Chapter 5:

Job-Order
Costing
CORNERSTONES OF MANAGERIAL
ACCOUNTING, 6E
Characteristics of the Job-
Order Environment
Customized or built-to-order products fit into this category,
as do services that vary from customer to customer.
◦ A job is one distinct unit or set of units.
◦ Examples: printing, construction, furniture making, medical and
dental services, automobile repair, beautician services
For job-order production systems, costs are accumulated
by job.
This approach to assigning costs is called a job-order
costing system.

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Process Production and
Costing
Firms in process industries mass-produce large quantities of similar or
homogeneous products.
This approach to cost accumulation is known as a process-costing system.
Examples of process manufacturers include:
◦ Food canning and manufacturing
◦ Cement/Petroleum
◦ Pharmaceutical and chemical manufacturing

Process firms accumulate production costs by process or by department for a

given period of time.
Unit costs are measured using the following equation:
Unit costs = Process Costs ÷ Output

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The Differences Between
Job-Order and Process Costing

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Actual Costing
Two ways are commonly used to measure the costs associated with
production: actual costing and normal costing.
In an actual cost system, only actual costs of direct materials, direct labor, and
overhead are used to determine unit cost.
However, there are several issues involved in using actual costing.
◦ Defining Overhead Costs: Overhead items do not have the direct relationship with
units produced that direct materials and direct labor do.
◦ Uneven Overhead Costs: Many overhead costs are not incurred uniformly
throughout the year.
◦ Waiting until the end of the year to total the actual overhead costs is typically unrealistic.
◦ Uneven Production: Distortions can occur when averages are used with uneven
production.
◦ Strict actual cost systems are rarely used because accurate day-to-day unit cost information is needed on a
timely basis.

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Normal Costing
Normal costing solves the problems associated with
actual costing.
A normal cost system determines unit cost by adding
actual direct materials, actual direct labor, and
estimated overhead.
Overhead can be estimated by approximating the year’s
actual overhead at the beginning of the year and then
using a predetermined rate throughout the year to
obtain the needed unit cost information.
Virtually all firms use normal costing.
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Importance of Unit Costs
Unit cost is a critical piece of information for a manufacturer.
Unit costs are essential for valuing inventory, determining income, and making numerous
important decisions.
Disclosing the cost of inventories and determining income are financial reporting requirements
that a firm faces at the end of each period.
In order to report the cost of its inventories, a firm must know the number of units on hand
and the unit cost.
The cost of goods sold (COGS), used to determine income, requires units sold and their unit
cost.
Full cost information is useful as an input for internal decisions as well as for financial reporting.
In the long run, for any product to be viable, its price must cover its full cost.
Service and nonprofit firms also require unit cost information.

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Normal Costing and Estimating
Overhead
In normal costing, overhead is estimated and applied to
production. The basics of overhead application can be
described in three steps:
◦ Step 1: Calculate the predetermined overhead rate
◦ Step 2: Apply overhead to production throughout the
year
◦ Step 3: Reconcile the difference between the total
actual overhead incurred during the year and the total
overhead applied to production.

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Actual Overhead and Applied
Overhead
This exhibit illustrates the concepts of over- and underapplied
overhead.

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Departmental Overhead Rates
A plantwide overhead rate or single overhead rate has been explained by
dividing all estimated overhead for a factory by the estimated activity level
across the entire factory.
Some manufacturers and service firms believe that multiple overhead rates
give more accurate costing information.
Departmental overhead rates are a widely used type of multiple overhead rate.
A departmental overhead rate is estimated overhead for a department divided
by the estimated activity level for that same department.
The steps involved in calculating and applying overhead are the same as those
involved for one plantwide overhead rate.

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Seven-Step to Job Costing
Step 1: Identify the chosen cost object.
Step 2: Identify the direct costs of the job.
Step 3: Select the cost-allocation bases.
Step 4: Identify the indirect costs.
Step 5: Compute the rate per unit.
Step 6: Compute the indirect costs.
Step 7: Compute the total cost of the job.
 Job-Order
Cost Sheet
The job-order cost sheet is
subsidiary to the work-in-process
account and is the primary
document for accumulating all
costs related to a particular job.

Work in process consists of all incomplete work

In a job-order system, this will be all of the

unfinished jobs.

The balance in Work in Process at the end of the

month will be the total of all the job-order cost
sheets for the incomplete jobs.

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Materials Requisition Form
The materials requisition form asks for the type,
quantity, and unit price of the direct materials issued
and, most importantly, the number of the job.
The form is the source document for direct materials
assigned to a job.
The cost accounting department can enter the cost
of direct materials onto the correct job-order cost
sheet.
If the accounting system is automated, this posting
may entail directly entering the data into a
computer, using the materials requisition forms as
source documents.
No attempt is made to trace the cost of other
materials, such as supplies, lubricants, and the like,
to a particular job.
These indirect materials are assigned to jobs through
the predetermined overhead rate.

