Chapter 4

Job Costing

1 Describe the building-block concepts of costing systems

2 Distinguish job costing from process costing

3 Describe the approaches to evaluating and implementing job-costing

systems

4Outline the seven-step approach to normal costing

5 Distinguish actual costing from normal costing

6 Track the flow of costs in a job- costing system

7 Dispose of under- or overallocated manufacturing overhead costs at the

end of the fiscal year using alternative methods

8 Understand variations from normal costing

Building-Block Concepts of Costing Systems

Before we begin our discussion of costing systems, let’s review the cost-related
terms from Chapter 2 and introduce some new terms.

1. A cost object is anything for which a measurement of costs is desired—

for example, a product, such as an iMac computer, or a service, such as
the cost of repairing an iMac computer.
2. Direct costs are the cost that related to particular cost object that can be
traced in an economically feasible (cost-effective) way—for example, the
cost of the main computer board and parts to make an iMac computer.
3. The indirect costs of a cost object are costs related to a particular cost
object that cannot be traced to it in an economically feasible (cost-
effective) way—for example, the salaries of supervisors who oversee
multiple products, only one of which is the iMac, or the rent paid for the
repair facility that repairs many different Apple computer products.
Indirect costs are allocated to the cost object using a cost-allocation
method. Recall that cost assignment is a general term for assigning costs,
whether direct or indirect, to a cost object. Cost tracing is the process of
assigning direct costs. Cost allocation is the process of assigning indirect
costs. The relationship among these three concepts can be graphically
represented as

We also need to introduce and explain two more terms to understand

costing systems:
4. Cost pool. A cost pool is a grouping of individual indirect cost items. Cost
pools can range from broad, such as all manufacturing-plant costs, to
narrow, such as the costs of operating metal-cutting machines. Cost pools
are often organized in conjunction with cost-allocation bases.
5. Cost-allocation base. How should a company allocate the costs of
operating metal-cutting machines among different products? One way is
to determine the number of machine-hours used to produce different
products. The cost-allocation base (number of machine-hours) is a
systematic way to link an indirect cost or group of indirect costs (operating
costs of all metal-cutting machines) to cost objects (different products).
For example, if the indirect costs of operating metal-cutting machines is
$500,000 based on running these machines for 10,000 hours, the cost-
allocation rate is $500,000 , 10,000 hours = $50 per machine-hour, where
machine-hours is the cost-allocation base. If a product uses 800 machine-
hours, it will be allocated $40,000, or $50 per machine@hour * 800
machine-hours. The ideal cost-allocation base is the cost driver of the
indirect costs because there is a cause-and-effect relationship between
the cost-allocation base and the indirect costs. A cost-allocation base can
be either financial (such as direct labor costs) or nonfinancial (such as the
number of machine-hours). When the cost object is a job, product,
service, or customer, the cost- allocation base is also called a cost-
application base. However, when the cost object is a department or
another cost pool, the cost-allocation base is not called a cost-application
base.
Learning Objective Job-Costing and Process-Costing Systems
2

We will use the above concepts to design the costing systems described in this
chapter.

Job-Costing and Process-Costing Systems

1. Job-costing system. In a job-costing system, the cost object is a unit or

multiple units of a distinct product or service called a job. Each job
generally uses different amounts of resources. Example, custom-made
furniture, Auditing services and Advertising services.
2. Process-costing system. In a process-costing system, the cost object is
masses of identical or similar units of a product or service. Example,
Citibank provides the same service to all its customers when processing
customer deposits. Intel provides the same product (say, a Core i5 chip)
to each of its customers. All Minute Maid consumers receive the same
frozen orange juice product.

See examples page 110

Learning Objective Job Costing: Evaluation and Implementation

3

Example of Robinson Company, which manufactures and installs specialized

machinery for the paper-making industry. In early 2017, Robinson receives a
request to bid on the manufacturing and installation of a new paper-making
machine for the Western Pulp and Paper Company (WPP). Robinson had never
made a machine quite like this one, and its managers wonder what to bid for
the job. In order to make decisions about the job, Robinson’s management team
works through the five-step decision-making process.

