Topic Job Order 3 Costing - Open University Malaysiaoumvle.oum.edu.my/oumvle_upload/blockmain/BBAP2103... · operations namely job order costing system and process costing system.

� INTRODUCTION

Previously, the concepts and types of costs have been explained. As a continuation, this third topic discusses how costs connected with production of products or services are grouped and allocated. The process known as product costing is an important task in management accounting as it can determine the cost of a product or service. The main purpose of product or service costing is to group all costs involved in a production process and then allocate them to the final product. Product costing is relevant for all types of businesses, whether they offer services or goods, and it is necessary for all types of organisations, whether they are profit-motivated or not. There are two main types of product costing systems for manufacturing operations namely job order costing system and process costing system. The discussions in this topic will focus on a product costing system, in particular, the

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� Job Order Costing

LEARNING OUTCOMES By the end of this topic, you should be able to:

1. Define product costing;

2. Explain the meaning, purpose and features of job order costing;

3. Describe the use of documents as well as document flow in job ordercosting;

4. Summarise production activity flow as well as accounting activityflow;

5. Relate manufacturing cost flow in job order costing; and

6. Report the use of materials, labour and factory overhead.

TOPIC 3 JOB ORDER COSTING �

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job order costing system for manufacturing operations. The next topic will then explain the process costing system.

FOREWORD

Product cost information is required for various purposes. Among them are for planning, budget preparation, cost control and supply of information for the decision making process such as pricing, determination of product mix and quantity that has to be produced, as well as the performance evaluation of employees. Besides that, from the accounting and financial reporting aspects, product cost information is required to evaluate the inventory in the balance sheet, calculate the cost of goods sold in the income statement and supply information for the purpose of taxation, contract pricing, insurance claims and many more. Product costing is not only limited to manufacturing firms. It is required in all types of organisations whether they are profit-oriented or not and whether they are involved in producing goods or providing services. The role and use of product cost in a commercial firm is the same as that in a manufacturing firm, whereby the product cost can be inventoried and thus converted into cost of goods sold immediately upon sale of the product. In the case of a service firm, however, service cost cannot be inventoried because of the nature of services, which cannot be kept or sold later as can be done for products or goods. Even so, service firms such as banks, post offices, hospitals and municipal councils still require cost information for the purpose of planning, cost controlling and decision making.

3.1

SELF-CHECK 3.1

Give two examples of organisations; one example of a service organisation and one of a commercial or manufacturing firm, and discuss the use of product or service cost for the organisations concerned.

� TOPIC 3 JOB ORDER COSTING

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PRODUCT COSTING

What does product costing mean?

Based on the grouping of cost information, both total cost and cost per unit of each product can be determined. The accuracy of cost information is extremely critical to the companyÊs success, where it can make a huge impact on the net income reported. This information is also essential to assist in making important decisions, especially in determining which product to produce, as well as the quantity and the price of the product. A product costing system contains several accounts for recording various types of manufacturing costs, namely, direct material cost, direct labour cost and manufacturing overhead cost. The cost flow across manufacturing accounts can be simplified such as in Figure 3.1. All these accounts are integrated into the companyÊs general ledger. One of the important features of product costing is the use of perpetual inventory system, where cost information can be updated instantly. In general, there are two types of product costing systems that are used widely in manufacturing operations, namely, job order costing and process costing. The choice of a suitable product costing system depends on the type of industry and manufacturing process, and it is possible that manufacturers use both at the same time.

Product costing is a process that involves the measuring, recording and reporting of product cost.

3.2


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Figure 3.1: Flow of cost through manufacturing accounts


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JOB ORDER COSTING

What is the role of job order costing?

For this system, the costs of direct material, direct labour and manufacturing overhead need to be allocated to each job or product. A control account for the perpetual inventory and subsidiary ledger is required for raw material, work in process and finished goods inventory. Each inventory account has to be debited for any addition and credited for any reduction so that the balance in each account reflects the balance at hand. Job order costing is suitable for use in production that involves different products, produced for each period and for products that are on special order from customers.

