Ziggnicity: Job Order Costing

Job Order Costing

Accurate costing is critical to a company’s success. For example, in order to set a selling price for a new job and to know whether it profited from past jobs, the company needs a good costing system. This article will discuss how (manufacturing) costs are assigned to specific jobs.

BUT FIRST, Let's have a quick review of the following concepts:

1. Cost accounting involves the measuring, recording, and reporting of product costs. The cost data accumulated by companies determine both the total cost and the unit cost of each product. This cost information produced by the cost accounting system will be used by the company for cost management (planning and control) and financial reporting

2. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the books (general ledger) of a company. It uses the perpetual inventory system. Such a system provides immediate, up-to-date information on the cost of a product. There are two basic types of cost accounting systems: (1) a job order cost system and (2) a process cost system.

3. A job order cost system, assigns costs to each job or to each batch of goods. The flow of manufacturing costs in a job order cost system matches the physical flow of the materials as they are converted into finished goods. As the materials are issued and transferred to the factory, manufacturing costs are assigned to the Work in Process Inventory account. When a job is completed, the company transfers the cost of the job to Finished Goods Inventory. Later when the goods are sold, the company transfers their cost to Cost of Goods Sold.

There are two major steps in the flow of costs:

(1) accumulating the manufacturing costs incurred, (debits to Raw Materials, Factory Labor, Manufacturing overhead,) ; as of this point costs are not yet associated to specific jobs.

(2) assigning the accumulated costs to the work done (entries for materials, labor, and overhead used in production. As well as cost of completed goods and sold goods)

Accumulating Manufacturing Costs

To illustrate a job order cost system, we will use the January transactions of KAIA-MOTO Manufacturing Company, which makes gardening tools.

RAW MATERIALS COSTS

When KAIA-MOTO receives the raw materials it has purchased, it debits the costs of the materials to Raw Materials Inventory. The company would debit this account for the invoice cost of the raw materials and freight costs chargeable to the purchaser. It would credit the account for purchase discounts taken and purchase returns and allowances. KAIA-MOTO makes no effort at this point to associate the cost of materials with specific jobs or orders.

For example, assume that KAIA-MOTO Manufacturing purchases on account 2,000 handles (Stock No.RM0011) at Php5 per unit (Php10,000) and 800 modules (Stock No.RM0012) at Php40 per unit (Php32,000) for a total cost of Php42,000 (Php10,000 plus Php32,000). The entry to record this purchase on January 4 is:

1/4	Raw Materials Inventory	42,000
	Accounts Payable		42,000

Later in this article, the company will then assign raw materials inventory to work in process and manufacturing overhead.

FACTORY LABOR COSTS

Basically ,the cost of factory labor consists of three costs:

(1) gross earnings of factory workers,

(2) employer payroll taxes on these earnings, and

(3) fringe benefits (such as sick pay, pensions, and vacation pay) incurred by the employer.

Companies debit labor costs to Factory Labor as they incur those costs.

Assuming that KAIA-MOTO Manufacturing incurs Php32,000 of factory labor costs. Of that amount, Php27,000 relates to wages payable and Php5,000 relates to payroll taxes payable in January.

The entry to record factory labor cost for the month is:

1/31	Factory Labor	32,000
	Factory Wages Payable		27,000
	Employer Payroll Taxes Payable		5,000

The company would subsequently assign factory labor to work in process and manufacturing overhead.

MANUFACTURING OVERHEAD COSTS

There are many types of overhead costs. An entity may recognize these costs daily, as in the case of factory equipment repairs and the use of factory supplies and indirect labor. Or, it may record overhead costs periodically through adjusting entries (as in the case of property taxes, depreciation, and insurance) This is done using a summary entry, which summarizes the totals from multiple transactions.

An example for this would be the following entry (using assumed amounts):

1/31	Manufacturing Overhead	13,800
	Utilities Payable		4,800
	Prepaid Insurance		2,000
	Accounts Payable		2,600
	Accumulated Depreciation		3,000
	Property Taxes Payable		1,400

The company would then assign manufacturing overhead to work in process.

Assigning Manufacturing Costs to Work in Process

Assigning manufacturing costs to work in process results in the following entries: (Refer to previous cheat sheet)

1. Debits made to Work in Process Inventory.

2. Credits made to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

An essential accounting record in assigning costs to jobs is a job cost sheet, A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job. Companies keep a separate job cost sheet for each job. The job cost sheets constitute the subsidiary ledger for the Work in Process Inventory account. A subsidiary ledger consists of individual records for each individual item—in this case, each job. The Work in Process account is referred to as a control account because it summarizes the detailed data regarding specific jobs contained in the job cost sheets. Each entry to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets.