1. Identify the problems and uncertainties.

The decision of whether and how much to bid for the WPP job depends
on how management resolves two critical uncertainties: (1) what it will
cost to complete the job; and (2) the prices Robinson’s competitors are
likely to bid.
2. Obtain information.
Robinson’s managers first evaluate whether doing the WPP job is
consistent with the company’s strategy. Do they want to do more of these
 kinds of jobs? Is this an attractive segment of the market? Will Robinson
be able to develop a competitive advantage over its competitors and
satisfy customers such as WPP? After completing their research,
Robinson’s managers conclude that the WPP job fits well with the
company’s strategy and capabilities.
Robinson’s managers study the drawings and engineering specifications
provided by WPP and decide on the technical details of the machine. They
compare the specifications of this machine to similar machines they have
made in the past, identify competitors that might bid on the job, and
gather information on what these bids might be.
3. Make predictions about the future.
Robinson’s managers estimate the cost of direct materials, direct
manufacturing labor, and overhead for the WPP job. They also consider
qualitative factors and risk factors and evaluate any biases they might
have. For example, do engineers and employees working on the WPP job
have the necessary skills and technical competence? Would they find the
experience valuable and challenging? How accurate are the cost
estimates? What biases do Robinson’s managers have to be careful
about?
4. Make decisions by choosing among alternatives.
Robinson’s managers consider several alternative bids based on what
they believe competing firms will bid, the technical expertise needed for
the job, business risks, and other qualitative factors. Ultimately Robinson
decides to bid $15,000. The manufacturing cost estimate is $9,800, which
yields a markup of more than 50% on manufacturing cost.
5. Implement the decision, evaluate performance, and learn.
Robinson wins the bid for the WPP job. As Robinson works on the job,
management accountants carefully track all of the costs incurred (which
are detailed later in this chapter). Ultimately, Robinson’s managers will
compare the predicted amounts (as in step 3) against actual costs to
evaluate how well the company did on the WPP job.

In its job-costing system, Robinson accumulates the costs incurred for a job in
different parts of the value chain, such as manufacturing, marketing, and
customer service. We focus here on Robinson’s manufacturing function (which
also includes the installation of the machine). To make a machine, Robinson
purchases some components from outside suppliers and makes other
components itself. Each of Robinson’s jobs also has a service element: installing
a machine at a customer’s site and integrating it with the customer’s other
machines and processes.

One form of a job-costing system that Robinson can use is actual costing, which
is a costing system that traces direct costs to a cost object based on the actual
direct-cost rates times the actual quantities of the direct-cost inputs used.
Indirect costs are allocated based on the actual indirect-cost rates times the
actual quantities of the cost-allocation bases. An actual indirect-cost rate is
calculated by dividing actual annual indirect costs by the actual annual quantity
of the cost-allocation base.

As its name suggests, actual costing systems calculate the actual costs of jobs.
Yet actual costing systems are not commonly found in practice because actual
costs cannot be computed in a timely manner. The problem is not with
computing direct-cost rates for direct materials and direct manufacturing labor.
For example, Robinson records the actual prices paid for materials. As it uses
these materials, the prices paid serve as actual direct-cost rates for charging
material costs to jobs. As we discuss next, calculating actual indirect-cost rates
on a timely basis each week or each month is, however, a problem. Robinson
can only calculate actual indirect-cost rates at the end of the fiscal year.
However, the firm’s managers are unwilling to wait that long to learn the costs
of various jobs because they need cost information to monitor and manage the
cost of jobs while they are in progress. Ongoing cost information about jobs also
helps managers bid on new jobs while working on current jobs.

Two reasons for using longer periods, such as a year, to calculate indirect-cost
rates.