Example 3.1

A printing company is printing wedding invitation cards or name cards with different designs, according to the orders and needs of the customers. For a print order of the wedding cards, it may need 500 pieces of standard size, scented paper. The order for the 500 cards is known as a job.

According to the job order costing system, cost will be identified, grouped and allocated to the jobs. Then, the grouped costs for one job will be divided into the number of units contained in the job so as to obtain the cost per unit, by averaging.

Example 3.2

The situation is the same in a tailoring shop where the tailor produces various types of shirts and uniforms at any one time. Other examples in which is suitable to use job order costing are: a construction project involving the building of housing estates, shop-houses or office buildings; the catering service provided by MAS Catering for various international airline systems and the production of teak-wood furniture.

3.3

A job order costing system prepares separate records of cost information for each product quantity (known as a job) that passes through the production process.


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Job order costing can also be applied to service firms. Architecture firms, accounting firms, law firms, hospitals and advertising firms are examples of organisations that can use job order costing to determine the cost for each job carried out for the purpose of recording and billing. Each job has its own features, hence, its own cost. The use of job order costing allows service firms to group all relevant costs to the job or service concerned in the same way as it is done by a manufacturing firm, by applying the same basic concept and procedures. From the angle of cost recording and cost allocation, the tasks become more challenging and difficult when the company sells many different types of products, as compared to the production of one product or service only. Consequently, cost records need to be kept separately for each product or job. An architect is sure to keep consultancy service records and house plan production costs separately for each client. This means that the job order costing will require more effort and energy with regard to record keeping, compared to process costing system.

USE OF DOCUMENTS IN JOB ORDER COSTING SYSTEM

Before discussing this subtopic further, let us look back briefly on the subject of manufacturing cost. Based on the previous topic, manufacturing cost is classified into three main categories namely direct materials, direct labour and manufacturing overhead. In the discussion of job order costing, you will see how each cost category is recorded and grouped. In job order costing, the costs for direct material, direct labour and manufacturing overhead are allocated to each job done. All these costs constitute the input for the product costing system. As soon as the cost is involved, it is added into the work in process inventory account in the ledger. In order to track the manufacturing cost allocated to each job, the subsidiary ledger has to be updated. The subsidiary ledger account that is allocated to each job constitutes a document that is known as a job cost sheet.

3.4

ACTIVITY 3.1

Besides the examples mentioned above, give another example and explain briefly how job order costing is applied.


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3.4.1 Job Cost Sheet

As soon as a production order is issued, the accounts department prepares a job cost sheet. The job cost sheet is prepared separately for each job. An example of this is shown in the following Figure 3.2.

Figure 3.2: Job cost sheet

SELF-CHECK 3.2

What are the important documents that can assist in the grouping of information in the job order costing system?


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In a job cost sheet, three sections are used to group the costs of direct material, direct labour and manufacturing overhead. Two more sections are used to record the total cost and the average cost per unit and to trace the units delivered to the customer. Besides being considered as a medium to charge or assign cost to a job, the job cost sheet also acts as a subsidiary ledger where it contains details of the work in process that will increase the balance in the work in process inventory account.

3.4.2 Material Acquisition Form

When raw materials are required for a production process, they will be transferred from the warehouse or storeroom to the production department. In order to allow the raw materials to be taken out, the supervisor of the production department has to fill in the material acquisition form initialled by an authorised officer to be shown to the store supervisor. The following Figure 3.3 is an example of a material acquisition form.

