4-1 Product and Service Costing: Overhead Application and Job-Order System Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine.

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Product and Product and Service Costing: Service Costing:

Overhead Overhead Application and Application and

Job-Order SystemJob-Order SystemPrepared by

Douglas Cloud Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Differentiate the cost accounting systems of service and manufacturing firms and of unique and standardized products.

2. Discuss the interrelationship of cost accumulation, cost measurement, and cost assignment.

3. Compute a predetermined overhead rate, and use the rate to assign overhead to production.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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4. Explain the difference between job-order and process costing, and identify the source documents used in job-order costing.

5. Describe the cost flows associated with job-order costing, and prepare the journal entries.

6. Explain why multiple overhead rates may be preferred to a single, plantwide rate.

ObjectivesObjectivesObjectivesObjectives

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Continuum of Services and Continuum of Services and Manufactured ProductsManufactured Products

Continuum of Services and Continuum of Services and Manufactured ProductsManufactured Products

PureService

Manufactured Product

Bungee jumping Beauty Salon Restaurant Automobiles Software Cereals

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Features of Service Firms and Their Interface Features of Service Firms and Their Interface with the Cost Management Systemwith the Cost Management System


FeatureImpact on Cost

Management SystemRelationship to Business

Intangibility Services cannot be stored. There are no inventory accounts.

Services cannot be protected through patents.

There is a strong ethical code.

Services cannot readily be displayed or communicated.

Prices are difficult to set. Costs must be related to entire organization.

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Management System

Inseparability Consumer is involved in production.

Cost are accounted for by customer type.

Other customers are involved in production.

Centralized mass production of services is difficult

Systems must be generated to encourage consistent quality.

Relationship to Business

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Management System

Heterogeneity Standardization and quality control are difficult.

A strong systems approach is needed.

Productivity measurement is ongoing.

TQM is critical.


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Management System

Perishability Service benefit expire quickly.

There are no inventories.

Service may be repeated often for one customer.

There needs to be a standardized system to handle repeat customers.


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Relationship of Cost Accumulation, Cost Measurement, and Cost Assignment

CostAccumulation

CostMeasurement

CostAssignment

Record Costs: Classify Costs: Assign to Cost Objects:

Product 2Product 2

Product 1Product 1Purchase materials

Direct MaterialsDirect MaterialsAssemblers’ payroll

Finishers’ payroll Direct LaborDirect Labor

OverheadOverhead

Supervisors’ Payroll

Depreciation

Utilities

Property taxes

Landscaping

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Cost AccumulationCost Accumulation

Cost accumulation refers to the recognition and recording of costs.

The cost accountant needs to develop source documents, which keep track of costs as they occur. A source document describes a transaction. Data from these source documents can then be recorded in a database. Well-designed source documents can supply information in a flexible way.

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There are two commonly used ways to measure the costs associated with production: actual costing and normal costing.

An actual cost system uses actual costs for direct materials, direct labor, and overhead to determine unit cost.

Normal costing systems measure overhead costs on a predetermined basis and use actual costs for direct materials and direct labor.

Cost MeasurementCost Measurement

Cost measurement refers to classifying the cost.

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Rubber stops are made for cellos. The cost of rubber is $0.30 per ounce and two ounces are required per stop. The price of labor is $8 per hour and it takes .10 hour to make a stop. Thus, one stop should cost $1.40 calculated as follows:

Example: Prime CostsExample: Prime Costs

$0.30 x 2 = $0.60$8.00 x .10 = 0.80

$1.40

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Actual overhead $20,000 $40,000 $40,000

Actual units produced 40,000 40,000 160,000

Per-unit overhead $0.50 $1.00 $0.25

April June August

Actual overhead/Actual overhead/Actual productionActual production

Actual overhead/Actual overhead/Actual productionActual production

Example: Using Actual OverheadExample: Using Actual Overhead

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A predetermined overhead rate is calculated using the following formula:

Overhead ApplicationOverhead ApplicationOverhead ApplicationOverhead Application

A Normal Costing View

Overhead rate =Budgeted annual overhead

Budgeted annual activity level

Continuing with the cello example:

Overhead rate =$90,000

225,000= $0.40

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1. Units produced

2. Direct labor hours

3. Direct labor dollars

4. Machine hours

5. Direct materials

Overhead ApplicationOverhead ApplicationOverhead ApplicationOverhead Application

Estimated Overhead

Activity Driver

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Data on Engine HousingData on Engine Housing

Cost of operating lathe $80,000Total units produced 20,000Total machine hours used 12,500

Simple ComplicatedSimple Complicated

Number of housings 10,000 10,000Time on lathe 0.25 MHr 1 MHrOperating cost assignedusing unit produced $4.00 $4.00

Operating cost assignedusing machine hours $1.60 $6.40

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Choosing the Activity LevelChoosing the Activity LevelChoosing the Activity LevelChoosing the Activity Level

Expected activity level is simply the production level the firm expects to attain for the coming year.

Normal activity level is the average activity usage that a firm experiences in the long term (normal volume is computed over more than one year).

