JOB ORDER COSTING

Learning Objectives

After reading and studying the topic, you should be able to answer the following questions:

1. How do job order and process costing systems, as well as their related valuation methods, differ?

2. What are the fundamental characteristics of a job order costing system?

3. What are the primary documents supporting a job order costing system and what purposes are
served by each of them?

4. How are costs accumulated in a job order costing system?

5. How are standard costs used in a job order costing system?

6. How does information from a job order costing system support management decision making?

7. How are losses treated in a job order costing system?

 Terminology

Abnormal loss: A loss of units in excess of expected levels (normal loss) during production; normal
losses are part of the cost of the job, while abnormal losses are written off as a period cost

Cost-plus contract: A contract in which the customer agrees to reimburse the producer for the direct
costs and some indirect costs of the job plus a specified profit margin over cost

Defects: Production process errors that cause a loss of units through rejection at inspection for failure to
meet appropriate quality standards or designated product specifications that can be economically
reworked and later sold

Employee time sheet: A source document that indicates the jobs on which an employee worked and the
direct labor time consumed

Intranet: A restricted network for sharing information and delivering data from corporate databases to
local-area network (LAN) desktops

Job: A single unit or group of units identifiable as being produced to distinct customer specifications

Job order cost sheet: A source document that provides virtually all the financial information about a
particular job; the set of all job order cost sheets for uncompleted jobs composes the Work in Process
Inventory subsidiary ledger

Job order costing system: A system of product costing used by companies that make relatively small
quantities of distinct batches of identifiable, tailor-made products that conform to specifications designated
by the purchaser; the focus of recordkeeping is on individual jobs

Material requisition form: A source document that indicates the types and quantities of material to be
placed into production or used in performing a service; it causes materials and their costs to be released
from the Raw Material Inventory and sent to Work in Process Inventory

Normal loss: A loss of units that falls within a tolerance level that is expected during production; normal
losses are part of the cost of the job, while abnormal losses are written off as a period cost

Process costing systems: Systems used by companies that make large quantities of homogeneous
goods such as breakfast cereal, candy bars, detergent, gasoline, and bricks; given the mass
manufacturing process, one unit of output cannot be readily identified with specific input costs within a
given period

Shrinkage: Losses of materials or partially completed products inherent in the manufacturing process
such as evaporation, leakage, or oxidation

Spoilage: Production process errors that cause a loss of units through rejection at inspection for failure to
meet appropriate quality standards or designated product specifications that cannot be economically
reworked

Standard cost system: A valuation method that develops unit norms or standards for direct material and
direct labor quantities and/or costs; overhead is applied to production using a predetermined rate that is
considered the standard

Variance: The difference between the actual quantity, price, or rate and its related standard cost; labled
favorable if actual is less than standard and unfavorable if actual is greater than standard
 Lecture Outline

LO.1: How do job order and process costing systems, as well as their related valuation methods,
differ?

A. Introduction

1. Product costing systems are used to assign production or performance costs to products or
services for internal and external financial reporting purposes.

2. Firms that produce heterogeneous and custom outputs need a job order costing system that can
track product costs to the product or customer level.

3. Firms that produce homogeneous outputs in batch or continuous production processes can use
process costing to compute an “average” product cost.

4. The chapter begins by distinguishing between job-order and process costing and discusses three
methods of valuation that can be used with each system (actual costing, normal costing, and
standard costing). The chapter then takes an in-depth look at job order costing. Finally, the
chapter concludes by describing how spoilage and losses are accounted for in a job order
system.

B. Methods of Product Costing

1. General

a. Before product cost can be computed, a determination must be made about the cost
accumulation system (job order or process costing) and the valuation method to be used
(actual, normal, or standard costing).

b. There are six possible combinations of cost systems and valuation methods.

2. Cost Accumulation Systems

a. A job order costing system is the product costing system used by entities that make
relatively small quantities or distinct batches of identifiable, unique products (services).

i. The word “job” is synonymous with client, engagement, project, or contract.

b. A process costing system is the product costing system used by entities that produce large
quantities of homogeneous goods such as breakfast cereal, detergent, and gasoline where
one unit of output cannot be readily identified with specific input costs within a given period.

