April 8, 2010

1. April 8, 2010 Systems Design: Job-Order Costing

2. April 8, 2010 • System Design – Job Order Costing • What is Product Costing • Types of Product Costing • When and how to use Job-Order Costing • Journal entries and income statement

3. Product Costing • Product Costing is the mapping and allocating of costs to a specific product • Its purpose is to provide executives with critical information including: • How to minimize costs • How to price a product competitively and profitably • There are two main methodologies of Product Costing • 1. Job-Order Costing – each job is different • 2. Process Costing – many of the same products

4. Job Order Costing • Job-Order Costing is the costing methodology applied in companies in the following circumstances: • Produce many different products or packages • Manufacture to order so each job is different • Examples would be: • SNC (engineering and construction) • Airbus (aircraft) • Other? • In these cases, a company needs to know, often on an order by order basis, what are the costs associated with fulfilling the order • Cost records for each job will be required to support decision making and billing of the customer

5. Process Costing • Process Costing is the costing methodology applied in companies in the following circumstances: • Produce many units of a single product • Each unit is substantially similar to other units • Examples would be: • Lenovo (PC manufacturing) • Frito lay (Snacks and beverages) • Others? • That each of these products are substantially the same, managers are able to apply the same average cost to each unit

6. Distinguishing between Product Cost and Job-Order Costing Situations • Example • Abitibi • Pulp & paper • Bombardier • Aircraft • Toyota • Barrick Gold • Mining production • Laramide Resources • Mining development • Coca-cola • System

7. Job-Order Costing—An Overview • Our objective is to arrive at the Product Cost of for each Job • There are three categories of cost which go into this build up • Direct Materials • Direct Labour • Manufacturing Overhead • Direct Materials can be easily traced to any particular job • A requisition for Raw Materials is issued identifying what job the inventory is for • Direct Labour can be easily traced to jobs • Each labourer submits a log of what jobs he/she worked on and for what amount of time • Manufacturing Overhead – this is where judgment and methodologies are required

8. Job-Order Costing – Manufacturing Overhead • Manufacturing Overhead • Indirect Materials • Indirect Labour • Other Overhead (tax on factory, depreciation, insurance, etc.) • Take two cost item examples: • Depreciation on production machinery, and • Cost of the labourer who maintains the production equipment • Other? • These are Product Costs because they are costs associated with producing products • As a test, we can ask if the company did not produce the product, would it have purchased the machinery in the first place or hired the people?

9. Job-Order Costing – Allocating Manufacturing Overhead • Manufacturing Overhead Costs need to be somehow allocated to each job • If they were not allocated, the company would underestimate its cost, and therefore under-price its work • Manufacturing Overhead is applied to the jobs that are in process • It can be allocated on a number of bases: • Direct labour hours • Direct labour dollars • Machine hours • At this level, selecting the allocation base is done based largely on judgment • It may help to select the largest cost; eg labour or machine costs in order to maximize any correlation • Later in the course, Activity Based Costing will hone some of this

10. Estimated total manufacturingoverhead cost for the coming period POHR = Estimated total units in theallocation base for the coming period Job-Order Costing – Allocating Manufacturing Overhead • Calculating the Pre-determined Overhead Rate • Indirect labour = $450,000 • Indirect materials = $200,000 • Other manufacturing overhead = $50,000 • Forecast direct labour hours = 700,000 • Calculate the POHR

11. Job-Order Costing – An Example • Happy Co has its first Job of the period which it needs to cost • Use the POHR from the previous example • Assume • Direct labour required = 200 hours • Labour costs = $7.00 per hour • Direct Materials = $400.00 • Calculate the Product Cost for job 1

12. Job-Order Costing – Example Solution • Use the POHR from the previous example = $1 per hour DL • Direct labour required = 200 hours • Labour costs = $7.00 per hour • Direct Materials = $400.00 • Product cost for Job 1 is $2,000

13. Job-Order Costing – The Documentation • In the real world, there are documents to track and authorize all expenditures, including • Materials requisition forms to track and control Direct Materials • Employee time tickets to track Direct Labour • The output from these documents feed into a Job Costing Sheet upon which the POHR is applied to arrive at the final cost of the job • Samples to follow (with a $4 POHR assumption)

14. Job Cost Sheet

15. Materials Requisition Form

16. Job Cost Sheet

17. Employee Time Ticket

18. Job Cost Sheet

19. Application of Manufacturing Overhead

20. Completing the Job Cost Sheet

21. Caution! Interpreting Job Costs • 1. Job Order Costing is based on an ESTIMATE of business volumes • If volumes are higher than the estimate • Manufacturing Overhead will likely have been over allocated • Fixed costs and therefore total cost will actually be lower per unit • Products as a result may be overpriced, which in turn could reduce demand and impact production decisions • The reverse is true as well • 2. The average cost per unit that comes out of the forecasts is not the marginal cost of producing an additional unit • It is likely that accepting an additional at below average cost will positively contribute to profitability • This is also because of the fixed/variable cost relationship