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 Time Ticket
The means by which direct labor Time tickets are used only for direct
costs are assigned to individual jobs laborers. Indirect labor costs are
is the source document known as a assigned to jobs through the
time ticket. predetermined overhead rate.
Time tickets are collected and All completed job-order cost sheets of
transferred to the cost accounting a firm can serve as a subsidiary ledger
department where the information for the finished goods inventory.
is used to post the cost of direct
labor to individual jobs. Then, the work-in-process account
consists of all of the job order cost
sheets for unfinished jobs.

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Flow of Costs Through a Job-
Order Costing Firm

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 Schedule of Cost of
Goods Statement of Cost of
Manufactured Goods Sold

A schedule of cost of goods sold usually

is prepared at the end of each reporting
period, as shown here for Johnson
Leathergoods for January.

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Income Statement
Controlling accounts accumulate all of the selling and administrative
expenses for a period. At the end of the period, all of these costs flow to
the period’s income statement.

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Posting of Journal Entries to
the Accounts

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Producing and Supporting
Departments
Nearly every company or factory has producing departments and support
departments.
Producing departments are directly responsible for creating the products or
services sold to customers.
◦ Example: A public accounting firm might have producing departments devoted to
auditing, tax, and management advisory services.
◦ In a factory, producing departments are those that work directly on the products
being manufactured, such as the grinding and assembly departments.

Support departments provide essential services for producing departments,

but they do not actually make the product or service being sold.
◦ Examples include the maintenance, grounds, engineering, housekeeping, personnel,
and photocopying departments.

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 Determining Product Costs:
Predetermined Dept. Overhead Rates
Once the direct overhead costs of each department are determined,
the next step is to assign the support department costs to producing
departments using causal factors (drivers).

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Assigning Costs of Multiple
Support Departments
The three methods of assigning costs of multiple support
departments to producing departments are:
◦ the direct method,
◦ the sequential method
◦ the reciprocal method.
In determining which support department cost
allocation method to use, companies must determine
the extent of support department interaction and weigh
the individual costs and benefits of each method.
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CHAPTER 6:
PROCESS
COSTING
CORNERSTONES OF MANAGERIAL
ACCOUNTING, 5E
CHARACTERISTICS OF PROCESS
MANUFACTURING

• Each product within a line passing through the processes would

receive similar ‘‘doses’’ of materials, labor, and overhead costs.
• Process costing works well whenever homogeneous products pass
through a series of processes and receive similar amounts of
manufacturing costs.

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 TYPES OF PROCESSES
• Sequential processing requires that • Partially completed units (e.g., two
units pass through one process before subcomponents) can be worked on
they can be worked on in the next simultaneously in different processes
process in the sequence. and then brought together in a final
process for completion.

• Parallel processing is another

processing pattern that requires two or
more sequential processes to produce a
finished good.

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WHAT’S IN COMMON?

• No matter which processing pattern exists within a firm, all units

produced share a common property.
– Units are homogeneous and subjected to the same operations for a given
process and each unit produced in a period should receive the same unit
cost.
• Understanding how unit costs are computed requires insight of the
manufacturing cost flows that take place in a process-costing firm.

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 HOW COSTS FLOW THROUGH THE
ACCOUNTS IN PROCESS COSTING
• The manufacturing cost flows for a process-costing system are the same as those for a job-
order system.
• As raw materials are purchased, the cost of these materials flows into a raw materials
inventory account.
• Similarly, raw materials, direct labor, and applied overhead costs flow into a work-in-
process (WIP) account.
• When goods are completed, the cost of the completed goods is transferred from WIP to the
finished goods account.
• Finally, as goods are sold, the cost of the finished goods is transferred to the cost of goods
sold account.
• The journal entries generally parallel those described in a job-order costing system.
• Although job-order and process cost flows are generally similar, some differences exist.
• In process costing, each producing department has its own WIP account. As goods are
completed in one department, they are transferred to the next department.
• The costs attached to the goods transferred out are also transferred to the next department.
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HOW COSTS FLOW THROUGH THE
ACCOUNTS IN PROCESS COSTING (CONT.)

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 ACCUMULATING COSTS IN
THE PRODUCTION REPORT
• In process costing, costs are accumulated by department for a period of
time.
• The production report is the document that summarizes the manufacturing
activity that takes place in a process department for a given period of time.
• A production report contains information on costs transferred in from prior
departments as well as costs
– Added in the department such as direct materials, direct labor, and overhead
– Similar to the job-order cost sheet
– A subsidiary to the WIP account

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 ACCUMULATING COSTS IN
THE PRODUCTION REPORT (CONT.)
• A production report traces the flow of units through a
department, identifies the costs charged to the department,
shows the computation of unit costs, and reveals the
disposition of the department’s costs for the reporting period.

