true for costs of vacation pay and holiday pay.

2. The denominator reason (quantity of the allocation base)

- The need to spread monthly fixed indirect costs over fluctuation levels of monthly output
(allocation base)(the denominator).
E.g. Assume an OH rate based on direct labor hours. If depreciation for a month is
$20,000 and expected direct labor hours that month are 40,000 hours. The OH rate
includes an amount equal to 50 cents per DL hrs for depreciation. However, if
expected DL hrs are 80,000 in the following month, the OH rate for that month will
include 25 cents per DL hr for depreciation.
The calculation of monthly indirect cost rate is affected by the number of workdays in
a month.
 Pooling all indirect costs together over the course of a full year and calculating a single
annual indirect cost rate helps to smooth the effect of the above problems on the cost of a
specific cost object.

Normal Costing: Normal Job Costing Systems in Manufacturing Firms

- Now you know an annual OH rate is preferable to OH rates calculated on a weekly or
monthly basis for the above reasons. What does this mean to a company that uses actual
costing? This means to know the actual cost of its product (job), the company will have to
wait until the end of the year.
- However, mgt cannot wait until the end of the year, or even until the end of the month, to
find out how much a particular job costs. Cost data are most useful when they are
immediately (timely) available.
- The cost accountant is usually expected to report the total cost of a job as soon as it is
finished. At this time the actual total OH costs are not available, as they would be at the end
of a fiscal period. As a solution predetermined (POR) or budgeted OH rates are calculated
for each cost pool at the beginning of a fiscal year, and OH costs are allocated to jobs as
work progresses.
- A POR is an estimate of the amount of OH expense that a company will incur for every unit
of some activity (called a cost driver) that is consumed.
- Using the budgeted OH (OH application) rate gives rise to Normal costing.
- Normalizing applies the same amount of overhead to jobs during the year, regardless of when
jobs were worked on or when overhead was incurred during the year.
Example 2 Refer to example 1 and compute the cost of Job WPP 298 using Normal costing

Cost Accounting AAUCC 2009 Page 7 of 16

 Solution
The real part of the computation starts from step 5
Step 5 FOH allocation rate?
Budgeted FOH rate = Budgeted OH = $ 1,120,000 =$40/DL hr
Budgeted alloc. base 28000hrs
Step 6. FOH allocated (applied) to Job Wpp 298?

FOH allocated = budgeted FOH rate × actual quantity

$40 × 88hrs $3,520
Step 7. Cost of Job Wpp298?
DM 40606
DL 1579
FOH 3520
$9705

Explanation of Transactions (Cost Flows)- Perpetual System Assumed

- One of the jobs started and completed by Robinson Company during the month of February,
Year 3 was job WPP 298. But other jobs were also being made during the same month even
if we were concerned with job WPP 298. All the transactions relating to manufacturing and
nonmanufacturing activities in February, Year 3 for several jobs is given below:
a) Purchases of materials (direct and indirect) on credit $89,000
Journal entry: Materials control ------------- 89,000
Accounts payable control ------------- 89,000
Both have the word control because they are general ledger accounts.
b) Materials sent to the manufacturing plant floor: DMs $81,000 and Indirect materials
$4000
Journal entry: WIP control ------------------81,000
Mfg OH control ------------- 4000
Materials control -------------------- 85,000
The cost of RMs sent to the mfg plant and remaining in store can be determined using
the different cost flow assumptions-SI, FIFO, LIFO, WA. The LCM method should
also be applied to value RM inventory.
c) Total mfg payroll for February: direct $39000 ; indirect,$15000
Journal entry: WIP control ------------------39,000
Mfg OH control ------------- 15000
Materials control -------------------- 54,000

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 Note that total factory payroll may be charged to the factory payroll clearing account
until enough information is available to distribute these costs to the work in process
and factory overhead accounts.
Factory Payroll Clearing xx
     Wages & Salaries Payable xx
     Withholding Accounts xx
To record the factory payroll.