22. Accounting – What Accounts Need to be Set Up? • Raw Materials • Accounts Payable • Work in Progress • Salaries and Wages Payable • Manufacturing Overhead • Other Accounts that role into Manufacturing Overhead; eg • Taxes Payable (on production facility) • Accumulated Depreciation (on production property and equipment) • We will trace through the Journal Entries for Job Order Costing

23. Journal Entry – Material Purchases • Purchase Raw Materials • Debit Raw Materials • Credit Accounts Payable

24. Journal Entry – Material Usage • Materials Requisition form executed • Work in Process • Manufacturing Overhead • Credit Raw Materials • Direct Materials (WIP) • Indirect Materials (MOH)

25. Journal Entry – Labour Costs • Employee time ticket is executed – similar to materials • Work in Process • Manufacturing Overhead • Credit Salaries and Wages Payable • Direct Labour (WIP) • Indirect Labour (MOH)

26. Journal Entry – Other Manufacturing Overhead Items • Other Manufacturing Overhead items • Debit Manufacturing Overhead • Credit relevant balance sheet accounts • Then, Debit WIP • Credit Manufacturing Overhead

27. Journal Entry – Cost of Goods Manufactured • Completion of production • Debit Finished Goods • Credit WIP

28. Journal Entry – Overhead Applied • Manufacturing Overhead can be “cleared” through to WIP (which eventually flows to FG and COGS), or directly to COGS • Debit WIP • Credit Overhead

29. Journal Entry – Sales • Sale • Debit Accounts Receivable • Credit Sales • Debit COGS • Credit Finished Goods

30. Journal Entry – Overhead Adjustment • Actual Manufacturing Overhead is known at the end of the period • Note: As much of this will have flown through from WIP to FG to COGS, it is simple and practical to adjust Manufacturing Overhead through COGS • Over-applied Overhead • Debit Overhead • Credit COGS (decrease it and increase profit) • Under-applied Overhead • Debit COGS (increase it and reduce profit) • Credit Overhead

31. Journal Entry – Accounting for Nonmanufacturing Costs • Non Manufacturing Costs (Selling and Administration) • Debit Salaries Expense • Credit Salaries Payable • Debit Advertising Expense • Credit Accounts Payable • Debit other relevant expenses (examples?) • Credit cash, A/P or other

32. May be more complex but . . . May be more accurate because it reflects differences across departments. Multiple Predetermined Overhead Rates To this point, we have assumed that there is a single predetermined overhead rate called a plantwide overhead rate. Large companies often use multiple predetermined overhead rates.

33. Account flow overview

34. Review • System Design – Job Order Costing • What is Product Costing • Types of Product Costing • When and how to use Job-Order Costing • Journal entries and income statement

35. Tutorial

36. End of Chapter 2

37. Direct Labor • IndirectLabor Summary of Cost Flows Work in Process(Job Cost Sheet) Salaries and Wages Payable • Direct Labor • Direct Materials • IndirectLabor Mfg. Overhead Actual Applied • Indirect Materials

38. Direct Materials • Direct Materials • Indirect Materials • Indirect Materials Summary of Cost Flows Raw Materials Work in Process(Job Cost Sheet) • Material Purchases Mfg. Overhead Actual Applied

39. Summary of Cost Flows In addition to indirect materials and indirect labor, other actual manufacturing overhead costs are debited to the Manufacturing Overhead account. Mfg. Overhead Actual Applied • Indirect Materials • IndirectLabor • OtherOverhead

40. Summary of Manufacturing Overhead Cost Flows Work in Process(Job Cost Sheet) Mfg. Overhead Actual Applied • Direct Materials • Indirect Materials • OverheadApplied to Work inProcess • Direct Labor • IndirectLabor • Overhead Applied • OtherOverhead If actual and applied manufacturing overheadare not equal, a year-end adjustment is required.

41. Summary of Goods Manufactured Cost Flows Work in Process(Job Cost Sheet) Finished Goods • Cost ofGoodsMfd. • Direct Materials • Cost ofGoodsMfd. • Direct Labor • Overhead Applied

42. Cost ofGoodsSold • Cost ofGoodsSold Summary of Job-Order System Cost Flows Work in Process(Job Cost Sheet) Finished Goods • Cost ofGoodsMfd. • Direct Materials • Cost ofGoodsMfd. • Direct Labor • Overhead Applied Cost of Goods Sold

43. $30,000 $30,000 Disposition of Under- or Overapplied Overhead PearCo’sMfg. Overhead PearCo’s Costof Goods Sold Unadjusted Balance Actualoverhead costs $650,000 Overhead appliedto jobs $680,000 AdjustedBalance $30,000 overapplied