Management Accounting

Week 5 Tutorial
Chapter 7: Job costing systems
7.1 Describe the procedures used in job costing.

In job costing, direct costs such as direct materials and direct labour are traced to each
individual job. Then the indirect costs, usually overhead costs, are allocated to all of
the jobs on which has been done during the period using either an actual or estimated
allocation rate. This rate is developed by dividing an actual or estimated overhead cost
by an actual or estimated volume of an allocation base. Typical allocation bases
include labour cost, labour hours, and machine hours. If an estimated allocation rate is
used, then end-of-period adjustments need to be made for any underapplied or
overapplied overhead cost.

7.2 Describe an inventoriable product cost.

Inventoriable product costs are those costs that are included as part of the cost of
inventory (i.e. work-in-process and finished goods). These costs are subsequently
expensed as cost of sales on the sale of the completed products. In accordance with
financial accounting conventions, inventoriable product costs include direct materials,
direct labour and overhead costs.

7.5 Compare actual and normal cost systems. Discuss the ways in which they
are similar and the ways they differ.

Both systems treat direct material and direct labour costs in the same manner; these
costs are assigned to the jobs on which they were actually incurred using the actual
amount of allocation base used per job. The difference deals with indirect costs. In an
actual cost system, actual indirect costs are totalled at the end of the period and then,
retroactively, allocated to the jobs worked on during the period. In a normal cost
system, indirect costs and activity are estimated at the start of the period and an
estimated allocation rate is used during the period to assign the costs to jobs as work
takes place.

7.10 Explain how manufacturing overhead cost pools and cost allocation are
related.

Cost pools are groups of overhead costs, that is, common costs for resources used to
manufacture products or provide services. These costs need to be distributed among
the goods and services to match cost with revenue during an accounting period. Cost
allocation is the method used to distribute costs across units of goods or services.

7.13 Job Costing, determination of manufacturing overhead rates

 One Glass Brewery estimates the following activity for the coming year:

At the end of the financial period the following information was collected:

Required
(a) What was the predetermined manufacturing overhead rate calculated
at the beginning of the year?
(b) What was the actual manufacturing overhead rate for the year?
(c) Explain the difference between the rates calculated in (a) and (b)
above.

(a) Predetermined overhead rate for the year is:

$100 000 / 10 000 hours = $10 per hour

(b) Actual overhead rate for the year is:

$120 000 / 9000 hours = $13.33 per hour

(d) The rate difference is due to the underestimation of the costs ($20 000) and
overestimation of the labour hours (1000 hours).

7.14 Job costing, over- and underapplied overhead, journal entries

Shane’s Shovels produces small, custom earth-moving equipment for
landscaping companies. Manufacturing overhead is allocated to work in
process using an estimated overhead rate. During April, transactions for
Shane’s Shovels included the following:

Beginning and ending work in process were both zero.

 Required
(a) What was the cost of jobs completed in April?
(b) Was manufacturing overhead underapplied or overapplied? By how
much?
(c) Write out the journal entries for these transactions, including the
adjustment.

(a) Notice that the company uses normal costing (overhead is allocated using an
estimated rate). However, under normal costing the company is required to
make an end-of-period adjustment for any overapplied or underapplied
overhead. This means that the after-adjustment costs assigned to jobs completed
will be actual cost:

Direct materials issued to production $180 000

Indirect materials issued to production 30 000
Overhead incurred 250 000
Direct labour costs 75 000
Total Actual Costs Incurred $535 000

(b) This month overhead was underapplied by $55 000. This is the difference
between total overhead costs of $280 000 (indirect materials of $30 000 plus
other manufacturing overhead incurred of $250 000) and manufacturing
overhead allocated of $225 000.

(c) Work in process $180 000

Raw materials inventory (direct materials used) $180 000

Overhead cost control $30 000

Raw materials inventory (indirect materials used) $30 000

Overhead cost control $250 000

Various accounts $250 000

Work in process $225 000

Overhead cost control (allocations) $225 000

Work in process $75 000

Wages payable $75 000

Finished goods $480 000

Work in process $480 000

The problem states that beginning and ending WIP inventories were both zero.
Therefore, all jobs were completed. Total WIP costs = $180 000 + $225 000 +
$75 000 = $480 000

Cost of sales $480 000

Finished goods $480 000
 The problem does not provide any information about the delivery of jobs to
customers. However, jobs are usually transferred to customers upon completion,
so the following entry assumes that all finished goods inventory is transferred to
cost of sales.

Cost of sales $55,000

Overhead cost control (adjustment) $55 000

The amount of underapplied overhead was calculated in Part (b). Notice this is
also equal to the balance of entries to the overhead control account: $30 000 +
$250 000 – $225 000. The balance in the overhead control account will be zero
after this entry is recorded.

Notice that with the overhead cost adjustment the total costs recorded in cost of
sales of $535 000 ($480 000 + $55 000) are equal to the total costs in part (a).

7.18 Journal entries

Langley uses a job costing system. At the beginning of the month of June,
two orders were in process as follows:

There was no inventory in finished goods on 1 June. During June, orders

numbered 106 to 120 were put into process.

Direct materials requirements amounted to $13 000, direct labour costs

for the month were $20 000, and actual manufacturing overhead recorded
during the month amounted to $28 000.

The only order in process at the end of June was order 120, and the costs
incurred for this order were $1150 of direct materials and $1000 of direct
labour. In addition, order 118, which was 100 per cent complete, was still
on hand as of 30 June. Total costs for this order were $3300. The entity's
overhead allocation rate in June was the same as that used in May and is
based on labour cost.

Required
(a) Prepare journal entries (with supporting calculations) to record the
cost of goods manufactured, the cost of sales, and the closing of the
overapplied or underapplied overhead to cost of sales.
 (b) Describe the two different approaches to closing overapplied or
underapplied overhead at the end of the period. How do you choose
an appropriate method?

(a) Work-in-Process $13 000

Raw Materials Inventory $13 000

Work-in-Process $20 000

Wages Payable $20 000

Work-in-Process ($20 000 × 1.5)a $30 000

Overhead Cost Control $30 000

Overhead Cost Control $28 000

Various Accounts $28 000

Finished Goodsb $64 750

Work-in-Process $64 750

Cost of salesc $61 450

Finished Goods $61 450

Overhead Cost Control $2 000

Cost of sales $ 2 000
a
The overhead rate can be determined from the data on beginning work-in-
process. For example, the data for order 88 implies that the rate is $1800/1200 =
150% of direct labour cost. The same rate can be determined from the data for
order 105.
b
Beginning work-in-process $ 5 400
Direct materials 13 000
Direct labour 20 000
Overhead allocated 30 000
Total manufacturing costs 68 400
Ending work-in-process ($1150 + 1000 + 1500) (3 650)
Cost of goods manufactured $64 750
c
Beginning finished goods $ 0
Cost of goods manufactured 64 750
Goods available for sale 64 750
Ending finished goods (3 300)
Cost of sales $61 450

(b) The overapplied or underapplied overhead can be closed to cost of sales as

shown above. Alternatively, it can be prorated to work-in-process, finished
goods, and cost of sales in proportion to the flow of costs in each account during
the period. The criterion usually used is whether the overhead adjustment is
material in size. Each organisation has different criteria for setting the lower
limit for materiality, but it is often between 5% and 10% of the amount of actual
overhead cost. In this textbook, 10% is generally considered to be material.