1. The numerator reason (indirect-cost pool). The shorter the period, the
greater is the influence of seasonal patterns on the amount of costs.
2. The denominator reason (quantity of the cost-allocation base). Another
reason for longer periods is to avoid spreading monthly fixed indirect
 costs over fluctuating levels of monthly output and fluctuating quantities
of the cost-allocation base.

Normal Costing

We can’t wait till the end of the year to calculate the actual indirect cost rate;
we need the cost information in a monthly or weekly basis. Therefore, we
predetermine (budget) the indirect cost rate at the beginning of a fiscal year.

Because it’s hard to calculate actual indirect-cost rates on a weekly or monthly

basis, managers cannot calculate the actual costs of jobs as they are completed.
Nonetheless, managers want a close approximation of the costs of various jobs
regularly during the year, not just at the end of the fiscal year. They want to
know manufacturing costs (and other costs, such as marketing costs) to price
jobs, monitor and manage costs, evaluate the success of jobs, learn about what
did and did not work, bid on new jobs, and prepare interim financial statements.
Because companies need immediate access to job costs, few wait to allocate
overhead costs until the end of the accounting year. Instead, a predetermined
or budgeted indirect-cost rate is calculated for each cost pool at the beginning
of a fiscal year, and overhead costs are allocated to jobs as work progresses. For
the numerator and denominator reasons described previously, the budgeted
indirect-cost rate for each cost pool is computed as:

Summary

Under actual costing each month's actual costs and each month's actual production volume are used
to assign overhead costs. Since most companies will experience month to month fluctuations in
activity, the actual monthly overhead rates will likely vary from month to month.

Therefore,

Normal costing uses a predetermined annual overhead rate to assign manufacturing overhead to
products. In other words, the overhead rate under normal costing is based on the budgeted overhead
costs for the entire accounting year and the budgeted production volume for the entire year.

Normal costing will result in an overhead rate that is more uniform and realistic for all of the units
manufactured during an accounting year.
Learning Objective Outline the seven-step approach to normal costing
4

General Approach to Job Costing Using Normal Costing

We will illustrate job costing using the example of Robinson Company, which
manufactures and installs specialized machinery for the paper-making industry.
In early 2017, Robinson receives a request to bid on the manufacturing and
installation of a new paper-making machine for the Western Pulp and Paper
Company (WPP).

We illustrate normal costing for the Robinson Company example using the
following seven steps to assign costs to an individual job. This approach is
commonly used by companies in the manufacturing, merchandising, and service
sectors.

Step 1: Identify the Job That Is the Chosen Cost Object.

The cost object in the Robinson Company example is Job WPP 298,
manufacturing a paper-making machine for Western Pulp and Paper
(WPP) in 2017.

Step 2: Identify the Direct Costs of the Job.

§ Direct materials
§ Direct manufacturing labor

Step 3: Select the Cost-Allocation Bases to Use for Allocating Indirect Costs to
the Job.

Robinson chooses direct manufacturing labor-hours as the sole allocation base

for linking all indirect manufacturing costs to jobs. In 2017, Robinson budgets
28,000 direct manufacturing labor-hours.
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base.

Robinson creates a single cost pool called manufacturing overhead costs. This
pool represents all indirect costs of the Manufacturing Department that are
difficult to trace directly to individual jobs. In 2017, budgeted manufacturing
overhead costs total $1,120,000.

Step 5: Compute the Rate per Unit of Each Cost-Allocation Base Used to
Allocate Indirect Costs to the Job.

= 1,120,000/ 28,000 = $40

Step 6: Compute the Indirect Costs Allocated to the Job.

Indirect cost that is allocated to this job is >>> 88 * 40 = 3,520

Step7: Compute the Total Cost of the Job by Adding All Direct and Indirect
Costs Assigned to the Job.
Learning Objective Actual Costing
5

How would the cost of Job WPP 298 change if Robinson had used actual
costing rather than normal costing?

