Different Kinds of Production Environments and Cost Flow in Job Costing

1. Chapter 14 Job Costing

2. Kinds of Production Environments LO1: Describe the different kinds of production environments

3. Job shops and Job costing Customized products in small lots Shipyards, custom-built houses High traceability of many costs Overhead is an exception With small batches and make-to-stock The batch is the unit of analysis Has distinct job number All units move as one through the production process Job is either complete or not Cost therefore either in COGM or in WIP Production Environments LO1: Describe the different kinds of production environments

4. Process shops and process costing Similar products in large lots Chemicals, fertilizer Limited traceability of costs to individual units Units in the same batch might be at different levels of completion Need to allocate costs between COGM and WIP Operations costing Aspects of both job and process costing Garment manufacturing Production Environments LO1: Describe the different kinds of production environments

5. Test Your Knowledge! The most logical business which would use job order costing would be: • an oil refinery. • a paper company. • a custom-home builder. • a car dealership. A maker of custom ordered items would most likely use job order costing.

6. Cost Flows Through Accounts LO2: Explain the flow of costs in a job shop

7. Regardless of environment, flow of costs through the inventory accounts is similar Job shops Individual job is the “unit of analysis” Can trace materials and labor to individual job Have to allocate overhead Account balances are sum of costs if individual jobs Cost Flows Beginning WIP = Value of jobs unfinished at start of accounting period Ending WIP = Value of jobs unfinished at end of accounting period COGM = Value of jobs completed during the accounting period LO2: Explain the flow of costs in a job shop

8. Test Your Knowledge! In a job-order costing system, direct labor costs are shown as an increase to what account? • Finished goods inventory. • Work-in-process inventory. • Cost of goods manufactured. • Raw materials inventory. Direct labor costs increase work-in-process inventory.

9. Cost Flows in a Job Shop: Magna LO2: Explain the flow of costs in a job shop

10. Inventory Accounts (12/1): Magna

11. Materials flow through the inventory accounts Might separate accounts by kind of material For direct materials, keep track of which job materials were issued to Examples: Components For indirect materials, put into overhead control account Examples: Supplies Analyzing Materials LO2: Explain the flow of costs in a job shop

12. Analyzing Materials: Magna

13. Accumulated in control account Avoids having to deal with salary, bonus, and other benefits as separate items Avoids having to deal with separate wage rates for different workers (e.g., due to seniority) If direct labor, charge out to individual jobs If indirect labor, charge out to overhead control Analyzing Labor Costs LO2: Explain the flow of costs in a job shop

14. Analyzing Labor: Magna LO2: Explain the flow of costs in a job shop

15. Analyzing Overhead LO3: Apply overhead to jobs using predetermined rates

16. Calculate Rate at start of accounting period Use estimated costsand denominator volume Use this rate to apply overhead to individual jobs Overhead applied to Job N = driver units in job N * pre-determined rate Normal costing Triggers end of period adjustments Pre-Determined Overhead Rates LO3: Apply overhead to jobs using predetermined rates

17. Suppose: Predetermined variable overhead rate = $0.30 per direct labor dollar. Predetermined fixed overhead rate = $1.20 per direct labor dollar. Overhead Costs: Magna LO3: Apply overhead to jobs using predetermined rates

18. Analyzing WIP Accounts We get the data for individual amounts for materials, labor and overhead for each job from the prior analyses LO3: Apply overhead to jobs using predetermined rates

19. Flow Through the WIP Account LO3: Apply overhead to jobs using predetermined rates

20. Flow Through The FG Account: COGS LO3: Apply overhead to jobs using predetermined rates

21. Under LIFO, all 2,200 units would be sold from December’s production. Thus, 2,200 x $68 = $149,600.

22. Actual Rate < Pre-determined Rate Actual Rate > Pre-determined Rate Under-applied overhead Over-applied overhead End of Period Adjustments • Use of estimated rates means a difference between the inflows and outflows into the overhead control account Actual overhead = Amount of overhead costs Applied overhead = Allocate to products by a pre-determined rate • We can charge out too much or too little. IF • Generally, LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

23. Calculations for Magna LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

24. $69,620 $78,582 $1.10 / labor $ $83,544 $6,962 (over-applied) $0.10 higher $6,962

25. Three methods permitted Write off entire amount to COGS Prorate (i.e., allocate) among WIP, FG and COGS accounts Re-compute the rates All three methods comply with GAAP All methods essentially allocate the under- / over-applied overhead Differ in the accounts charged for the error Disposition LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

26. $4,623,800 $4,629,450 1 Add under-applied overhead and subtract overapplied overhead to determine the adjusted COGS as $4,629,450. 1

27. Disposition: Comparison Write off is least correct Assumes entire error relates to COGS Proration is better Assumes error is proportional to end of period value Should be proportion to current period overhead in the account Correcting rates is most accurate LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

28. Write off to COGS is the easiest method. OK if amount is not large Easy to implement. Most inaccurate. Proration (i.e., allocating among) is common. Uses of end of year balances as the basis Most commonly used Re-computing rates is most accurate. Easy if system is computerized Which Method To Use? LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

29. If overhead is under-applied, we have used “smaller than actual” rates. Thus, inventory accounts are under-valued. The adjustment therefore increases inventory values and cost of goods sold. Opposite reasoning of over-applied overhead. The adjustment decreases inventory values and COGS. Examples LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

30. Example: Proration Proration allocates the under- or over-applied overhead to WIP, FG and COGS accounts Uses end of year balances as the allocation basis LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

31. Exercise 14.26 Basic job costing (LO2) Tubbs and Company manufactures custom motorcycles. Tubbs uses a job-cost system and provides the following information related to the work-in-process account for the month of January: Tubbs applies manufacturing overhead based on direct labor cost. Job No. 232 was the only job still in process at the end of January. As of January 31, this job, which was started in January, contains direct materials of $4,250 and direct labor of $2,500. Required: Determine the cost of goods manufactured during January.

32. Exercise 14.26 (Continued) Determine the cost of goods manufactured during January. We can use the inventory equation for the WIP account to answer the question. Beginning WIP + (materials + labor + applied overhead) = COGM + Ending WIP. We know the items on the left hand side. But, we need to calculate Ending WIP, which will be the costs charged to job 232.

33. Exercise 14.26 (Concluded) Determine the cost of goods manufactured during January. (We use the total amounts charged to WIP to calculate the overhead rate as $36,000 applied overhead /$24,000 labor $ = $1.50 per labor dollar.) Thus, we have: COGM = $22,500 + (25,000+24,000 + 36,000) - $10,500 = $97,000.