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Study on Job Order Costing and Process Costing

A central aim of this paper is to provide the study on job order costing and process costing. This paper shows how to measure cost in situations and also this type of cost accounting system is called job order costing because production is arranged by the job. The paper covers the other main type of costing system-called process costing.

All businesses face the same situation. They must draw a crowd-sell enough goods and services to earn a profit. So, regardless of the type of business you own or manage, you need to know how much it costs to produce your product or service. This applies regardless of the type of career you plan to have. Such as: marketing managers must consider their unit product cost in order to set the selling price high enough to cover costs. Engineers study the materials, labor, and overhead that go into a product to pinpoint ways to cut costs. Production managers then decide whether it is more profitable to make the product or to outsource it. The Finance Department arranges financing for the venture. The Accounting Department provides all the cost data for making these decisions.

Furthermore, that it is important for managers in all areas to know how much it costs to make a product.

Critical review

Job Order Costing System:

Distinguish between process costing and job order costing and identify companies that would use each costing method.

Identify the documents used in job order costing system.

Compute predetermined overhead rates and explains why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

Understand the flow of costs in a job order costing system and prepare appropriate journal entries to record costs.

Apply overhead cost to work in process (WIP) using a predetermined overhead rate.

Prepare a schedule of cost of goods manufactured and cost of goods sold.

Prepare T-accounts to show the flow of costs in a job order costing system.

Explain the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

Definition and Explanation of Job Order Costing System:

A job order costing system is used in situations where many different products are produced each period. For example clothing factory would typically made many different types of jeans for both men and women during a month. In a job order costing system, costs are traced to the jobs and then the costs of the job are divided by the number of units in the job to arrive at an average cost per unit.

Job order costing system is also extensively used in service industries. Hospitals, law firms, movie studios, accounting firms, advertising agencies and repair shops all use a variety of job order costing system to accumulate costs for accounting and billing purposes. The details here deal with a manufacturing firm, the same concept and procedures are used by many service organizations.

The record keeping and cost assignment problems are more complex in a job order costing system when a company sells many different products and services than when it has only a single product or service. Since the products are different, the costs are typically different. Consequently, cost records must be maintained for each distinct product or job. For example an attorney in a large criminal law practice would ordinarily keep separate records of the costs of advising and defending each of her clients. And a clothing factory would keep separate track of the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing system requires more effort than a process costing system. Companies classify manufacturing costs into three broad categories: (1) direct materials, (2) direct labor, (3) manufacturing overhead. As we study the operation of a job costing system, we will see how each of these three types of costs is recorded and accumulated.

Measuring Direct Materials Cost in Job Order Costing System:

At the beginning of production process a document known as "bill of materials" is used for standard products. A bill of materials is a document that lists the type and quantity of each item of materials needed to complete a unit of standard product. In case where it is not possible to use a bill of materials because the product is not a standard product the production staff determines the materials requirements from the blueprints submitted by the customer.

Measuring Direct Labor Cost in Job Order Costing System:

Direct labor cost is handled in much the same way as direct materials cost. Direct labor consists of labor charges that are easily traced to a particular job. Labor charges that cannot be easily traced directly to any job are treated as part of manufacturing overhead. The later category of labor cost is known as indirect labor and includes tasks such as maintenance, supervision and cleanup. Workers use time tickets to record the time they spend on each job and task. At the end of the day, the time tickets are gathered and accounting department enters the direct labor hours and costs on individual job cost sheets.

Application of Manufacturing Overhead:

Manufacturing overhead must be included with direct labor on the job cost sheet since manufacturing overhead is also a product cost. However, assigning manufacturing overhead to units of product can be a difficult task. Herewith three reasons as follows:

Manufacturing overhead is an indirect cost. This means that it is either impossible or difficult to trace these costs to a particular product or job.

Manufacturing overhead consists of many different items ranging from the grease used in machines to the annual salary of production manager.

Even though output may fluctuate due to seasonal or other factors, manufacturing overhead costs tend to remain relatively constant due to the presence of fixed costs.

Given these problems, about the only way to assign overhead costs to production is to use an allocation process.

Job Order Costing System-The Flow of Costs:

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.

Multiple Predetermined Overhead Rates:

When a single predetermined overhead rate is used for entire factory it is called plant wide overhead rate. This is fairly common practice-particularly in smaller companies. But in large companies, multiple predetermined overhead rates are often used.

Problems of Overhead Application:

We need to consider two complications relating to overhead application and herewith more information:

Under-applied overhead and over-applied overhead calculation.

Disposition of any balance remaining in the manufacturing overhead account at the end of a period.

Predetermined Overhead Rate and Capacity:

Companies typically base their predetermined overhead rates on the estimated, or budgeted, amount of allocation base for the upcoming period. This is the method that is used in the chapter, but it is practice that is recently come under severe criticism.

Recording 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 manufacturing overhead account.

Recording Cost of Goods Manufactured and Sold:

When a job has been completed, the finished out put is transferred from the production department to the finished good, 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.

