JOB ORDER COSTING Accurately calculating the cost of each potential customer is critically important because the company needs to be sure that the price exceeds the cost associated with satisfying the order Absorption Costing A costing system that determines product costs o All manufacturing costs fixed variable are assigned to units of product Units fully absorb manufacturing costs o Required by most countries for external financial reports and tax reports I JOB ORDER COSTING OVERVIEW a Under absorption costing product costs include all manufacturing costs i Fixed costs that cannot be directly traced to any particular product are assigned to products and services by averaging across time and across products b Job Order Costing Used in situations where many different products are produced each period i Costs are traced and allocated to jobs ii Average cost per unit Costs of the Job of Units in the Job 1 Used by companies that include production of large scale projects that have diverse outputs and by service industries iii Ex Company is hired to make a product Direct Materials cost 660 they will be working for 5 hours iv Measuring Direct Materials Cost 1 Bill of Materials document that lists the type and quantity of each type of direct material needed to complete a unit of product 2 Materials Requisition Form document that specifies the type and quantity for materials to be drawn from the storeroom and identifies the job that will be charged for the cost of the materials Form controls the flow of materials into production and for making entries in accounting records v Job Cost Sheet Records the materials labor and manufacturing overhead costs charged to that job 1 After direct materials are issued the costs of these materials are automatically recorded on the job cost sheet 2 A 3 A 4 Totals for direct materials direct labor and manufacturing overhead are transferred to the Cost Summary section and added together to obtain the total cost for the job vi Measuring Direct Labor Cost 1 Direct labor consists of labor charges that are easily traced to a 2 particular job Indirect Labor labor charges that cannot be easily traced to any job are treated as part of manufacturing overhead 3 Completed Time Ticket hour by hour summary of the employee s activities throughout the day vii Computing Predetermined Overhead Rates 1 Assigning manufacturing overhead to a specific job involves difficulties because a MOH is an INDIRECT COST impossible difficult to trace costs b Consists of many different items c Because of the fixed costs in MOH total MOH costs tend to remain relatively constant from one period to next even though of units produced can fluctuate widely 2 Allocation is used to assign overhead costs to products a Done by selecting an allocation base that is common to all the company s products and services b Allocation Base A measure such as direct labor hours machine hours that is used to assign overhead costs to products and services i Most widely used bases are direct labor hours direct cost machine hours and units of product when company has only a single product c Commonly assigned to products using a predetermined overhead rate i POHR Estimated Total MOH Cost Estimated total amount of allocation base ii Computed before the period begins using 4 step process 1 Estimate total amount of the allocation base 2 Estimate the total Fixed MOH cost for the coming period and the variable MOH cost unit of the allocation base 3 Use the cost formula Y a bX to estimate the total MOH cost for the coming period 4 Compute the POHR iii Determined before estimating the total MOH cost because total MOH cost includes the variable overhead costs that depend on the amount of allocation base viii Applying Manufacturing Overhead 1 Overhead Application process of assigning overhead cost to jobs 2 Overhead Applied to A Particular Job POHR x Amount of Allocation base incurred by the job a EX Company is producing a car Estimates that 40 000 Direct Labor Hours would be required to support the production planned for the year Estimates that 220 000 of total fixed MOH for the coming year with 2 5 of Variable MOH Job Cost sheet indicates 27 direct labor hours are charged b Y a bX 220 000 2 5 x 40 000 320 000 c POHR Total MOH Estimated Total Allocation Base 320 000 40 000 8 Direct Labor Hour d OH Applied to Job 8 x 27 Hours 216 3 Normal Cost System Applies overhead to jobs by multiplying the POHR by the actual amount of the allocation base incurred by jobs a NOT the actual amount of overhead caused by the job Actual overhead costs are NOT assigned to jobs Simple a share of the total overhead that was estimated at the beginning of the year ix The Need for a Predetermined Rate 1 The actual total amount of the allocation base incurred isn t used because if the actual rate is computed monthly quarterly seasonal factors on overhead costs or in the allocation base can produce fluctuations in the overhead rate x Choice of an Allocation Base for Overhead Cost 1 Ideally the allocation base direct labor hours direct labor cost in the POHR should drive the cost a Cost Driver a factor that causes overhead costs b Allocation base used should really drive or cause overhead costs and direct labor isn t always the most appropriate allocation base c Activity Based costing is designed to more accurately reflect the demands that products customers and other cost objects make on overhead resources xi Computation of Unit Costs 1 Unit Product Cost Total Product Cost of Units 2 Used for valuing unsold units in ending inventory and for determining COGS 3 This unit product cost is an average cost and should NOT be interpreted as the cost that would actually be incurred if another unit were produced a The incremental cost of an additional unit is something LESS than the average unit cost because much of the actual overhead costs would not change if another unit were produced II JOB ORDER COSTING THE FLOW OF COSTS a Product costs flow through inventories on the balance sheet and then on to COGS in the income statement account i Raw materials purchases are recorded in the Raw Materials inventory ii Raw Materials any materials that go into the final product When raw materials are used in production their costs are transferred to the Work In Process inventory account as direct materials iii Work In Process Units of product that are only partially complete and will require further work before they are ready for sale to the customer 1 Direct Labor
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