1,215,000/27000 = $45

MOH >>> 45*88 = 3,960

Total manufacturing cost of job = direct materials costs + direct manufacturing

labour + manufacturing overhead costs >>> 4,606 + 1,579 + 3,960 = 10,145

The manufacturing cost of the WPP 298 job is higher by $440 under actual
costing ($10,145) than it is under normal costing ($9,705) because the actual
indirect-cost rate is $45 per hour, whereas the budgeted indirect-cost rate is $40
per hour. That is, $45 - $40 * 88 actual direct manufacturing labor-hours = $440.

At the end of the year, though, costs allocated using normal costing will not, in
general, equal actual costs incurred. If the differences are significant,
adjustments will need to be made so that the cost of jobs and the costs in various
inventory accounts are based on actual rather than normal costing because
companies need to prepare financial statements based on what actually
happened rather than on what was expected to happen at the beginning of the
year. We describe these adjustments later in the chapter.
Learning Objective 6 A Normal Job-Costing System in Manufacturing

General ledger

A job-costing system has a separate job-cost record for each job. A summary of
the job-cost record is typically found in a subsidiary ledger. The general ledger
account—Work-in-Process Control—presents the total of these separate job-
cost records pertaining to all unfinished jobs.
 Exhibit 4-7 shows T-account relationships for Robinson Company’s general
ledger. The general ledger gives a “bird’s-eye view” of the costing system. The
amounts shown in Exhibit 4-7 are based on the monthly transactions and journal
entries that follow.

General ledger accounts with “Control” in their titles (for example, Materials Control and
Accounts Payable Control) have underlying subsidiary ledgers that contain additional
details, such as each type of material in inventory and individual suppli- ers Robinson
must pay.

Explanations of Transactions

We next look at a summary of Robinson Company’s transactions for February 2017 and
the corresponding journal entries for those transactions.

Material A/P control

control 89,000
Robinson Company’s transactions for February 2017
89,000 85,000
1. Purchases of materials (direct and indirect) on credit,
$89,000
WIP control
Materials control 89,000 81,000 188,800
MOH
A/P control 89,000
39,000 control
4,000
2. Usage of direct materials, $81,000, and indirect 80,000
materials, $4,000 11,200 15,000

Work in process control (WIP) 81,000 Cash control 75,000

MOH control 4,000 54,000 94,000
Material control 85,000
57,000

60,000
3. Manufacturing payroll for February: direct labor, $39,000, and indirect labor,
$15,000, paid in cash

WIP control 39,000 Acc. Dep. control FG control

MOH control 15,000 18,000 188,800 180,00
Cash control 54,000
8,800

4. Other manufacturing overhead costs incurred during MOH

February, $75,000, consisting of Allocated
§ supervision and engineering salaries, $44,000 (paid in 80,000 COGS
cash); 180,000
§ plant utilities, repairs, and insurance, $13,000 (paid in
80,000
cash); and
§ plant depreciation, $18,000

MOH control 75,000

Cash control 57,000
Acc. Dep. control 18,000 MKTing exp.
Cus. Ser.
exp. 45,000
15,000
5. Allocation of manufacturing overhead to jobs, $80,0001
(2,000 h * 40)

WIP control 80,000

Manufacturing overhead allocated 80,000

6.The sum of all individual jobs completed and transferred to finished goods in
February 2017 is $188,800

Finished good control 188,800

WIP control 188,800

1
Under normal costing, manufacturing overhead allocated—or manufacturing overhead applied—is the amount of
manufacturing overhead costs allocated to individual jobs based on the budgeted rate ($40 per direct manufacturing labor-hour)
multiplied by the actual quantity of the allocation base used for each job.
7. Cost of goods sold, $180,000

COGS 180,000
FG control 180,000

8. Marketing costs for February 2017, $45,000, and customer-service costs for
February 2017, $15,000, paid in cash

Marketing exp. 45,000

Customer 15,000 REV.
service exp. 270,000
Cash 60,000
control
9. Sales revenues from all jobs sold and delivered in February 2017, all on credit,
$270,000