3. Valuation Methods

a. An actual cost system is a valuation method that uses actual direct material, direct labor, and
overhead costs in determining the cost of Work in Process Inventory.

i. Service businesses that have few customers and/or low volume may use an actual cost
system.
 b. A normal cost system is a valuation method that uses actual direct material, actual direct
labor, and applied overhead (estimated using predetermined overhead rates) in determining
the cost of Work in Process Inventory.

i. This chapter assumes the use of normal costing.

c. In a standard cost system, standards (predetermined benchmarks) are developed for direct
material and direct labor quantities and/or costs and overhead is applied to production using
a predetermined rate that is considered the standard.

i. These standards can be used to plan future activities and to value the various inventory
accounts and Cost of Goods Sold.

ii. A standard cost system allows companies to quickly recognize variances from expected
production costs and to correct problems from excess usage and/or costs, a capability
not found in actual cost systems and provided only for overhead in normal cost systems.

LO.2: What are the fundamental characteristics of a job order costing system?

C. Job Order Costing System

1. In a job order costing system, product costing is concerned with: cost identification; cost
measurement; and product cost assignment.

2. Costs are accumulated individually by job.

a. A job is a single unit or group of like units identifiable as being produced to distinct customer
specifications.

b. Each job is treated as a unique cost object.

c. The output of a given job can be a single unit or multiple similar or dissimilar units.

i. The total accumulated job cost may be averaged over the number of units produced to
determine a per-unit cost provided all the units within the batch are similar.

ii. No per unit cost can be determined if the output consists of dissimilar units for which
individual cost information has not been accumulated.

3. Costs of different jobs are maintained in separate subsidiary ledger accounts and are not added
together or commingled in those ledger accounts.

a. Direct material, direct labor, and overhead costs are accumulated for each job.

b. The normal costing method of valuation is used since actual direct material and direct labor
costs are fairly easy to identify and associate with a particular job but overhead costs are not
usually traceable to specific jobs and must therefore be allocated to production.

4. The job order costing system provides information important to managing profitability and setting
prices for outputs. Custom manufacturers typically price their goods using two methods:
 a. Cost-plus contract is a contract in which the customer agrees to reimburse the producer for
the direct costs and some indirect costs of the job plus a specified profit margin over cost;
and

b. Competitive bidding is a technique where companies must accurately estimate the costs of
making the unique products associated with each contract. The company will incur losses
when actual costs exceed the bid price and will have profit when actual costs are less than
the bid price.

5. The trend in job order costing is to automate the data collection and data entry functions.

a. Automating the recordkeeping functions relieves production employees of that burden. In

many companies, intranets are being created to manage the information pertaining to jobs.

i. An intranet is a mechanism for sharing information and delivering data from corporate
databases to the local-area network (LAN) desktops. Intranets use Web technology and
are restricted networks that can enhance communication and distribute information.

LO.3: What are the primary documents supporting a job order costing system and what purposes
are served by each of them?

D. Job Order Costing: Details and Documents

1. General

a. A job can be categorized by the stage of existence in its production life cycle as follows:

i. contracted for but not yet started;

ii. in process; and

iii. completed.

b. Job order costing is used by companies making products according to user specifications and
may require unique raw materials which may not be acquired until a job is under contract and
it is known that production will occur.

2. Job Order Cost Sheet

a. The job order cost sheet is a source document that provides virtually all the financial
information about a particular job.

i. The set of all job order cost sheets for uncompleted jobs composes the Work in Process
Inventory subsidiary ledger and thus the total costs contained in all the job cost sheets for
uncompleted jobs should reconcile to the Work in Process Inventory control account
balance in the general ledger.

b. Direct material information is gathered from the material requisition forms, while direct labor
information is found on employee time sheets or employee labor tickets. Overhead is applied
to production using predetermined overhead rates.
3. Materials Requisitions

a. A material requisition form is a source document that indicates the types and quantities of
materials to be placed into production or used in performing a service.

i. A material requisition form causes materials and their costs to be released from the Raw
Materials Inventory warehouse.

b. Completed material requisition forms provide the ability to verify the flow of materials from the
warehouse to the department and job that received the materials. They are usually
prenumbered and come in multicopy sets so that completed copies can be maintained in the
warehouse, in the production department, and with each job.