Figure 3.3: Material acquisition form

This form contains detailed information on the type, price and quantity of material that is to be taken out of the storeroom. It identifies which job will be charged for the use of the material. This form constitutes a resource document that forms the basis of an account entry and also acts as a way of controlling the flow of raw materials into the production operation. A copy of the form is sent to the accounting department, where the cost of the material acquired is transferred from the raw materials account to the work in process account, and also to enable


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the direct material cost information to be entered into the job cost sheet for the product or job that is being processed. In this technological age, most factories use a computer system to process production. Each department is linked online to the system. Such a system quickens the costing process, reduces the use of paper and minimises clerical errors. With this system, the material acquisition form is prepared through a computer terminal by the supervisor in the production department, and then the form is automatically sent to the terminals at the warehouse and accounting department. For a more complex production operation where production is done in stages, it is more suitable to use an operation management system or method called mmaterial-requisitions planning (MRP). This computerised system helps the manager in scheduling the production of each stage by ensuring that each material, component or partially-finished material needed is always available for the next production stage.

3.4.3 Time Ticket

What does time ticket mean?

This form or ticket is filled by the employee to record the total time that is allocated to do various production jobs. Let us refer to the example of a time ticket in the following Figure 3.4.

Figure 3.4: Time ticket

A ttime ticket is a resource document that is used to record the hours of direct labour used for a job.


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The time taken for each job is multiplied by the employeeÊs wage rate and the direct labour cost is recorded in the work in process account and job-cost sheet by the accounting department. This employee also did an hour of cleaning work in the factory. The accounting department will record this time as indirect labour, where the cost for this one hour is reported as manufacturing overhead. There are many factories that depend on a time-clock system or computerised time recording system, where the employee enters the starting and ending time of each job into the system using a barcode. The system is connected to a computer that sends the time record information from the database online to the accounting department for recording purposes.

Figure 3.5: Document flow


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APPLICATION OF MANUFACTURING OVERHEAD COST

What is the purpose of costing and in your opinion, why is it important to a company? Among the three manufacturing costs, overhead cost is the most difficult cost to allocate. This is because overhead cost is indirect cost, as it does not have a clear or direct relationship with the job or product unit. Therefore, it is relatively difficult to detect and trace the overhead cost to the job or product. Among other reasons, manufacturing overhead consists of various types of items from small ones like the costs of brooms and machine lubricating oil to large ones like the salaries of the managers in the production department. Thus, it is difficult to allocate various overhead costs to a specific product. As overhead cost has to be incurred in order for production to be carried out, it becomes part of the product cost. Thus, it is necessary to allocate manufacturing overhead cost to the job in order to get a complete picture of the product cost. In reference to the problem of allocation described above, one of the ways to allocate overhead to the product is to use the allocation process.

To carry out this process, a suitable allocation base has to be chosen. The allocation base is a measurement in the form of an activity such as direct labour hours or machine hours. It is used as a base to allocate overhead to the product.

The process of allocating cost to job or product is known as aapplication of overhead cost.

3.5

EXERCISE 3.1

1. What is the function of the job cost sheet in job order costing?

2. Explain how the sales order, production order, material acquisition form and labour time ticket are involved in the production process and production costing.


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This allocation base is used to calculate the predetermined overhead rate in the following formula:

Estimated Total Manufacturing Overhead Cost =

Estimated Total Activity or Allocation BasePredetermined Overhead Rate

Please note that the predetermined overhead rate is based on an estimate and not on actual figures. This is because the predetermined rate is calculated before the period concerned starts. In actual fact, the company can also calculate the overhead rate based on actual information. Suppose that the company waits till the end of the accounting period so that the actual overhead cost and the total allocation base, for example, the direct labour hours that have been used through the period concerned, can be identified. The rate obtained is sure to be accurate but the information may be less useful because it is not prepared on a timely basis. In other words, the manager has to wait until the end of the period before he/she gets the actual information, whereas the product cost information is required at the early stage for the purpose of planning, control and decision making on matters such as pricing and so on. The company is also forced to calculate the actual overhead rate more frequent because it depends on different period of job completion. This will cause the actual overhead rate to fluctuate. For these reasons, most companies prefer to use the predetermined overhead rate compared to the actual overhead rate. The predetermined overhead rate is used to allocate overhead cost to a job. This allocated overhead cost is known as aabsorbed overhead. It is shown in the formula below:

Absorbed Overhead

= PredeterminedOverhead Rate �

Total Activity or Allocation Base Involved in the Job


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Example 3.3

Suppose a company estimates the total manufacturing overhead cost for the following year at RM240,000 and total direct labour hours of 44,000. The job cost sheet for Job J002 shows the use of direct labour totalling 1,500 hours. The predetermined overhead rate and total overhead cost allocated to Job J002 are calculated as follows:

Predetermined Overhead RateTotal Overhead Cost RM240, 000

= = Direct Labour Hours 44, 000

= RM5.45 per hour

Absorbed Overhead = Predetermined Rate �Direct Labour Hours Used in J002 = RM5.45 � 1,500 hours = RM8,175

The overhead cost absorbed by Job J002 is RM8,175 and will be reported into the work in process account and job cost sheet.

FLOW OF ACTIVITY AND COST IN JOB ORDER COSTING SYSTEM

After understanding the use of documents and job order costing, let us now look at an illustration of how production costs for a job are recorded and reported when the job costing system is used. Let us refer to the summary of production and accounting activities for a job order costing system as shown in the following Figure 3.6.

3.6

EXERCISE 3.2

1. What is predetermined overhead rate, and how is it calculated?

2. Which account is credited when overhead is absorbed into work in process? Do you think the absorbed overhead amount will equal the actual overhead amount involved? Substantiate your answer.


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Figure 3.6: Summary of the production and accounting activities flow chart for a job order costing system


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To understand further, let us study a monthÊs production process in a company that specialises in making uniforms. For example, Professional Attire Sdn. Bhd. has two jobs for the month of November.

(a) Job O157 is the production of 822 uniforms for factory workers. It started in the month of October and has an accumulated a manufacturing cost of RM12,000 up to 1st November. This job is expected to be completed at the end of November.

(b) Job N158 is an order for 150 uniforms for security personnel. The job started in the month of November. This job is expected to be completed in the following month.

Next, the production activities throughout November will be explained together with the relevant journal entries.

3.6.1 Purchase and Use of Materials

On 1 November, the companyÊs material inventory balance was RM5,000. For that month, two hundred rolls of plain blue cloth, five rolls of plain green cloth, and tailoring materials such as thread, buttons, zips etc were bought on credit at the price of RM23,000. The purchase of these raw material was recorded in the journal entries as:

(1) Materials��23,000 Account Payable�� 23,000

The raw materials that are still unused are considered as assets to the company, thus they are recorded in the inventory account, not in the expense account. (a) Acquisition of Direct and Indirect Materials

Throughout November, RM17,000 worth of direct material and RM2,500 worth of indirect material were acquired from the store for production. The following are the journal entries for the transfer of materials to the production department:

(2) Work in Process�� 17,000 Manufacturing Overhead��.�... 2,500 Material��.�� 19,500

The raw material used should be recorded in the work in process account. When the direct material cost is entered into the work in process, then it is


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also recorded in the job cost sheet concerned. The entry is illustrated in the following Figure 3.7, where RM5,000 from the RM17,000 of raw material is recorded in the N158 job cost sheet, and the balance into the O157 job cost sheet. The material totalling RM2,500 that is shown in the previous journal entries is recorded in the manufacturing overhead account because it comprises indirect materials that are used for production of the month.

(Note: The acquisition form and job cost sheet have been simplified)

Figure 3.7: Material cost flow

Please note again that in Figure 3.7, job cost sheet O157 has an opening balance of RM12,000, that is the accumulated manufacturing costs involved for the month of October which are carried forward to November. With the assumption that no other job was carried forward from October other than Job O157, the work in process account also shows the same opening balance. In other words, the work in process account will show the total balance of all costs in the job cost sheets that are in process at any point in time. This is because the work in process account acts as a control account and the job cost sheet acts as a subsidiary ledger.


