Job Order Costing - The Flow of Cost:

Learning objective of this article:

1. Understand the flow of costs in a job order costing system and prepare appropriate journal entries to record cost.
2. Apply overhead cost to work in process using a predetermined overhead rate.
3. Prepare T accounts to show the flow of costs in a job order costing system.
4. Prepare schedule of cost of goods manufactured and cost of goods sold.

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To understand the flow of costs in job order costing system, we shall consider a single month's activity for a company, a producer of product A and product B. The company has two jobs in process during April, the first month of its fiscal year. Job 1, of 1000 units of product A was started in march. By the end of march, $30,000 in manufacturing costs had been recorded for the job 1. Job 2 an order for 10,000 units of product B was started in April.

The Purchase and Issue of Materials:

On April 1, the company had $7,000 in raw materials on hand. During the month, the company purchased an additional $60,000 in raw materials. The purchase is recorded in journal entry (1) below:

(1)

Raw Materials		60,000		Dr.
	Accounts Payable		60,000	Cr.

Raw materials is an asset account. Thus, when raw materials are purchased, they are initially recorded as an asset--not as an expense.

Issue of Direct and Indirect Materials:

During April, $52,000 in raw materials were requisitioned from the storeroom for use in production. These raw materials include both direct and indirect materials. Entry (2) records issuing the materials to the production department.

(2)

Work in Process		50,000		Dr.
Manufacturing Overhead		2,000		Dr.
	Raw Materials		52,000	Cr.

The materials charged to work in process (WIP) represents direct materials for specific jobs. As these materials are entered into the work in process account, they are also recorded on the appropriate job cost sheets. This point is illustrated in Exhibit 1.1 where $28,000 of the $50,000 in direct materials is charged to Job 1 cost sheet and the remaining $22,000 is charged to job 2 cost sheet. (In this example, all data are presented in summary form and the job cost sheet is abbreviated.)
The $2,000 charged to manufacturing overhead in entry (2) represents indirect materials used in production during April. Observe that the manufacturing overhead account is separate from work in process account. The purpose of the manufacturing overhead account is to accumulate all manufacturing overhead costs they are as they are incurred during a period.
Before leaving Exhibit 1.1 we need to point out one additional thing. Notice from the exhibit that the job cost sheet for job 1 contains a beginning balance of $30,000. We stated earlier that this balance represents the cost of work done during march that has been carried forward to April. Also note that work in process account contains the same $30,000 balance. The reason the $30,000 appears in both places is that the work in process account is a control account and the job cost sheets form a subsidiary ledger. Thus, the work in process account contains a summarized total of all costs appearing on the individual job cost sheet for all jobs in process at any given point in time. (Since the company had only job 1 in process at the beginning of April, job 1's $30,000 balance on that date is equal to the balance in the work in process account.

Exhibit 1.1

Issue of Direct Materials Only:

Some times the materials drawn from the raw materials inventory account are all direct materials. I this case, the entry to record the issue of the materials into production would be as follows:

Work in process		XXX		Dr.
	Raw materials		XXX	Cr.

Labor Cost:

As work is performed each day in various departments of the company, employee time tickets are filled out by workers, collected, and forward to the accounting department. In the accounting department, wages are computed and the resulting costs are classified as either direct or indirect labor. This costing and classification for April resulted in the following summary entry:

(3)

Work in process		60,000		Dr.
Manufacturing overhead		15,000		Dr.
	Salaries and wages payable		75,000	Cr.

Only direct labor is added to the work in process account. In this example, direct labor is $60,000 for April.
At the same time the direct labor costs are added to work in process, they are also added to the individual job cost sheets, as shown in the Exhibit 1.2. During April, $40,000 of direct labor cost was charged to job 1 and the remaining $20,000 was charged to job 2. The labor cost charged to manufacturing overhead represent the indirect costs of the period, such as supervision, janitorial work, and maintenance.

Exhibit 1.2

Manufacturing Overhead Costs:

All costs of operating the factory other than direct materials and direct labor are classified as manufacturing overhead costs. These costs are entered directly into the manufacturing overhead account as they are incurred. To illustrate, assume that the company incurred the following general factory costs during April:

Utilities (heat, water, and power)	$21,000
Rent on factory equipment	16,000
Miscellaneous factory costs	3,000
	--------
Total	$40,000
	======

The following entry records the incurrence of these costs:

(4)

Manufacturing overhead		40,000		Dr.
	Accounts Payable		40,000	Cr.