4. Employee Time Sheets

a. An employee time sheet is a source document that indicates for each employee the jobs
worked on during the day and the amount of hired labor time consumed.

b. the employee station is accompanied by a tag or bar code specifying the job number.

c. The time work is started and stopped are recorded on the time sheet as the day progresses
and is reviewed by supervisors for accuracy.

d. Large businesses often use time keeping software instead of manual time sheets.
Employees just swipe their ID cards and job cards through an electronic scanner as they
change from one job to another.

e. Knowledge of employee labor rates is required in transferring employee time sheet

information to the job order cost sheet.

i. Time sheet information is also used for payroll preparation.

f. Time sheets may also be used for the following purposes:

i. If total actual labor costs differ significantly from the original estimate, the manager
responsible for labor cost control will have to explain the difference.

ii. The number of hours worked on a cost plus contract may also be audited by the buyer as
with government contracts or other buyers.

iii. Time sheets provide information on overtime hours so that the company can comply with
the Fair Labor Standards Act which requires non-management employees be paid time-
and-one-half when they work more than 40 hours in a week.

5. Overhead

a. Actual overhead incurred during production is charged (debited) to a Manufacturing

Overhead Control account.

b. If actual costing is used (meaning that actual overhead is applied to jobs) the cost accountant
must wait until the end of the period to divide actual overhead cost incurred in each
designated cost pool by a related measure of activity or cost driver. Then actual overhead is
applied to jobs by multiplying the actual overhead rate by the actual measure of activity
associated with each job.
 c. In a normal costing system, overhead is applied to job order cost sheets by using one or
more annualized predetermined overhead application rate(s).

i. Overhead is assigned to jobs by multiplying the predetermined overhead rate by the

actual measure of the activity base associated with each job.

ii. Overhead is applied at the end of the period or at completion of production, whichever is
earlier.

iii. Overhead must be applied at the end of each period so that the Work in Process
Inventory account contains costs for direct material, direct labor, and overhead
associated with jobs still in process.

6. Completion of Production

a. When production of a job is complete, its job cost sheet is removed from the Work in Process
Inventory subsidiary ledger and transferred to the Finished Goods Inventory file where it will
now serve as a subsidiary ledger for that account.

b. Job order costing documents and cost flows are depicted in the job order cost sheet.

c. Job cost sheets for sold jobs are kept in a company’s permanent files, providing management
with a historical summary about total costs and, if appropriate, the cost per finished unit for a
given job.

i. The cost per unit may be helpful for planning and control purposes as well as for bidding
on future contracts.

LO.4: How are costs accumulated in a job order costing system?

E. Job Order Costing Illustration

1. Journal entries illustrating the flow of costs for the Fabrication Department of Dean’s Ironworks
are presented in the text and summarized below (Note that work on several jobs including Job
#PF108 was performed during the month as indicated in the first four journal entries.):

a. Materials are charged to production:

Work in Process Inventory—Fabrication (Job #PF108) 4,875

Work in Process Inventory—Fabrication (other jobs) 520
Manufacturing Overhead Control—Fabrication (indirect material) 25
Raw Material Inventory 5,420
To record direct and indirect materials issued per September requisitions

b. Labor is charged to production:

Work in Process Inventory—Fabrication (Job #PF108) 6,902

Work in Process Inventory—Fabrication (other jobs) 1,447
Manufacturing Overhead Control—Fabrication (indirect labor) 1,250
Wages Payable 9,599
To record September wages
 c. Actual overhead costs are recorded as incurred:

Manufacturing Overhead Control—Fabrication 5,900

Accumulated Depreciation 2,500
Prepaid Insurance 200
Utilities Payable 1,900
Cash 500
Various accounts 800
To record actual September overhead costs exclusive of indirect material and
indirect, non-salaried labor

d. Overhead is charged (applied) to production:

Work in Process Inventory—Fabrication (Job #PF108) 5,070

Work in Process Inventory—Fabrication (other jobs) 900
Manufacturing Overhead Control—Fabrication 5,970
To apply overhead for September using predetermined rates

e. Job #PF108 is transferred from Fabrication to the next department (Installation):

Work in Process Inventory—Installation 16,847

Work in Process Inventory—Fabrication 16,847
To transfer Job #PF108 from Fabrication to Installation

f. After installation department costs are added, Job #PF108 is transferred from Installation to
the next department (Finishing):

Work in Process Inventory—Finishing 22,376

Work in Process Inventory—Installation 22,376
To transfer Job #PF108 from Installation to Finishing

g. Job #PF108 is completed and is transferred from Finishing to Finished Goods:

Finished Goods Inventory—Job #PF108 28,091

Work in Process Inventory—Finishing 28,091
To transfer completed Job #PF108 to FG Inventory

h. Job #PF108 is delivered with the $35,250 sales price to be collected in 30 days:

Accounts Receivable—Willowdale Homeowners’ Association 35,250

Sales 35,250
To record the sale of goods on account

Cost of Goods Sold—Job #PF108 28,091

Finished Goods Inventory—Job #PF108 28,091
To record the CGS for the above sale

The completed job cost sheet can be used by managers in all departments to determine how well
costs were controlled.

LO.5: How are standard costs used in a job order costing system?

F. Job Order Costing Using Standard Costs

 1. Direct material and direct labor costs of similar units may fluctuate from period to period or job to
job due to changes in component costs if actual costs are used.

a. The use of standard costs for direct material and direct labor can minimize the effects of such
cost fluctuations in the same way that predetermined rates do for overhead costs.

2. A standard costing system determines product cost by using predetermined norms, or standards,
in the inventory accounts for prices and/or quantities of cost components.

a. Once production is completed, standard production cost is compared to actual production

cost to determine the efficiency of the production process.

b. A variance is the difference between an actual and a budgeted price, rate, or quantity.

c. Standards can be used in a job order system only if a company typically engages in jobs that
produce fairly similar products.

i. One type of standard job order costing system uses standards only for input prices of
material or only for labor rates, a reasonable approach provided all output relies on
similar kinds of material or labor.

d. The text provides two brief examples to illustrate the use of price and rate standards

i. The Coat of Many Colors house-painting example is for a company that produces a
heterogeneous output.

ii. The Green Manufacturing example is for a company that produces a homogeneous
output.

e. Variances can be computed for actual-to-standard differences regardless of whether

standards have been established for both quantities and prices or for prices or rates only.

i. Standard costs for materials and labor provide the same types of benefits as
predetermined overhead rates—more timely information and comparisons against actual
amounts.

f. Standard cost job order systems are reasonable substitutes for actual or normal costing
systems as long as the standards provide managers with useful information.

i. In fact, any type of product costing system is acceptable if it is effective and efficient in
serving the company’s unique production needs, provides information desired by
management, meets external reporting demands, and can be maintained at a cost that is
reasonable when compared to the benefits received.

LO.6: How does information from a job order costing system support management decision
making?

G. Job Order Costing to Assist Managers

1. Managers are interested in controlling costs of each department as well as for each job.
 a. Actual costs are periodically compared to budgets so managers can respond to significant
variances.

b. The primary difference in job order costing for a service organization and a manufacturing
firm is that a service organization may use an insignificant amount of direct material on each
job, so that direct material may be accounted for as part of overhead rather than being
accounted for separately.

2. Job order costing is beneficial to managers in planning, controlling, decision making, and
evaluating performance.

a. Managers can effectively estimate future job costs and establish realistic bids and selling
prices if they know the costs of individual jobs.

b. Budgets and standards can be used to provide information against which actual costs can be
compared at reasonable time intervals for control and performance evaluation purposes.