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(b) Acquisition of Direct Materials Only In the previous Figure 3.7, the raw materials acquired are for both direct and indirect material usage. Sometimes only direct raw materials are required; thus, the acquisition will be entered as follows:

Work in Process�� xxx Material�� xxx

The following Figure 3.8 shows you the labour cost flow.

Figure 3.8: Labour cost flow


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3.6.2 Use of Labour

The accounting department will use time tickets to calculate labour cost according to the payment rate of wages and salaries of the employees. The relevant labour cost is then classified as direct labour or indirect labour. Direct labour is recorded in the work in process account while indirect labour is entered into the manufacturing overhead account. Based on Figure 3.8, the company has incurred a total of RM24,024 for labour cost for the month of November. An amount of RM3,204 of total labour cost is indirect labour cost. The balance of RM13,500 (1,125 hours x RM12 per hour) is direct labour cost charged to Job O157, and the balance of RM7,320 (610 hours x RM12 per hour) is for Job N158. The journal entries to record the labour cost are as follows:

(3) Work in Process�� 20,820 Manufacturing Overhead��.�... 3,204

Wages and Salaries Payable �� 24,024

When direct labour cost is recorded in the work in process account, it is simultaneously recorded in both job-cost sheets. The labour cost classified in manufacturing overhead is indirect labour cost, such as the costs of supervision, security and general repair and maintenance in the factory area. This indirect labour cost is not included in the job cost sheet because it cannot be traced to any job.

3.6.3 Use of Factory Overhead

Take note that all other costs except for costs of direct material and direct labour are included in the manufacturing overhead cost. The actual costs are recorded directly, that is, they are debited into the manufacturing overhead account the moment they are incurred. The summary of the actual overhead and absorbed overhead costs are shown in the following Figure 3.9.


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Figure 3.9: Manufacturing overhead cost flow

(a) Recording Actual Overhead Cost

For example, suppose that the company has incurred the following costs for the month of November:

RM Utilities (Water and Electricity)��. 4,500 Rental of Factory Equipment��. 15,000 General Maintenance Costs�� 3,000 Total�� 22,500


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The following are the journal entries of the costs incurred above:

(4) Manufacturing Overhead��... 22,500 Accounts Payable �� 22,500

Besides this, suppose that the company also declares the amount of depreciation on the factory equipment as RM4,400, and RM1,200 of its prepaid insurance has expired for the month of November, and the amount of accrued taxes on the factory equipment is RM1,800. In order to record the costs above, the following entries are required.

(5) Manufacturing Overhead��... 7,400 Accumulated Depreciation�� ..4,400 Prepaid Insurance ��..�� .. 1,200 Tax Payable ��..�� ..1,800

The manufacturing overhead account is a control account and it is closely connected to many subsidiary accounts such as utilities, prepayments and many other accounts payable. (b) RRecording Absorbed Overhead Cost

The overhead cost is recorded in the work in process account using the predetermined overhead rate that is calculated at the beginning of the year as discussed in the earlier subtopic. The predetermined overhead rate is calculated by dividing the total estimated overhead cost for the year concerned with the estimated total units or activity that is taken as the allocation base (can be based on machine hour, direct labour hour etc.)


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Example 3.4

Suppose that Syarikat Professional Attire estimates that it requires an amount of RM752,000 for manufacturing overhead cost, and 40,000 direct labour hours for the current year production. By referring to the previous Figures 3.8 and 3.9, we find that 1,125 direct labour hours are used for Job O157 and 610 direct labour hours for Job N158. The total is 1,735 hours. The calculation of the predetermined overhead rate and total absorbed overhead for Jobs O157 and N158 is as follows:

Estimated Total Overhead Cost RM752, 000 = =

Direct Labour Hours 40, 000 Direct Labour hours Predetermined Overhead Rate

= RM18.80 per direct labour hour Overhead absorbed by O157 = RM18.80 x 1,125 direct labour hours = RM21,150 Overhead absorbed by N158 = RM18.80 x 610 direct labour hours = RM11,468

Therefore, the total overhead cost that is absorbed is RM32,618 (1,735 direct labour hours x RM18.80 per hour). This will be applied or charged to the Work in Process Account. The journal entry to record the absorbed overhead cost to the Work In Process is:

(6) Work in Process ��32,618 Manufacturing Overhead ��.�� 32,618

ACTIVITY 3.2

If the actual overhead cost incurred is debited directly to the manufacturing overhead account, how then is the overhead cost charged to the work in process account?