Wages & Salaries Payable xx

     Cash xx
To record the payment of the factory payroll

Factory Overhead Control xx

      Factory Payroll Clearing xx
To record the indirect labor costs.
Work in Process Control xx
      Factory Payroll Clearing xx
To record the direct labor costs

d) Payment of total mfg payroll for februry,$54,000

Journal entry: Wages payable control --------- 54,000

Cash control ------------------------ 54,000
e) Additional mfg OH costs incurred during February, $75,000. These costs consist of
engineering and supervisory salaries, $44000; plant utilities and repairs, $4000; plant
depreciation, $18000; and plant issurance, $2000.
Journal entry: Mfg OH control ----------------- 75,000
Salaries payable control ----------------- 44,000
A/P control ----------------------------- 11,000
Accumulated depreciation control ------ 18,000
Prepaid Insurance control ----------------- 2000

f) Allocation of manufacturing OH to Jobs, $80,000

We assume 2,000 actual DL hrs were used for all jobs in February Year 3
$40 × 2,000 hrs = $80,000
From the 2,000 hours Job WPP 298 used 88 hours only. So OH cost allocated to it will be:
88 hrs × $40 = $3,520
Overhead cost computed is entered in the Manufacturing Overhead Applied section of the
individual job cost sheet
Manufacturing overhead is applied to Work-in Process using the predetermined rate. The
offsetting credit entry is to the Manufacturing Overhead allocated account.
Journal entry: WIP control ----------------80,000

Cost Accounting AAUCC 2009 Page 9 of 16

 Mfg OH allocated -----------------80,000
When predetermine OH rates are used, OH is applied at the end of the period or at
completion of production, whichever is earlier.

FOH can be recorded either in a separate accounts for actual and applied OH or in a single
account. If actual and applied accounts are separate, the applied account is a contra account
to the actual OH account and is closed against it at year-end. Both are temporary accounts.

g) Completion and transfer to finished goods of 12 individual jobs, $188,800. Job no.
298 was one of the jobs completed in February at a cost of $9705
Journal entry: Finished Goods Control ----------188,800
WIP Control ------------------ 188,800

Job order-cost sheet for completed jobs are removed from the WIP subsidiary ledger and
become the subsidiary ledger for the finished goods inventory control account.

h) Cost of goods sold, $180,000. Job 298 was one of the jobs sold and delivered to
customers in February.
Journal Entry: COGS ----------------------- 180,000
Finished goods --------- 180,000

i) Marketing and customer service payroll and advertising costs accrued for February :

Mktg dept. salaries ----- $35000

Advertising costs ------- 10,000
Customer-service costs -- 15000
$60,000
Journal entries:

Mktg and advertising costs ------ 45,000

Customer service costs ------------ 15,000
Salaries payable ------------ 50,000
A/P control ------------------ 10,000
Nonmanufacturing Costs and Job Costing
- In chapter two we pointed out that companies use product costs for different purposes.
- For external reporting purpose product costs include only manufacturing costs. But for
pricing, product-mix, and cost management decisions product costs include
nonmanufacturing costs such as marketing and customer service costs. For the latter purpose
we can trace direct nonmanufacturing costs to the job and use a budgeted cost rate to allocate
indirect nonmanufacturing costs to the job. This is the same approach to job costing we
followed for manufacturing costs.
- By assigning both manufacturing costs and nonmanufacturing cost to jobs, we can compare
all costs of the different jobs against the revenues they generate and evaluate their
contribution to the overall profit.