Unit information section: The unit information Unit

section has two major subdivisions: ^^^^^^^^
• units to account for Cost
• units accounted for ^^^^^^^^
Cost information section: The cost
information section has two major
subdivisions:
• costs to account for
• costs accounted for LO-1
THE IMPACT OF WORK-IN-PROCESS
INVENTORIES ON PROCESS COSTING

• Calculating the unit cost is easy—just divide total cost by the number of units
produced.
• The presence of WIP inventories causes problems:
– Defining the units produced can be difficult, given that some units produced during
a period are complete, while those in ending inventory are not. This is handled
through the concept of equivalent units of production.
• How should the costs and work of beginning work-in-process (BWIP) be
treated? Should they be counted with the current period work and costs or
treated separately?
• Two methods have been developed to solve this problem: the weighted average
method and the FIFO method.

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EQUIVALENT UNITS OF PRODUCTION

• By definition, EWIP is not complete.

• Thus, a unit completed and transferred out during the period is not identical (or equivalent) to one
in EWIP inventory, and the cost attached to the two units should not be the same.
• In computing the unit cost, the output of the period must be defined, a significant issue for process
costing.
• The solution is to calculate equivalent units of output.
• Equivalent units of output are the complete units that could have been produced given the total
amount of manufacturing effort expended for the period under consideration.
• Determining equivalent units of output for transferred-out units is easy; a unit would not be
transferred out unless it was complete.
• Every transferred-out unit is an equivalent unit.
• Units remaining in EWIP inventory are not complete.
• Someone in production must ‘‘eyeball’’ EWIP to estimate its degree of completion.
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TWO METHODS OF TREATING BEGINNING
WORK-IN-PROCESS INVENTORY

• In computing a current-period unit cost for a department, two

approaches have evolved for dealing with the prior-period output and
prior-period costs found in BWIP:
– The weighted average costing method and
– The FIFO costing method.

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THE WEIGHTED AVERAGE
COSTING METHOD
• The weighted average costing method combines beginning
inventory costs and work done with current-period costs and work to
calculate this period’s unit cost.
• Costs and work carried over from the prior period are counted as if
they belong to the current period.
• Beginning inventory work and costs are pooled with current work and
costs, and an average unit cost is computed and applied to both units
transferred out and units remaining in ending inventory.

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 THE FIFO COSTING METHOD
• The FIFO costing method separates work and costs of the equivalent units in beginning
inventory from work and costs of the equivalent units produced during the current
period.
– Only current work and costs are used to calculate this period’s unit cost.
– It is assumed that units from beginning inventory are completed first and transferred out.
– The costs of these units include the costs of the work done in the prior period as well as the
current period costs necessary to complete the units.

• Units started in the current period are divided into two categories:
– units started and completed and
– units started but not finished (EWIP).
• Units in both of these categories are valued using the current period’s cost per equivalent
unit.
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WEIGHTED AVERAGE
COSTING
• The weighted average costing method treats beginning inventory costs and
the accompanying equivalent output as if they belong to the current period.
– This is done by adding the manufacturing costs in BWIP to the manufacturing
costs incurred during the current period.
• The total cost is treated as if it were the current period’s total manufacturing
cost.
– Beginning inventory output and current period output are merged in the
calculation of equivalent units.
– Under the weighted average method, equivalent units of output are computed
by adding units completed to equivalent units in EWIP.

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FIVE STEPS IN PREPARING
A PRODUCTION REPORT
• The production report is subsidiary to the WIP account for a
department.
• The following five steps describe the general pattern of a process-
costing production report:
– physical flow analysis
– calculation of equivalent units
– computation of unit cost
– valuation of inventories (goods transferred out and EWIP)
– cost reconciliation

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 EVALUATION OF THE
WEIGHTED AVERAGE METHOD
ADVANTAGES DISADVANTAGES
• Unit cost computations are • Inaccuracies in computing unit costs
simplified for current period output and for
units in BWIP
• Units in BWIP are treated as those
of the current period and all • If the unit cost in a process is stable
from one period to the next, the
equivalent units belong to the
weighted average method is accurate.
same category to calculate unit
costs. • If the price of manufacturing inputs
increases from one period to the
next, the unit cost of current output is
understated, and the unit cost of
BWIP units is overstated.

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 MULTIPLE DEPARTMENTS
• In process manufacturing, some departments receive partially completed
goods from prior departments.
• Treat transferred-in goods as a separate material category when calculating
equivalent units
• The department receiving transferred-in goods would have three input
categories:
– one for the transferred-in materials
– one for materials added
– one for conversion costs

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APPENDIX: PRODUCTION REPORT-
FIRST-IN, FIRST-OUT COSTING

• Under the FIFO costing method, the equivalent units and

manufacturing costs in BWIP are excluded from the current period
unit cost calculation.
• This method recognizes that the work and costs carried over from the
prior period belong to that period.

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DIFFERENCES IN FIRST-IN, FIRST-OUT
AND WEIGHTED AVERAGE METHODS

FIFO WEIGHTED AVERAGE

• More Accurate: If changes • Most firms use this method

occur in the prices of the due to simplicity.
manufacturing inputs from one • FIFO has little advantage over
period to the next. weighted average, if unit costs
• Better cost control are calculated for short
• Better pricing decisions periods.

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