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3.6.4 Problem of Over and Under Absorption of Overhead

The actual overhead cost incurred for a period and the absorbed overhead cost (using predetermined overhead rate) are usually different. In general, this may be caused by the inaccuracy of the estimation used to calculate the predetermined overhead rate, or by the inappropriate activity level or allocation base used. As a corrective step, the company can recheck the predetermined overhead rate applied. The manufacturing overhead account can have a debit or a credit balance.

When the overhead is over-absorbed, the manufacturing overhead cost is overstated, and thus the value of the inventory and/or expenses has to be reduced (adjusted downwards).

This means that the manufacturing overhead cost is understated, and the inventory and/or the expenses need to be increased (adjusted upwards). If we look at the above example, and with reference to the previous Figure 3.8, we find that the manufacturing overhead account of the company has a debit balance, that is, an actual amount that exceeds the absorbed amount by RM2,986. The overhead account balance is carried forward from the current month to the following month. Next paragraph, however, when moving to the next accounting period or financial year, this account balance will be eliminated. One way of eliminating or adjusting this account balance (regardless of whether it is a debit or credit balance) is to transfer it to the cost of goods sold account. For example, suppose the company transfers the balance from the overhead account to the cost of goods sold account.

On the other hand, if the actual overhead exceeds the absorbed overhead, the overhead account will show a debit balance known as an uunder-absorbed overhead.

If the absorbed overhead exceeds the actual overhead incurred, then the manufacturing overhead account will have a credit balance. This credit balance is known as oover-absorbed overhead.


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(7) Costs of Goods Sold ��. 2,986 Manufacturing Overhead ��2,986

With the above entries, the overhead cost that is understated is added or charged to the cost of goods sold for the current period. Another method of eliminating the account balance is to transfer it to the work in process, finished goods inventory and cost of goods sold, using weighted average based on the balance of the accounts.

3.6.5 Cost of Goods Manufactured

All the costs incurred during production are debited to the work in process account. Further details of the costs incurred for each job are as shown in the job cost sheet in the previous Figure 3.2. When a job is completed, the finished goods are transferred from the production department to the finished goods store. The physical transfer of finished goods must be accompanied by the transfer of the production cost from the work in process account to the finished goods account. The total cost transferred represents the cost of goods manufactured for the period concerned. Let us refer back to Figure 3.8 (Syarikat Professional Attire). A total of RM17,000 of direct material, RM20,820 of direct labour and RM32,618 of manufacturing overhead costs absorbed are recorded in the work in process account. The same illustration shows that Job O157 was started in October and completed in November. The balance of the accumulated manufacturing costs for Job O157 amounting to RM12,000 constitutes the cost that was carried forward from October. Job N158 was started in November but overhead was estimated to complete in December. Thus, the accumulated manufacturing overhead cost of RM23,788 for Job N158 that was not completed remains in the work in process account and this balance is carried forward to the next month. This amount is also reported in the balance sheet on 30 September, if it is prepared, as an item of work in process inventory.

SELF-CHECK 3.3

Why do over-absorbed and under-absorbed overhead occur?