RAW MATERIALS COSTS

Companies assign raw materials costs when their materials storeroom issues the materials. Requests for issuing raw materials are made on a prenumbered materials requisition slip. The materials issued may be used directly on a job, or they may be considered indirect materials. The requisition should indicate the quantity and type of materials withdrawn and the account to be charged. The company will charge direct materials to Work in Process Inventory ,and indirect materials to Manufacturing Overhead.

The company may use any of the inventory costing methods (FIFO, LIFO,or average-cost) in costing the requisitionsto the individual job cost sheets. Periodically, the company journalizes the requisitions. For example, if KAIA-MOTO Manufacturing uses Php24,000 of direct materials and Php6,000 of indirect materials in January,the entry is:

1/31	Work in Process Inventory	24,000
	Manufacturing Overhead	6,000
	Raw Materials Inventory		30,000

The requisition slips show total direct materials costs of Php12,000 for Job No. 101, Php7,000 for Job No.102,and Php5,000 for Job No.103.The posting of requisition slip R247 and other assumed postings to the job cost sheets for materials are shown below. After the company has completed all postings,the sum of the direct materials columns of the job cost sheets (the subsidiary accounts) should equal the direct materials debited to Work in Process Inventory (the control account).

(Companies post to control accounts monthly and post to job cost sheets daily.)

FACTORY LABOR COSTS Companies assign factory labor costs to jobs on the basis of time tickets prepared when the work is performed. The time ticket indicates the employee, the hours worked, the account and job to be charged, and the total labor cost. Many companies accumulate these data through the use of bar coding and scanning devices. When they start and end work, employees scan bar codes on their identification badges and bar codes associated with each job they work on. When direct labor is involved, the time ticket must indicate the job number, as shown in Illustration 20-8. The employee’s supervisor should approve all time tickets.

The time tickets are later sent to the payroll department,which applies the employee’s hourly wage rate and computes the total labor cost. Finally, the company journalizes the time tickets.It debits the account Work in Process Inventory for direct labor, and debits Manufacturing Overhead for indirect labor. For example, if the Php32,000 total factory labor cost consists of Php28,000 of direct labor and Php4,000 of indirect labor,the entry is:

1/31	Work in Process Inventory	28,000
	Manufacturing Overhead	4,000
	Factory Labor		32,000

As a result of this entry, Factory Labor has a zero balance, and gross earnings are assigned to the appropriate manufacturing accounts. Let’s assume that the labor costs chargeable to KAIA-MOTO’s three jobs are Php15,000, Php9,000, and Php4,000. The illustration below shows the Work in Process Inventory and job cost sheets after posting. As in the case of direct materials, the postings to the direct labor columns of the job cost sheets should equal the posting of direct labor to Work in Process Inventory.

MANUFACTURING OVERHEAD COSTS

Companies charge the actual costs of direct materials and direct labor to specific jobs. In contrast, manufacturing overhead relates to production operations as a whole. As a result, overhead costs cannot be assigned to specific jobs on the basis of actual costs incurred. Instead, companies assign manufacturing overhead to work in process and to specific jobs on an estimated basis through the use of a predetermined overhead rate. The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. The company may state the activity in terms of direct labor costs,direct labor hours,machine hours,or any other measure that will provide an equitable basis for applying overhead costs to jobs. Companies establish the predetermined overhead rate at the beginning of the year. Small companies often use a single, company-wide predetermined overhead rate. Large companies often use rates that vary from department to department. The formula for a predetermined overhead rate is as follows.

Overhead relates to production operations as a whole. To know what “the whole” is, the logical thing is to wait until the end of the year’s operations.At that time the company knows all of its costs for the period. As a practical matter, though, managers cannot wait until the end of the year. To price products accurately,they need information about product costs of specific jobs completed during the year.Using a predetermined overhead rate enables a cost to be determined for the job immediately.

KAIA-MOTO Manufacturing uses direct labor cost as the activity base. Assuming that the company expects annual overhead costs to be Php280,000 and direct labor costs for the year to be Php350,000,the overhead rate is 80%,computed as follows:

Php280,000 / Php350,000= 80%

This means that for every peso of direct labor,KAIA-MOTO will assign 80 cents of manufacturing overhead to a job.The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when it completes the job. Historically, companies used direct labor costs or direct labor hours as the activity base.The reason was the relatively high correlation between direct labor and manufacturing overhead. Today more companies are using machine hours as the activity base,due to increased reliance on automation in manufacturing operations. Many companies now use activity-based costing in an attempt to more accurately allocate overhead costs based on the activities that give rise to the costs. A company may use more than one activity base. For example,if a job is manufactured in more than one factory department, each department may have its own overhead rate. For KAIA-MOTO Manufacturing, overhead applied for January is Php22,400 (direct labor cost of Php28,000 80%). The following entry records this application.