In addition, let us assume that during April, the company recognized $13,000 in accrued property taxes and that $7,000 in prepaid insurance expired on factory buildings and equipment. The following entry records these items:

(5)

Manufacturing overhead		20,000		Dr.
	Property taxes payable		13,000	Cr.
	Prepaid insurance		7,000	Cr.

Finally let us assume that the company recognize $18,000 in depreciation on factory equipment during April. The following entry records the accrual of this depreciation:

(6)

Manufacturing overhead		18,000		Dr.
	Accumulated Depreciation		18,000	Cr.

In short, all manufacturing overhead costs are recorded directly into the manufacturing overhead account as they are incurred day by day through a period. It is important to understand that manufacturing overhead is a control account for many--perhaps thousands--of subsidiary accounts such as indirect materials, indirect labor, factory utilities, and so forth. As the manufacturing overhead account is debited for costs during a period the various subsidiary accounts are also debited. In this example we omit the entries to the subsidiary accounts for the sake of brevity.

Calculation of Predetermined Overhead Rate and Application of Manufacturing Overhead to Work in Process (WIP):

Since actual manufacturing costs are charged to the manufacturing overhead control account rather than work in process account. How are manufacturing costs assigned to work in process? The answer is, by means of the predetermined overhead rate. A predetermined overhead rate is established at the beginning of each year. The predetermined overhead rate is calculated by dividing the estimated total manufacturing overhead cost for the year by the estimated total units in the allocation base (measured in machine hours, direct labor hours, or some other base). This rate is then used to apply overhead costs to jobs.
To illustrate assume that the company has used machine hours to compute predetermined overhead rate and that this rate is $6 per machine hour. Also assume that during April, 10,000 machine hours were worked on Job 1 and 5,000 machine hours were worked on Job 2 (a total of 15,000 machine hours). Thus, $90,000 in overhead cost  (15,000 machine hours  $6 per machine hour = $90,000) would be applied to work in process. The following entry records the application of manufacturing overhead to work in process:40% Price Drop: Panasonic DMC-ZS5 Black 12.1 Megapixel Digital Camera - DMC-ZS5K

(7)

Work in process		90,000		Dr.
	Manufacturing overhead		90,000	Cr.

The flow of cost through the manufacturing overhead account in Exhibit 1.3

Exhibit 1.3

The actual overhead cost in the manufacturing overhead account in Exhibit 1.3 are the costs that were added to the account in entries (2)--(6).  Observe that the incurrence of these actual overhead costs and the application of overhead to work in process represents two separate and entirely distinct processes.

The Concept of Clearing Account:

The manufacturing overhead account operates as a clearing account. As we have noted, actual factory overhead costs are debited to the accounts as they are incurred day by day through the year. A certain intervals during the year, usually when a job is completed, overhead cost is applied to the job by means of the predetermined overhead rate, and work in process is debited and manufacturing overhead is credited. This sequence of events is illustrated below:

Manufacturing Overhead (a clearing account)
Actual overhead costs are charged to this account as they are incurred throughout the period.	Overhead is applied to work in process using the predetermined overhead rate.

As we emphasized earlier, the predetermined overhead rate is based on estimates of what overhead costs are expected to be, and it is established before the year begins. As a result, the overhead cost applied during a year will almost certainly turn out to be more or less than the overhead cost that is actually incurred. For example, notice from Exhibit 1.3 that the company's actual overhead costs for the period are $5,000 greater than the overhead cost that has been applied to work in process (WIP), resulting in a $5,000 debit balance in the manufacturing overhead account. This debit balance in manufacturing overhead account is called under-applied overhead. Any credit balance in manufacturing overhead account is called over-applied overhead. Any balance in the manufacturing overhead account (under or over-applied overhead) is treated in one of the following ways:

1. Closed out to cost of goods sold
2. Allocated between work in process, finished goods, and cost of goods sold in proportion to the overhead applied during the current period in the ending balance of these accounts.

These two methods are illustrated on Disposition of Under- or Over-applied Overhead Balances page.
For the moment, we can conclude by nothing from Exhibit 1.3 that the cost of a completed job consists of the actual materials cost of the job, the actual labor cost of the job, and the overhead cost applied to the job. Pay particular attention to the following subtle but important point: Actual overhead costs are not charged to jobs; actual overhead costs do not appear on the job cost sheet nor do they appear in the work in process account. Only the applied overhead cost, based on the predetermined overhead rate, appear on the job cost sheet and in the work in process account. Study this point carefully.