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Calculation of Cost Per Unit The final step in the job cost sheet is to calculate the cost per unit. The total costs of direct raw material, direct labour and manufacturing overhead will be entered into the cost summary section of the job cost sheet. The cost per unit can then be calculated by dividing the total cost with the finished units. The cost per unit cannot be calculated if the job is not completed. The previous Figure 3.8 shows all the costs of direct materials, direct labour and manufacturing overhead of Job O157 that are completed are totalled and divided by 822 uniforms in order to get the cost per unit, that is RM71.35 (RM58,650/822). We need to remember that the cost per unit obtained is an average cost, and this amount of cost will not necessarily be incurred if we need to produce one more unit. Most overhead costs will not change at all if one more unit is produced. Thus, the incremental cost for producing one more unit is less than the average cost per unit mentioned. The completed job cost sheet will be transferred to the finished goods and then it will be taken out of the cost ledger and kept for future reference. For Figure 3.9, the transfer to the finished goods account is made with the following entries.

(8) Finished Goods ��58,650 Work in Process ��.��58,650

The amount of RM58,650 is the cost for the completed Job O157. It is shown in the job cost sheet in Figure 3.10.


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Figure 3.10: Manufacturing cost flow for Professional Attire Sdn. Bhd.

3.6.6 Cost of Goods Sold

When the finished goods are delivered or sold to customers, the cost per unit entered in the job cost sheet is used as the base for transferring the cost for goods sold mentioned from the finished goods account to the cost of goods sold account. If the job is on special order from a customer, then this is easier to do because the cost of the job can be totally transferred to the cost of goods sold account. Let us refer back to Figure 3.9. Suppose that only 400 pieces of uniform (Job O157) were delivered to the customer at the end of the November with a sales revenue of RM40,000. Therefore, only the cost for the 400 pieces, which is RM28,540 (RM71.35 � 400 pieces), will be transferred to the cost of goods sold with the following entries:


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(9) Account Receivable ��40,000 Sales��..��.��..40,000

(10) Cost of Goods Sold ��28,540 Finished Goods ��..��28,540

With the entries in (10), the manufacturing cost flow using the job order costing system is completed. The summary of the given cost flow is as shown in the previous Figure 3.10.

3.6.7 Reporting in Financial Statement

At the end of the period when the company financial statement is prepared, the cost of goods sold is reported in the financial statement where it is deducted from the sales revenue to obtain the gross profit. Let us refer back to Figure 3.9, where the balance sheet and the income statement are shown (assuming that the company has prepared a financial statement at the end of November). The cost of the job not yet completed (Job N158 � with accumulated cost of RM23,788) is kept in the work in process account. The balance for this account will be reported in the balance sheet as an item in the work in process inventory. The inventory for the raw materials not yet taken out for production will also be reported as inventory in the balance sheet. Similarly, the inventory of finished goods (Job O157 � with a total cost of RM30,110) that are not sold or not yet delivered to customers will be reported in the balance sheet. In short, the company will have three types of inventories reported in the balance sheet.


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EXERCISE 3.3

1. What do you understand by under-absorbed overhead and over-absorbed overhead? How are these amounts eliminated or adjusted at the end of the accounting period?

2. What will happen to the overhead rate that is based on direct labour hours if the direct labour force is replaced by an automated equipment system?

3. Why do some companies use various types of overhead rates instead of just one rate?

4. Indah Arkitek uses job-order costing to trace the costs of each bungalow-building project that it receives. The company offers house-plan drafting and consultancy services to customers. The table below is a report of the information on three projects of plan drafting for bungalows that are in process for the month of October.

Project

Siti Tan Samy

Draftsperson hours 84 70 63

Direct materials RM3,200 RM2,600 RM1,100

Direct labour RM6,700 RM5,500 RM5,000

The actual overhead cost for October is RM21,000. The overhead cost absorbed to the projects based on draftsperson hours is caused by most of the overhead being connected with the costs of equipment and the drafting office. The predetermined overhead rate is RM120 for one draftsperson hour. The projects under Siti and Tan were completed in October, while the project under Samy is still not complete at the end of October.

You are required to:

(a) Calculate the amount of overhead cost that should be charged to each project for October.