Theoretical activity level is the absolute maximum production activity of a manufacturing firm.

Practical activity level is the maximum output that can be realized if everything operates efficiently.

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In attempting to understand the concept of applied overhead, there are two points that should be emphasized.

1. Applied overhead is the basis for computing per-unit overhead cost.

2. Applied overhead is rarely equal to a period’s actual overhead.

Applied overhead = Overhead rate x Applied production activity

Basic Concept of Overhead ApplicationBasic Concept of Overhead ApplicationBasic Concept of Overhead ApplicationBasic Concept of Overhead Application

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Normal


Measures of Activity LevelNumber of Units

Time

Expected

Consumer Demand-Oriented Measures of

Activity Level

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Normal


Measures of Activity LevelNumber of Units

Time

Theoretical

Productive Capability Measures of Activity Level

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Suncalc, Inc. ExampleSuncalc, Inc. ExampleSuncalc, Inc. ExampleSuncalc, Inc. Example

Suncalc, Inc. produces two unique, solar-powered products: a pocket calculator and a currency translator.

The following estimated and actual data for 2004:

Budgeted overhead $360,000Normal activity (DLH) 120,000Activity (DLH) 100,000Actual overhead $320,000

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The firm bases it predetermined overhead rate on normal activity measured in direct labor hours:

Predeterminedoverhead rate

Budgeted overhead

Normal activity=

$360,000

120,000 DLH=

$3 per DLH=

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Using the overhead rate, applied overhead for 2004 is:

Applied overhead = Overhead rate x Actual activity usage

= $3 per DLH x 100,000 DLH

= $300,000

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Forty percent of the actual direct labor hours worked were used to produce 80,000 units of the pocket

calculator and the remaining 60 percent was used to produced 90,000 units of the currency translator.

Pocket Calculators

Currency Translator

Units produced 80,000 90,000Direct labor hours 40,000 60,000Overhead applied to production ($3 x DLH) $120,000 $180,000Overhead per unit $1.50 $2.00

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The difference between actual overhead and applied overhead is called overhead variance. If actual overhead is greater than applied overhead, then the variance is called underapplied overhead. If applied overhead is greater than actual overhead, the the variance is called overapplied overhead.

Underapplied and Overapplied OverheadUnderapplied and Overapplied Overhead

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The overhead variance is disposed of in one of two ways.

1. All overhead variance is allocated to cost of goods sold.

2. The overhead variance is allocated among work in process, finished goods, and cost of goods sold.

Disposition of Overhead VariancesDisposition of Overhead Variances

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Disposition of Overhead VariancesDisposition of Overhead Variances

Suncalc’s accounts had the following applied overhead balances for the end of 2004: Work-in-

Process Inventory, $60,000; Finished Goods Inventory, $90,000; Cost of Goods Sold, $150,000.

Suncale had $20,000 of underapplied overhead. The amount is allocated as follows:

Work-in-Process Inventory: $60,000/$300,000 x $20,000 = $4,000

Finished Goods Inventory: $90,000/$300,000 x $20,000 = $6,000

Cost of Goods Sold: $150,000/$300,000 x $20,000 = $10,000

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A Job-Order Cost SheetA Job-Order Cost SheetA Job-Order Cost SheetA Job-Order Cost Sheet

Job Number 16Date Ordered April 2, 2004Date Completed April 24, 2004Date Shipped April 25, 2004

For Benson CompanyItem Description ValvesQuantity Completed 100

Direct Materials Direct Labor Overhead

Requisition Number Amount

Ticket Number Hours Rate Amount Hours Rate Amount

12 $300 68 8 $6 $ 48 8 $10 $ 8018 450 72 10 7 70 10 10 100

$750 $118 $180

Direct materials $750Direct labor 118Overhead 180

Total cost $1,048

Unit cost $10.48

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Material Requisition FormMaterial Requisition FormMaterial Requisition FormMaterial Requisition Form

Date

DepartmentJob Number

Authorized Signature

Description Quantity Cost/Unit Total Cost

Jim Lawson

Casing 100 $3 $300

Material Requisition Number 678April 8, 2004

62

Grinding

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Job Time TicketJob Time TicketJob Time TicketJob Time Ticket

Authorized Signature

Start Time Stop Time Total Time Hourly Rate Amount Job Number

Jim Lawson

Job Time Ticket

Number 68Employee Number

Name

Date

8:00 10:00 2 $6 $12 1610:00 11:00 1 6 6 1711:00 12:00 1 6 6 161:00 6:00 5 6 30 16

45

Ann Wilson

April 12, 2004

Department Supervisor

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Accounting for Overhead

Actual overhead costs are never assigned directly to jobs.

Overhead is applied using a predetermined overhead rate.

Actual overhead costs are never assigned directly to jobs.

Overhead is applied using a predetermined overhead rate.

Estimated OverheadOverhead rate =

Estimated Direct Labor Hours

$900,000

90,000 DLH

= $10 per direct labor hour

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1. Direct materials costing $2,500 were purchased on account.

The receiving report and the invoice are used to record the receipt of the

merchandise and to control the payment.