3. Job order costing can help determine which jobs are really profitable and can assist managers in
monitoring costs, as illustrated by the Concrete Café and Paul’s Pirogues examples.

a. In the Concrete Café example, job costing helped the company identify which jobs were
responsible for disproportionately large costs. Consequently, the firm began concentrating its
efforts on smaller clients who were located closer to the primary office, causing a significant
increase in profits.

b. In the Paul’s Pirogues example, a small business owner who had previously just
“guesstimated” costs used job order costing to exercise better cost control, to generate better
inventory valuations for his financial statements, and better information to make day-to-day
operating decisions.

LO.7: How are losses treated in a job order costing system?

H. Product and Material Losses in Job Order Costing

1. General

a. The production processes may result in losses of materials or partially completed products.

b. Evaporation, leakage, or oxidation are inherent in the manufacturing process; such reductions
are called shrinkage.

i. Eliminating shrinkage may be difficult, impossible, or simply not cost beneficial.

c. Production process errors (either by humans or machines) can cause a loss of units.

i. Defects are units lost through rejection at inspection for failure to meet appropriate
quality standards or designated product specifications but which can be economically
reworked and later sold.

ii. Spoilage occurs when units are lost through rejection at inspection for failure to meet
appropriate quality standards or designated product specifications and such units cannot
be economically reworked.
 d. Normal loss is a loss of units that falls within a tolerance level that is expected during
production. Normal losses are part of the cost of the job, while abnormal losses are written off
as a period cost.

e. Abnormal loss is a loss of units in excess of expected levels (normal loss) during production.
Normal losses are part of the cost of the job, while abnormal losses are written off as a period
cost.

2. Losses Generally Anticipated on All Jobs

a. If a normal loss is generally anticipated on all jobs, the predetermined overhead application
rate should include an amount for the net cost of the loss, which is equal to the cost of
defective or spoiled work less the estimated disposal value, if any of that work.

b. This approach, illustrated with an example in the text, assumes that such losses are naturally
inherent or unavoidable in the production of goods and products and the estimated loss
should be allocated to the goods produced.

c. As defects or spoilage occur, the disposal value of nonstandard work is included in an

inventory account (if salable), and the net cost of the normal, nonstandard work is charged to
the overhead control account as would be the case with any other actual overhead cost:

Disposal value of defective work 22

Manufacturing Overhead Control 35
Work in Process Inventory – Job #38 57
To record disposal value of defective work incurred on Job #38 for Husserl Co.

3. Losses Specifically Identified With a Particular Job

a. If defects or spoilages are not generally anticipated but are occasionally experienced on
specific jobs because of job related characteristics, the estimated cost should not be included
in setting a predetermined overhead application rate.

b. The cost of the lost units remains with the job that caused the defects or spoilage.

c. However, since the defects/spoilage cost attaches to the job, the disposal value of such
goods reduces the costs of the job that created those goods as illustrated in the following
journal entry:

Disposal value of defective work 22

Work in Process Inventory – Job #38 22
To record disposal value of defective work incurred on Job #38 for Husserl Co.

4. Abnormal spoilage

a. The cost of abnormal losses should be written off as a period cost.

b. Abnormal losses should be separately identified and investigated to prevent future

recurrences.

c. In the following journal entry, the first debit represents the defective inventory’s disposal
value. The debit to Manufacturing Overhead is for the net cost of normal spoilage. The debit
to Loss from Abnormal Spoilage is the net cost of spoilage that was unnecessary and
unanticipated in setting the predetermined application rate.
Disposal Value of Defective Work 45
Manufacturing Overhead 120
Loss from Abnormal Spoilage 33
Work in Process Inventory - Job #135 198
To record reassignment of cost of defective and spoiled work on job #135
 Multiple Choice Questions

1. (LO.1) All of the following would most likely use a job order costing system except:
a. a dental practice.
b. an auto repair shop.
c. a small appliance maker.
d. an architectural firm.