Job Order Costing in Services Companies:

Job order costing is also used in service organizations such as law firms, movie studios, hospitals, and repair shops, as well as manufacturing companies. In a law firm, for example, each client represents a "job," and the costs of that job are accumulated day by day on a job cost sheet as the client's case is handled by the firm.

Use of Information Technology in Job Order Costing:

Bar code technology can be used to record labor time--reducing the drudgery in that task and increasing accuracy. Bar codes also have many other uses. In a company with a well-developed bar code system, the manufacturing cycle begins with the receipt of a customer's order in electronic form.

Advantages and Disadvantages of Job Order Costing System:

One of the primary advantages of job order costing system is that the management team has ready access to all the costs incurred for each job being completed. This allows the team to examine each cost incurred, finding out why it happened, and determine how it can be controlled better in the future, thereby contributing to better ongoing levels of profitability.

Case Studies:

Job Order Costing; General and Factory Ledger:

On December 31, 19A, after closing, the ledgers of the VLM Company contained these accounts and balances:

During January, 19B, these transactions were completed:

Purchase on account: Materials A, 10,000 units @ $5.20; Materials B, 12,000 units @ $3.75; indirect materials, $17,520.

Payroll totaling $110,000 was paid. Of the total payroll, $20,000 was for marketing and administrative salaries. Payroll deductions consisted of $15,500 for employees' income tax and 6.5% for FICA tax.

Payroll to be distributed as follows: Job 101, 5,000 direct labor hours @ $4.00; Job 102, 8,000 direct labor hours @ $5.00; Job 103, 6000 direct labor hours @ $3.00; indirect labor, $12,000; marketing and administrative salaries, $20,000. Employers payroll taxes are: FICA, 6.5%; state unemployment, 2.7%; federal unemployment, 0.7%.

Materials were issued on a first in first out (FIFO) basis as follows: Materials A, 10,000 units (charged to Job 101); Materials B, 12,000 units (charged to Job 102); Materials A, 1,000 units, and Materials B, 2,500 units (charged to Job 103). (Note: Transactions are to be taken in consecutive order.) Indirect materials amounting to $7,520 were issued.

Factory overhead was applied to jobs 101, 102, and 103 based on the rate of $2.00 per direct labor hour.

Jobs 101 and 102 were completed and sold on account for $120,000 and $135,000, respectively.

After allowing a 5% cash discount, a net amount of $247,000 was collected on account receivable.

Marketing and administrative expenses (other than salaries) paid during the month amounted to $15,000. Miscellaneous factory overhead of $10,800 was paid and transferred to the factory. Depreciation on machinery was $2,000.

Payment on account, other than payroll paid, amounted to $85,000.

The over- or under applied factory overhead is to be closed to the cost of goods sold account.

Required:

Trial balances of the general ledger and of the factory ledger as of January 1, 19B.

General ledger and factory ledger accounts opened and balances recorded from the January 1 trial balances.

Journal entries to record the January transactions.

The posting of January transactions to the general ledger, factory ledger, and subsidiary ledgers for materials, work in process, finished goods and factory overhead incurred.

Trial balances of the general ledger and the factory ledger as of January 31, 19B, reconciliation control accounts with subsidiary ledgers.

A statement of cost of goods sold for January.

Determination of Cost:

The presented of the Nola Cola Company has heard rumblings of dissatisfaction among board of directors about the relatively low net earnings of the company. Several directors are not satisfied with the accounting reports being issued.

They believe, it appears, that the shipping and delivery expenses are responsible, that advertising is in line, and that administrative expenses, although possibly somewhat above normal, are not out of control. Their primary criticism seems leveled at manufacturing costs.

Consequently, a meeting of the board of directors has been called in order to examine critically the accounting system is use for determining manufacturing costs; that is, the cost of a Nola Cola bottle ready for delivery as it comes from the last operation of the bottling process.

Sensing some of the problems involved, the president has adopted a recognized technique of executive strategy. Before having the controller explain the accounting system in use, the president has decided to ask for an opinion as to what item should be included in the proper determination of the cost of a bottle of Nola Cola. For example, the president believes there is mutual agreement that such items as syrup, water, carbonation, and bottle caps are properly part of manufacturing costs.

Solution:

A number of specific items may be mentioned:

Direct labor cost.

Wear and breaking of bottles and cases.

A share of manufacturing expenses other than direct materials ad direct labor, i.e., factory overhead.

As these specific items are mentioned, the discussion should be channeled into a consideration of several "general" problems of cost accounting:

The problem of setting up an equitable and economical cost determination system.

The need for the system also to provide devices and information for control and decision-making purposes.

The problem of measurement and assignment of overhead costs to work completed.

The fact that cost figures are, at best, estimates. Yet, although we may never know what the exact cost is, we can obtain useful information at a reasonable price.