Non-manufacturing Costs:

In addition to manufacturing costs, companies also incur marketing and selling costs. These costs should be treated as period expenses and charged directly to the income statement and therefore should not go into the the manufacturing overhead account. To illustrate the correct treatment of non-manufacturing costs, assume that the company (in this example) incurred $30,000 in selling and administrative salary costs during a months, the following entry records these salaries.

(8)

Salaries expense		30,000		Dr
	Salaries and wages payable		30,000	Cr

Depreciation on factory equipment is debited to manufacturing overhead account but depreciation on office equipment is considered a period expense and is not included in manufacturing overhead. Assume that depreciation of office equipment during the month was $7,000. The entry is as follows.

(9)

Depreciation expense		7,000		Dr
	Accumulated depreciation		7,000	Cr

Finally assume that advertising was $42,000 and that other selling and administrative expenses during the month was $8,000. The following journal entry records these items:

(10)

Advertising expenses		42,000		Dr.
Other selling and administrative expense		8,000		Dr.
	Accounts payable		50,000	Cr.

Since the amounts in entries above all go directly into expense accounts, they will have no effect on the costing of the company's production for the month. The same will be true of any other selling and administrative expenses incurred during the month including sales commission, depreciation on sales equipment, rent on office facilities, insurance on office facilities, and related costs.

Cost of Goods Manufactured (COGM):

When a job has been completed, the finished out put is transferred from the production department to the finished goods  warehouse. By this time, the accounting department will have charged the job with direct materials and direct labor cost and manufacturing overhead will have been applied using the predetermined overhead rate. A transfer of costs is made within the costing system that parallels the physical transfer of the goods to the finished goods warehouse. The costs of the completed jobs are transferred out of the work in process (WIP) account and into the finished goods account. The sum of all amounts transferred between these two accounts represents the cost of goods manufactured for the period.

Let us assume that the job 1 was completed during the period. The following entry transfers the cost of  job 1 from work in process (WIP) to finished goods.

(11)

Finished goods		158,000		Dr.
	Work in process		158,000	Cr

The $158,000 represents the completed cost of job 1, as shown on the job cost sheet in Exhibit 1.3. Since job 1 was the only job completed during April, the $158,000 also represents the cost of goods manufactured for the month.

The job 2 was not completed by month-end, so its cost will remain in the work in process (WIP) account and carry over to the next month. If a balance sheet is prepared at the end of April, the cost accumulated thus far on the job 2 will appear as "work in process inventory" in the assets section.

Cost of Goods Sold (COGS):

As units in the finished goods are shipped to the customers, their costs are transferred from the finished goods account into the cost of goods sold account. If complete job is shipped, as in the case where a job has been done to a customer's specification then it is a simple matter to transfer the entire cost appearing on the job cost sheet into the cost of goods sold account. In most cases, only a portion of the units involved in a particular job will be immediately sold. In these situations the unit cost must be used to determine how much product cost should be removed from finished goods and charged to cost of goods sold.

Assume that the company has completed 1000 units and 750 out of 1000 units have been shipped to customers for a price of $225,000. The unit product cost is $158. Following journal entries would record the sales (all sales are on account).

(12)

Accounts receivable		225,000		Dr.
	Sales		225,000	Cr.

(13)

Cost of goods sold		118,5000*		Dr.
	Finished goods		118,5000	Cr.

($158 × 750units = $118,500*)

With entry (13), the flow of cost through our job order costing system is completed.

Summary of Cost Flow:

To pull the entire example together, journal entries (1) through (13), T accounts, and schedules of cost of goods manufactured and cost of goods sold are presented below:

Journal Entries:

(1)
Raw Materials		60,000		Dr.
	Accounts Payable		60,000	Cr.
(2)
Work in process		50,000		Dr.
Manufacturing overhead		2,000		Dr.
	Raw materials		52,000	Cr.
(3)
Work in process		60,000		Dr.
Manufacturing overhead		15,000		Dr.
	Salaries and wages		75,000	Cr.
(4)
Manufacturing overhead		40,000		Dr.
	Accounts payable		40,000	Cr.
(5)
Manufacturing overhead		20,000		Dr.
	Property taxes payable		13,000	Cr.
	Prepaid insurance		7,000	Cr.
(6)
Work in process		18,000
	Manufacturing overhead		18,000
(7)
Work in process		90,000		Dr.
	Manufacturing overhead		90,000	Cr.
(8)
Salaries expenses		30,000		Dr.
	Salaries and wages payable		30,000	Cr.
(9)
Depreciation expense		7,000		Dr.
	Accumulated depreciation		7,000	Cr.
(10)
Advertising expense		42,000		Dr
Other selling and administrative expense		8,000		Dr.
	Accounts payable		50,000	Cr.
(11)
Finished goods		158,000		Dr.
	Work in process		158,000	Cr.
(12)
Accounts receivable		225,000
	Sales		225,000
(13)
Cost of goods sold		118,500
	Finished goods		118,500

T Accounts:

Accounts Receivable			Accounts Payable			Capital Stock
xx (12)  225,000				xx  (1)       60,000  (4)       40,000  (10)     50,000			xx
Prepaid Insurance			Salaries and Wages Payable			Retained Earnings
xx	(5)       7,000			xx (3)       75,000 (8)       30,000			xx
Raw Materials			Property Taxes Payable			Sales
Bal.      7,000 (1)     60,000	(20)   52,000			xx (5)      13,000			(12) 225,000
Bal.     15,000
						Cost of Goods Sold
Work in Process			Salaries expenses			(13)  118500
Bal.     30,000 (2)      50,000 (3)      60,000 (7)      90,000	(11)  158,000		(8)  30,000
			Depreciation expenses
			(9)    7,000
Bal.     72,000
Finished Goods			Advertising Expenses
Bal.     10,000 (11)  158,000	(13)  118,500		(10)  42,000
Bal.     49,000
Accumulated Depreciation			Other Selling and Administrative expenses
	xx (6)     18,000 (9)      7,000		(10)   8,000
Manufacturing Overhead
(2)         2000 (3)      15,000 (4)      40,000 (5)      20,000 (6)      18,000	(7)     90,000
Bal.       5,000
Explanation of entries: (1) Raw materials purchased.
(2) Direct and indirect materials issued into production.				(8) Administrative salaries expenses incurred.
(3) Direct and indirect factory labor cost incurred.				(9) Depreciation recorded on office equipment.
(4) Utilities and other factory costs incurred.				(10) Advertising and other expenses incurred
(5) Property taxes and insurance incurred on the factory.				(11) COGM  transferred into finished goods.
(6) Depreciation recorded on the factory assets.				(12) sale of job 1 recorded.
(7) Overhead cost applied to work in process.				(13) Cost of goods sold recorded for job 1.
XX = Normal balance in the account (for example accounts receivable normally carries a debit balance).

Cost of Goods Manufactured:

Direct materials	$50,000
Direct labor	$60,000
Manufacturing overhead applied to work in process	$90,000*
	---------------
Total Manufacturing cost	$200,000
Add: Beginning work in process	$30,000
	------------
	$230,000
Deduct: Ending work in process inventory	$72,000
	-----------
Cost of goods manufactured	$158,000
	=======
Cost of Goods Sold:
Finished goods inventory beginning	$10,000
	$158,000
	-----------
Goods available for sale	$168,000
Deduct: Finished goods inventory ending	$49,500
	----------
Unadjusted cost of goods sold	$118,500
Add: Under applied overhead	$5,000*
	-----------
Adjusted cost of goods sold	$123,500
	=======
*Overhead applied = $90,000 (15,000 Direct labor hours × $6.00 Predetermined overhead rate) Actual overhead = $95,000 Under applied overhead = $95,000 (actual) - $90,000 (applied) = $5,000 Entry to close the $5,000 of under applied  to cost of goods sold would be as follows: Cost of goods sold--------------------------------- 5,000 Dr          Manufacturing overhead-------------------------------- 5,000 Cr Note that the under-applied overhead is added to cost of goods sold. If overhead were over-applied, it would be deducted from cost of goods sold.

Income Statement:

Sales		$225,000
Les cost of goods sold ($ 118,500 + $5,000)		123,500
		-----------
Gross margin		101,500
Less selling and administrative expenses:
Salaries	$30,000
Depreciation	7,000
Advertising expenses	42,000
Other expense	8,000	87,000
	----------	-----------
Net operating income		$14,500
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