2. (LO.1) Which of the following costs is not charged to Work in Process in a normal cost system?
a. Actual overhead
b. Actual direct materials
c. Actual direct labor
d. Estimated indirect labor

3. (LO.1) Which of the following product costs would be charged to Work in Process assuming a
standard costing system?
a. Actual direct material costs
b. Actual overhead costs
c. Actual direct labor costs
d. Applied overhead costs

4. (LO.2) Select the incorrect job order costing system characteristic.

a. Costs are accumulated by job.
b. A job may consist of multiple units provided all units are similar.
c. Costs of different jobs cannot logically be averaged so a unique cost must be determined for
each job.
d. Jobs are usually produced to distinct customer specifications.

5. (LO.3) Which of the following serves at a subsidiary ledger for the Work in Process account?
a. Standard cost card
b. Material requisition form
c. Job requisition form
d. Job order cost sheet

6. (LO.3) Which of the following is not a source document used in job order costing systems?
a. Cost of production report
b. Employee time sheet
c. Job cost sheet
d. Material requisition form

7. (LO.4) Select the response that represents the correct flow of costs in a job order costing system.
a. Raw materials, work in process, cost of goods sold, finished goods
b. Raw materials, work in process, finished goods, cost of goods sold
c. Raw materials, overhead, work in process
d. Direct material, finished goods, work in process

8. (LO.4) The journal entry to apply overhead to production would include:

a. a debit to Manufacturing Overhead Control.
b. credits to various accounts such as Cash, Accumulated Depreciation, and Accounts Payable.
c. a credit to Manufacturing Overhead Control.
d. a credit to Work in Process.
9. (LO.4) The journal entry to transfer production from the Finishing Department to Finished Goods
would include a:
a. credit to Finished Goods.
b. debit to Cost of Goods Manufactured.
c. credit to WIP – Finishing.
d. credit to Cost of Goods Manufactured.

10. (LO.4) M Corporation manufactures a specialty line of jeans using a job-order-cost system.
During May, the following costs were incurred in completing Job M1: direct materials, $13,700;
direct labor, $4,800; administrative, $1,400; and selling, $5,600. Overhead was applied at the
rate of $25 per machine hour, and Job M1 required 800 machine hours. If Job M1 resulted in
7,000 good jeans, the cost of goods sold per unit would be
a. $5.50.
b. $6.30.
c. $5.70.
d. $8.50.

11. (LO.4) Q Company uses a normal cost system. The following information is from its financial
records for the year:
Total manufacturing costs, $2,500,000
Cost of goods manufactured, $2,425,000
Applied overhead, 30% of total manufacturing costs
Predetermined OH rate, 80% of direct labor cost

Assuming the company’s work in process inventory at January 1 was 75 percent of its December
31 work in process inventory, what is the carrying value of the company’s work in process
inventory at December 31?
a. $75,000
b. $100,000
c. $225,000
d. $300,000

12. (LO.5) Which of the following costing systems does not involve computing cost variances?
a. Actual costing system
b. Normal costing system
c. Standard costing system
d. All of the above systems involve computing cost variances

13. (LO.5) Select the incorrect statement concerning standard costs and job order costing.
a. A standard cost system determines product cost by using predetermined norms in the
inventory accounts for prices and/or quantities of cost components.
b. Standards can be used in a job order cost system only if a company typically engages in jobs
that produce fairly similar products.
c. Under GAAP, standard cost job order systems may not substitute for actual or normal costing
systems.
d. Standard cost variances can be computed for actual-to-standard differences regardless of
whether standards have been established for both quantities and prices or for prices or rates
only.
14. (LO.6) Which of the following statements is true concerning job order costing and management
decision making?
a. Job order costing assists managers in their planning, controlling, decision making and
performance evaluations functions.
b. Job order costing allows managers to trace costs associated with specific current jobs to
better estimate costs of future jobs.
c. Job order costing provides a means by which managers can better control the costs
associated with their operations.
d. All of the above are true statements.

15. (LO.7) Select the incorrect statement regarding the accounting for product losses.
a. Normal losses that are anticipated on all jobs are estimated and included in the development
of the predetermined OH rate.
b. Normal losses that are associated with a particular job are charged to a loss account in the
period they are incurred.
c. Abnormal losses are charged to a loss account in the period they are incurred.
d. The difference between normal and abnormal loss is one of degree and therefore must be
determined by management.