Cost Accounting AAUCC 2009 Page 10 of 16

 Budgeted Indirect Costs and End-Of Period Adjustments: The Three Approaches In
Accounting for Underallocated And Overallocated Mfg OH

- Though budgeted rates have advantages of obtaining timely cost of products, it is likely to be
inaccurate because they are based on estimates. So inevitably, FOH costs applied to the Work
in Process account and actual FOH costs incurred during a particular period will differ.
- The difference between actual overhead for the period, and estimated overhead for the period
is called the Overhead Variance.
If Estimated (applied) < Actual:
 Overhead is Underapplied (meaning the actual overhead costs for the period exceed the
amount of overhead added to jobs.)
If Estimated (applied) > Actual:
 Overhead is Overapplied (meaning the amount of overhead applied to jobs is greater
than the actual overhead incurred by the company.)
- Two separate Mfg OH accounts and their related balance in our example are as follows:

Mfg OH Control Mfg OH Applied

Dec.31 Dec.31, Year 3

Year 3 1,215,000 $1,080,000

The $135000 difference (1,215,000 – 1,080,000) net credit is underapplied amount.

Why are Actual and Applied Overhead Costs Different?
- The reasons actual and applied overhead costs are different are frequently separated into two
categories.
1) The numerator reason-- The actual quantities used and actual prices paid for the
various indirect resources are different from the prices and quantities estimated or
budgeted for the overhead rate calculation. This causes the spending variance (or
Budget Variance)
Inefficient use and control of FOH (Inefficiency in production) or inability to
accurately forecast overhead costs (poor estimation of the budget may be the reasons
for this. For example, overestimating of factory overhead will result in overapplied OH.
Overapplied OH can also result when actual overhead costs are lower than expected.
2) The denominator reason- The actual level of activity is different from the activity
level used to calculate the overhead rates. This causes the production volume variance
(Overhead Activity Variance).
For example, overestimating the activity base used in the denominator of the
predetermined rate will result in underapplied OH. Underestimating the cost allocation
base will result in overapplied overhead.

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- Accumulation of a larger underapplied balance is more serious than a trend in the opposite
direction any may indicate: inefficiency in production methods, excessive expenditures or a
combination of factors.
- Small underapplied overhead balance would also seem to indicate that the cost allocation
base (cost driver) was a good one.
Disposition Of Under/Overapplied FOH Balance
- At the end of each month the amount of overapplied OH/underaplied OH is transferred to the
following month, being reported in the interim balance sheet in deferred charge if
underapplied under prepaid expenses. And any overapplied balance as deferred credit or in
the interim income statement as a line item below COGS. An underapplied balance in one
period will be offset by overapplied by another month.
- But as this balance is applicable to the operations of the year just ended, the balance will not
appear on the end-of-year balance sheet. The ending balances in Mfg OH Control and Mfg
OH allocated are temporary accounts which should be closed at the end of the year.
- Three approaches to close the under/overapplied OH balance:
i) The adjusted allocation-rate
ii) The proration approach and
iii) The write-off to COGS(Immediate write-off)

i) Adjusted Allocation-Rate Approach

- Restates all OH entries in the general ledger and subsidiary ledgers using actual cost rates
rather than budgeted cost rates.
- The effect is that job-cost sheets(records), the inventory accounts(except RM inventory), and cost
of goods sold are accurately stated with respect to actual overhead.
- This means of disposing of variances is costly but has the advantage of improving the analysis of
product profitability. But the improvements in information technology and decreases in its cost
have made this method more appealing.

Adjustment = Actual FOH - Applied FOH = Actual OH rate - Budgeted OH rate

FOH applied Budgeted OH rate

. = 1,215,000 - 1,080,000 = $45 - $40

1,080,000 $40

= 0.125 or 12.5%
Actual OH exceeds the FOH applied by 12.5%

Now return to our example job No. 298

Under normal costing the Mfg OH allocated to the job is $3,520 .
Adjustment: (1 + 0.125) $3520 = $3,960

So the adjusted amount of Mfg OH allocated to job No.298 equals $3,960. Note that under
actual costing, mfg OH allocated on this job is $3,960

ii) Proration Approach

Cost Accounting AAUCC 2009 Page 12 of 16

- This involves allocation of the balance among WIP, Finished goods and COGS accounts on
the basis of the total amount of applied FOH included in those accounts at the end of the
year.
- Note that the proration approach does not adjust individual job-cost records (sheets)
- Material inventories are not included in this proration.