Installing a Cost Information and Accumulation System:

A textile manufacturer asks advice concerning the installation of a cost system. The manufacturer explains briefly that many different cloths are produced, starting with scoured wool that passes through the following processing before becoming finished cloth: picking and blending, carding, spinning, weaving, finishing, and dyeing. The company's sales representatives take orders considerably in advice of the actual production of the cloth, using samples produced during a special period set aside each season for the manufacture of samples. Competition is keen and the profit margin is low. The financing is received through bank loans.

Required:

The principle advantages of installing a cost system.

The principle additions or alterations necessary to operate a cost system. (The present accounting system is designated for the purpose preparing annual financial statements.)

An explanation of how matters can be arranged in order to find the cost of the principle stages of manufacture, such as carding, spinning, weaving, etc. (The carding machines operate three shifts per day; the spinning machines, two shifts; and the weaving machines, one shift.)

Solution:

A: The principle advantages of installing a cost system are:

The ascertainment of unit costs of the various products. Unit costs are variable in determining minimum sales prices and in eliminating unprofitable lines.

Improvement in efficiency by comparison of cost details at regular intervals.

More adequate information, which is available for inventory costing.

Establishing control over production.

B: To operate a cost system, it would be necessary to amplify the accounting procedure by providing for:

More detailed analysis of disbursements.

Perpetual inventory records.

Monthly accumulation of detailed figures relating to costs of each operation and product.

C: Divide the factory into departments for cost accumulating purposes corresponding to the natural divisions, such as Carding Department, Spring Department, and Weaving Department. Break down the analysis of factory overhead according to these department departments. This automatically takes care of the differences in operating shifts.

Designing Cost Accumulation Procedures:

A client has asked advice as to a satisfactory system of factory costs for a factory that is divided into two main divisions:

Machine Shop: This division makes steel molds used in the manufacture to plastic articles. These molds require careful precision work; and frequently, one person is employed at machining one mold for several weeks. The finished molds are used by the Plastic Division of the company. In addition, some other machine work is done for customers, although this forms the smaller portion of the shop's output.

Plastic Division: This division manufactures plastic articles including ash trays, buttons, knobs, etc. The process of manufacture consists of placing chemical powders in a mold, which is then placed under a steam press where pressure is applied for a few minutes. The chemical powders are the only materials used and are not processed before being placed in the mold. After being processed, a certain amount of finishing and inspection labor is necessary to complete the articles.

It is ascertained that:

The company has had no previous cost records.

Production in both divisions is controlled by job order tickets.

Materials are kept in one place, but no record has been kept of withdrawals.

Labor is paid at hourly rates, and a time clock at the factory entrance is used for determining the hours worked in any day.

Employees have been preparing satisfactory time tickets showing the hours worked on each job and, in the case of the plastics division, the number of units produced; but this record has never been balanced against the wages paid nor the record of production.

Spoilage is a substantial factor in both divisions.

The machine shop and the plastic division are in separate parts of the one building.

The company has a satisfactory system of general ledger accounting.

Solution:

Regardless of what cost system is installed, three changes should be made in the company's methods:

A control should be established over materials. Requisitions should be used.

Factory overhead should be segregated between the two divisions. Direct departmental charges should be made as much as possible. Common costs should be apportioned to each department on an equitable basis.

Clock cards should be balanced with employees' time sheets.

If these matters are resolved satisfactorily, the costs might be obtained as follows:

- Machine Shop

The product seems to be custom item so that job costing seems appropriate. Overhead should be charged to the product on some predetermined basis.

- Plastic Division

It seems that job order costing system is also possible here. The overhead might be charged to the product on different bases if the machine used would suggest different rates. This might make possible the creation of cost centers.

- General

Any cost system should permit comparison with estimated figures.

Meantime you should also be considered in other relevant articles:

Measuring Direct Materials Cost in Job Order Costing System

Measuring Direct Labor Cost in Job Order Costing System

Application of Manufacturing Overhead

Job Order Costing System--The Flow of Costs

Multiple Predetermined Overhead Rates

Under-applied overhead and over-applied overhead calculation

Disposition of any balance remaining in the manufacturing overhead account at the end of a period

Predetermined Overhead Rate and Capacity

Recording Non-manufacturing Costs

Recording Cost of Goods Manufactured and Sold

Job Order Costing in Services Companies

Use of Information Technology in Job Order Costing

Advantages and Disadvantages of Job Order Costing System

Job Order Costing Discussion Questions and Answers

Job Order Costing Exercises

Case Studies

CONCLUSION

This paper concludes by giving substantiations to distinguish between process costing and job order costing and identify companies that would use each costing method, should be able to identify the documents used in job order costing system and compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

As you know the flow of costs in a job order costing system and prepare appropriate journal entries to record costs. It should be apply overhead cost to work in process (WIP) using a predetermined overhead rate, prepare a schedule of cost of goods manufactured and cost of goods sold and also prepare T-accounts to show the flow of costs in a job order costing system.

Eventually to explain the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.


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