1 Materials Inventory 2 500 00

All Signs CompanyAll Signs CompanyAll Signs CompanyAll Signs Company

Accounts Payable 2 500 00

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2. Direct materials costing $1,500 were requisitioned for use in production.



2 Work in Process 1 500 00

Materials Inventory 1 500 00

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Job 101Materials

Req. No. Amount

1$ 300

2200

3 500

$1,000

Job 102Materials

Req. No. Amount

4$250

5250

3

$500

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3. Direct labor costing $850 was recognized.



3 Work-in-Process Inventory 850 00

Wages Payable 850 00

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Job 101Materials

Ticket Hours Rate Amount

1 15 $10 $1502 20 10 2003 25 10 250

60 $600

Job 102Materials

Ticket Hours Rate Amount

4 15 $10 $1505 10 10 100

25 $250

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4. Overhead was applied to production at the rate of $4 per direct labor hour. A total of 85 direct labor hours were worked.



4 Work-in-Process Inventory 340 00


Overhead Control 340 00

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5. Actual overhead costs of $415 were incurred: lease, $200; utilities, $50; depreciation, $100; accrued wages, $65.



5 Overhead Control 415 00

Lease Payable200 00

Utilities Payable50 00

Accumulated Depr.--Equipment100 00

Wages Payable65 00


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6. Job 101, with a total cost of $1,840, are completed and transferred to finished goods.



6 Finished Goods Inventory 1 840 00

Work-in-Process Inventory 1 840 00

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Job Number 101Date Ordered Jan. 1, 2004Date Completed Jan. 2, 2004Date Shipped Jan. 15, 2004

For Housing DevelopmentItem Description Street SignsQuantity Completed 20

Materials Direct Labor Overhead

Requisition Number Amount

Ticket Number Hours Rate Amount Hours Rate Amount

1 $300 1 15 $10 $150 15 $4 $ 602 200 2 20 10 200 20 4 803 500 3 25 10 250 25 4 100

$1,000 $600 $240

Direct materials $1,000Direct labor $600Overhead $240

Total cost $1,840

Unit cost $92


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7. Sold Job 101 for $2,760.



a. Cost of Goods Sold 1 840 00

b. Accounts Receivable 2 760 00


Finished Goods Inventory 1 840 00

Sales Revenue 2 760 00

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8. Underapplied overhead was closed to cost of goods sold.



8 Cost of Goods Sold 75 00


Overhead Control 75 00

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All Signs CompanyAll Signs CompanySchedule of Cost of Goods ManufacturedSchedule of Cost of Goods ManufacturedFor the Month Ended January 31, 2004For the Month Ended January 31, 2004

Direct materials:Beginning direct materials inventory $ 0Purchases of direct materials 2,500Total direct materials available for use $2,500Ending direct materials 1,000Total direct materials used $1,500

Direct labor 850Manufacturing Overhead:

Lease $ 200Utilities 50Depreciation 100Indirect labor 65

$ 415ContinuedContinuedContinuedContinued

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$ 415Less: Underapplied overhead 75Overhead applied 340

Current manufacturing costs $2,690Add: Beginning work in process 0Total manufacturing cost $2,690Less: Ending work in process -1,050Cost of goods manufactured $1,840

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Beginning finished goods inventory $ 0

Cost of goods manufactured 1,840

Cost of goods available for sale $1,840

Less: Ending finished goods inventory 0

Normal cost of goods sold $1,840

Add: Underapplied overhead 75

Adjusted cost of goods sold $1,915

All Signs CompanyAll Signs CompanyStatement of Cost of Goods SoldStatement of Cost of Goods Sold

For the Month Ended January 31, 2004For the Month Ended January 31, 2004

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All Signs CompanyAll Signs CompanyIncome StatementIncome Statement

For the Month Ended January 31, 2004For the Month Ended January 31, 2004Sales $2,760Less: Cost of goods sold 1,915Gross margin $ 845Less selling and administrative expenses:

Selling expenses $200Administrative expenses 550 750

Operating income $ 95

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SINGLE VERSUS MULTIPLE OVERHEAD RATES


Department A is labor-intensive and Department B is machine-intensive.

Department A Department B TotalDepartment A Department B Total

Overhead costs $60,000 $180,000 $240,000Direct labor hours 15,000 5,000 20,000Machine hours 5,000 15,00 20,000

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Prime costs $5,000 $0 $5,000Direct labor hours 500 0 500Machine hour 1 0 1Units produced 1,000 0 1,000

Job 23Job 23


Prime costs $0 $5,000 $5,000Direct labor hours 0 1 1Machine hours 0 500 500Units produced 0 1,000 1,000

Job 24Job 24

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Department A Department BOverhead cost $60,000 $180,000Cost driver 15,000 DLH 15,000 MHrDepartment overhead rate $4/DLH $12/MHrOverhead applied to Job #23 $2,000 ---Overhead applied to Job #24 --- $6,000

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ChapteChapterr

End ofEnd of

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4-1 Product and Service Costing: Overhead Application and Job-Order System Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine.

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