E.g Assume actual results for Year 3:

A/C balance Mfg OH
before proration included
WIP Control $50,000 $16,200
FDG Control 75,000 31,320
COGS 2,375,000 1,032,480
$2,500,000 $1,080,000
 The proration of the underapplied FOH is done as follows:

Account A/C bal. before Mfg OH % of total × Underapplied = Amount

proration included Mfg OH Mfg OH protrated
WIP Control $50,000 $16,200 1.50% × $135000 $2,025
FDG Control 75,000 31,320 2.90% × $135000 3,915
COGS 2,375,000 1,032,480 95.60% × $135000 129,060
Total $2,500,000 $1,080,000 100% $135,000

 Journal entry to record the proration and close the underallocated OH:
WIP Control ------------------------ 2,025
Finished goods Control ----------- 3,915
COGS ------------------------------- 129,060
Mfg OH allocated ----------------- 1,080,000
Mfg OH Control --------------- 1,215,000
 Account balance after proration(adjustment) :
WIP Control = $50,000 + $2,025 = $52,025
FDG Control = $75,000 + $3,915 = $78915
COGS = $2,375,000 + $129,060 $2,504,060
- If FOH had been overallocated, the four accounts would have been decreased (credited)
instead of increased.
- The above journal entry restates the Year 3 ending balances for WIP, Finished goods, and
COGS to what they would have been, if actual indirect-cost rates had been used rather than
budgeted indirect-costs rates. This method reports the same ending balance in the general
ledger as the adjusted allocation-rate approach.
- Some companies prorate based on the total ending account balances in work in process,
finished goods, and cost of goods sold. But this method gives the same result as the previous
proration only if the proportions of FOH costs to total costs, and therefore direct costs, are
the same in WIP, FDG, and COGS accounts which is rarely true. But its use is justified as

Cost Accounting AAUCC 2009 Page 13 of 16

 being less complex way of approximating the more accurate results from using indirect costs
allocated particularly when the FOH applied component in each account is not readily
available.

iii) Write-off to COGS

- This is the simplest approach. Any over/underapplied FOH cost is written off as an
adjustment to COGS as long as the difference is not material.
- If OH has been underapplied, less OH was charged to production than was incurred.
Therefore, COGS is understated, and the amount of the understated OH is added to COGS on
the income statement.
- If OH has been overapplied, the opposite is true and COGS is overstated, and the amount of
overstated OH is subtracted from COGS.
Journal Entry:

COGS ---------------------- 135,000

Mfg OH applied --------- 1,080,000
Mfg OH control ----- 1,215,000
The companies two Mfg OH accounts are closed with the difference between them included
in COGS.

Choice Among Approaches

- Which of these three approaches is the best one to use? In making this decision, managers
should be guided by how the resulting information will be used.
- If mangers intend to develop the most accurate record of individual job costs for profitability
analysis purposes, the adjusted allocation-rate approach is preferred. If the purpose is
confined to reporting the most accurate inventory and cost of goods sold figures in the
financial statements, proration based on the manufacturing overhead-allocated components in
the ending balances should be used because it adjusts balances to what they would have been
under actual costing.
- If the amount of undrallocated or overallocated is small- in comparison to total operating
income or some other measuring of materiality- the write-off to COGS approach yields a
good approximation to more accurate, but more complex, approaches. In this case the use of
this approach is justified by the cost benefit approach.