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JOB ORDER COSTING FOR SERVICE FIRMS

As was mentioned earlier, job order costing is not limited to manufacturing only. For a service firm, such as an architecture firm, each project received from a client constitutes a job. The service cost or fee will be grouped until the job or project is completed. Basic documents used represent direct materials. The time taken for drafting plans and consultation constitute direct labour costs, and the costs of clerical work, indirect materials, depreciation of equipment, rent and others are all grouped as overhead costs. For a dental clinic, each patient that comes in for dental treatment constitutes a job. For a set of dentures, the cost of direct materials is the cost of the dentures. The cost of direct labour consists of the time and expertise of the dentist for making the dentures and giving treatment to the patient. The overhead cost includes rent, depreciation of equipment, utilities, medication and etc.

3.7

(b) Prepare the journal entries to record the completion process of the projects under Siti and Tan, and to transfer the costs to the completed project account (or finished goods account).

(c) To calculate the balance in the work in process account at the end of the month concerned.

(d) To calculate the balance in the overhead account at the end of the month concerned and explain the meaning of this balance.

5. Seri Impiana Sdn Bhd uses job order costing and applies predetermined overhead rates based on direct labour hours. Last year, the estimates for manufacturing overhead and direct labour hours were RM85,000 and 17,000 hours respectively for the year. In the month of March, Job B525 was completed. The cost of materials for this job totalled RM5,200 and cost of labour was RM2,202 at the rate of RM6 per hour. At the end of the year, the records showed that the company had used 14,400 direct labour hours and incurred RM68,200 of actual manufacturing overhead costs.

You are required to:

(a) Determine the cost per unit that will be shown in the job cost sheet (Job B525 produced 120 units.)

(b) Determine the amount of overhead over-absorbed or under-absorbed for the year.


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In short, job order costing can be used in any company that offers various types of products or services. The following Figure 3.11 illustrates the cost flow for a service firm.

Figure 3.11: Cost flow for a service firm

� Product costing involves the measuring, recording and reporting of product cost.

� A job order costing system is a system that prepares separate records of cost information for each product quantity (known as a job) that passes through the production process. It is important in determining the cost of a product or service and widely used by organisations that offer various types of products and services.

� In job order costing, the costs of direct materials and direct labour are charged for each job by using a materials acquisition form and a time ticket respectively.

� The manufacturing overhead cost is allocated to the job by using a predetermined overhead rate.


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� There is a possibility of having the overhead over-absorbed or under-absorbed. This occurs when there is a difference in the actual overhead and the absorbed overhead.

� The balance in the manufacturing overhead account that shows the overhead as over-absorbed or under-absorbed will be adjusted (the cost increased or decreased) by transferring this account balance to the cost of goods sold account.

� Through the job order costing system, the costs of direct materials, direct labour and manufacturing overhead to carry out the job will be grouped into the work in process account as the control account, and these costs will also be recorded in the respective job-cost sheets that act as subsidiary ledgers.

� The cost for the completed job will be transferred from the work in process account to the finished goods account. The amount transferred constitutes the cost of goods manufactured for the period concerned.

� Once the goods or products are sold to the customer, the cost of the products concerned is transferred from the finished goods account to the cost of goods sold account.

� The cost of goods sold is calculated using the cost per unit that is obtained from the job-cost sheet concerned.

� At the end of the financial period, the cost of jobs not yet completed remains in the work in process account that will be reported in the balance sheet together with raw materials inventory account and the finished goods inventory account.

� For a job that is completed and sold, the cost of the goods will be reported in the income statement as the cost of goods sold. This is deducted from the sales revenue to get the gross profit.


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Absorbed overhead

Balance sheet

Cost summary

Finished good account

Job cost sheet

Job cost sheet

Job order costing system

Ledger

Material acquisition form

Material-requisitions planning (MPR)

Over-absorbed overhead

Predetermined overhead rate

Profit-oriented

Subsidiary ledger

Time ticket

Under-absorbed overhead

Work in process account

Work in process inventory

Topic Job Order 3 Costing - Open University Malaysiaoumvle.oum.edu.my/oumvle_upload/blockmain/BBAP2103... · operations namely job order costing system and process costing system.

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