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CHAPTER 5: JOB-ORDER COSTING Cornerstones of Managerial Accounting, 6e The Differences Between Job-Order and Process Costing Companies can be divided into two major types. Those firms producing similar products or services can use a process-costing accounting system. On the other hand, if a company’s products/ services are unique, they require a job-order accounting system. LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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 LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Characteristics of the Job-Order Environment For job-order production systems, costs are accumulated by job. This approach to assigning costs is called a joborder costing system. LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Process Production and Costing 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 LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Process Production and Costing Unit costs are measured using the following equation: Unit costs = Process Costs ÷ Output LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Differences Between Job-Order and Process Costing LO-1 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Normal Costing and Overhead Application Unit costs are important because managers need accurate cost information on materials, labor, and overhead when making decisions. For example, when a construction company bills a client at set points throughout the construction, it is important that unit cost be generated in a timely manner. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Actual Costing In an actual cost system, only actual costs of direct materials, direct labor, and overhead are used to determine unit cost. A normal cost system determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Importance of Unit Costs (cont.) 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. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Importance of Unit Costs to Service Firms The service firm must first identify the service ‘‘unit’’ being provided. For example, a hospital would accumulate costs by patient, patient day, and type of procedure. Because service firms do not produce physical products, they do not need to value work-inprocess and finished goods inventories. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step 1: Calculating the Predetermined Overhead Rate The predetermined overhead rate is calculated at the beginning of the year by dividing the total estimated annual overhead by the total estimated level of associated activity or cost driver: Overhead Rate = Estimated Annual Overhead ÷ Estimated annual activity level Notice that the predetermined overhead rate includes estimated amounts in both the numerator and the denominator. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step 2: Applying Overhead to Production Throughout the Year Once the overhead rate has been computed, the company can begin to apply overhead to production. Applied overhead is found by multiplying the predetermined overhead rate by the actual use of the associated activity for the period: Applied overhead = Predetermined overhead rate x Actual activity level LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step 2: Applying Overhead to Production Throughout the Year (cont.) Once this is calculated, the total cost of product for the period is the actual direct materials and direct labor, plus the applied overhead: Total costs = Actual direct materials + Actual direct labor + Applied overhead LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Calculating The Predetermined Overhead Rate and Applying Overhead to Production LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step 3: Reconciling Actual Overhead with Applied Overhead (cont.) The difference between actual overhead and applied overhead is called an overhead variance. If actual overhead is $400,000 for the year but $390,000 was applied to production, we would say that the variance is underapplied overhead. If actual overhead is $400,000 for the year but $410,000 was applied to production, we would say that the variance is overapplied overhead LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step 3: Reconciling Actual Overhead with Applied Overhead (cont.) Generally, the entire overhead variance is assigned to Cost of Goods Sold, since the amount is usually small or immaterial. Underapplied overhead is added to Cost of Goods Sold. Overapplied overhead is subtracted from Cost of Goods Sold. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Actual Overhead and Applied Overhead This exhibit illustrates the concepts of over- and underapplied overhead. LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reconciling Actual Overhead with Applied Overhead LO-2 © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.