Multiple Overhead Cost Pools

- A plant-wide overhead rate is a single overhead rate used throughout all departments of a
company. If all production departments in a manufacturing business have the same mix of
labor and machine, and all jobs require the same amount of work in a given department, then
it is appropriate to use a single, plant-wide overhead rate.
- However, if some departments are machine intensive and some are labor intensive, then the
amount of overhead applied will not approximate the overhead used in all departments. If we
use DL hours as the activity base in a labor intensive department, this will give a good result
but if we use DL hours in a machine intensive environment that has few labor hours actually
worked, the result will be very unsatisfactory. Machine-intensive departments typically use a

Cost Accounting AAUCC 2009 Page 14 of 16

 lot of overhead cost but if there are few labor hours and the rate is applied on the basis of DL
hours, little overhead will be applied.
- Even if all departments are labor intensive, the amount of labor time required for each job
might vary from one department to another. This could still result in imprecise application of
OH costs to a given job if a single labor based plant-wide rate was used for all departments.
- By using separate departmental overhead rates, the OH applied can be tailored to the specific
needs of a particular job. This will lead to more precise costing of products, which can be
critical if the business has to bid for jobs. But remember an important point: cost-benefit
guideline. The benefit of having this system to have more accurate information should
exceed the costing system adopted.

Example:
ABC Company uses Job costing system. The plant has a machining department and an
assembly department. It has two direct cost categories(DMs and Direct mfg labor) and two
mfg OH cost pools( the machining department OH, allocated to jobs based on actual
machine hours, and the assembly department OH, allocated to jobs based on actual direct
mfg labor cost
Budgeted amounts for the year:
Machining Assembly

Mfg OH ------------------------------ $48,000 $360,000

Direct mfg labor cost ---------------- 350,00 720,000
Direct mfg labor hrs ----------------- 50,000 80,000
Machine hrs ----------------------- 100,000 35,000
During October, the job cost sheet for job No.160 listed the following:
Machining Assembly
DMs used --------------- $12,000 $ 20,000
DL cost used ------------- 1400 4860
DL hrs --------------------- 200 540
Machine hrs -------------- 2000 700

The actual results for the year were as follows:

Machining Assembly
Mfg OH --------------- $390,000 $330,000
DL cost----------------- 300,000 750,000
DL hrs ------------------ 37500 78,125
Machine hrs -------------- 78,000 30,000
Required: Compute the cost of Job No. 160 using actual costing and normal costing

Solution: Actual Costing

The real part of the computation starts from step 5

Cost Accounting AAUCC 2009 Page 15 of 16

 Step 5. Actual FOH allocation rate?
Machining Assembly
Actual FOH rate = Actual OH = $390,000 $330,000
Actual allocation base 78,000hrs $750,000
= $5/DL hr 44%

Step 6 and 7. FOH cost allocated to the Job and total cost of the Job
Product Machining Assembly
Job No.160:
DM $12,000 $20,000
DL 14,000 4,860
FOH (actual)
($5 ×2000hrs) 10,000
(44%×4,860) 2138.40
Total $23,400 $26,998.40

Total cost of the job is $23,400 + $26,998.40 = $50,398.40

Solution: Normal Costing

Step 5. Budgeted FOH allocation rate?

Machining Assembly
Budgeted FOH rate = Budgeted OH = $ 480,000 $360,000
Budgeted alloc. base 100,000hrs $720,000
= $4.80/hr 50%
Step 6 and 7. FOH cost allocated to the Job and total cost of the Job
Product Machining Assembly Total
Job No.160:
DM $12,000 $20,000 $32,000
DL 1,400 4,860 6,260
FOH (actual)
($4.8 x2000hrs) 9,600
(50%x4860) 2,430 12,030
Total $23,000 $27290 $50,290

Note that the general ledger would contain FOH Control and FOH allocated amount for each
cost pool under normal costing not actual costing. End of period adjustments for
under/overallocated OH costs would be made separately for each cost pool.

Note also that the disposal of any under/overallocated overhead in each department is made
in a similar fashion as discussed previously but separately for each department

Cost Accounting AAUCC 2009 Page 16 of 16