A/R control 270,000

Revenues 270,000 A/R control
270,000
LO7 Budgeted Indirect Costs and End-of- Accounting-Year Adjustments

Managers try to closely approximate actual manufacturing overhead costs and actual
direct manufacturing labor-hours when calculating the budgeted indirect cost rate.
However, for the numerator and denominator reasons explained earlier in the chapter,
under normal costing, a company’s actual overhead costs incurred each month are
not likely to equal its overhead costs allocated each month. Even at the end of the
year, allocated costs are unlikely to equal actual costs because they are based on
estimates made up to 12 months before actual costs are incurred.

For financial statement purposes, companies are required to report results

based on actual costs. We now describe adjustments that management
accountants need to make when, at the end of the fiscal year, indirect costs
allocated differ from actual indirect costs incurred.

Underallocated indirect costs >>> the allocated amount of indirect costs in an

accounting period is less than the actual (incurred) amount.

Overallocated indirect costs >>> the allocated amount of indirect costs in an

accounting period is greater than the actual (incurred) amount.

Underallocated (overallocated) indirect costs = Actual indirect costs incurred -

Indirect costs allocated

Underallocated (overallocated) indirect costs are also called underapplied

(overapplied) indirect costs and underabsorbed (overabsorbed) indirect
costs.

Consider the manufacturing overhead cost pool at Robinson Company.

$1,215,000 - $1,080,000 = 135,000 difference (a net debit)/ underallocated
amount

This difference arises for two reasons related to the computation of the $40
budgeted hourly rate:

1. Numerator reason (indirect-cost pool). Actual manufacturing overhead

costs of $1,215,000 are greater than the budgeted amount of $1,120,000.

2. Denominator reason (quantity of allocation base). Actual direct

manufacturing labor- hours of 27,000 are fewer than the budgeted 28,000
hours.

Three main approaches to accounting for the $135,000 underallocated

manufacturing overhead caused by Robinson underestimating manufacturing
overhead costs and overestimating the quantity of the cost-allocation base:

(1) adjusted allocation-rate approach,

(2) proration approach,

(3) write-off to cost of goods sold approach.

(1) adjusted allocation-rate approach,

Once you know the actual MOH rate you go back and make adjustments using
the actual MOH rate.

1- First, the actual manufacturing overhead rate is computed at the end of

the fiscal year.

1,215,000/27,000 = $45 per direct manufacturing labour hour

2- Then the manufacturing overhead costs allocated to every job during the
year are recomputed using the actual manufacturing overhead rate (rather
than the budgeted manufacturing overhead rate).

Consider the Western Pulp and Paper machine job, WPP 298.
 45 * 88 = 3,960

3,960 – 3,520 = 440 that is the amount we need to add to the 3,520 to
become 3,960

3- Making this adjustment under normal costing for each job in the subsidiary
ledgers ensures that actual manufacturing overhead costs of $1,215,000 are
allocated to jobs.

The result is that at year-end, every job-cost record and finished-goods record—
as well as the ending Work-in-Process Control, Finished Goods Control, and Cost
of Goods Sold accounts—represent actual manufacturing overhead costs
incurred.

The adjusted allocation-rate approach yields the benefits of both the timeliness
and convenience of normal costing during the year and the allocation of actual
manufacturing overhead costs at year-end. Each individual job-cost record and
the end-of-year account balances for inventories and cost of goods sold are
adjusted to actual costs. These adjustments, in turn, will affect the income
Robinson reports.

Knowing the actual profitability of individual jobs after they are completed
provides managers with accurate and useful insights for future decisions about
which jobs to undertake, how to price them, and how to manage their costs.

(2) proration approach,

Spreads underallocated overhead or overallocated overhead among *ending

work-in-process inventory, *finished-goods inventory, and *cost of goods sold.
Materials inventory is not included in this proration because no manufacturing
overhead costs have been allocated to it.

We illustrate end-of-year proration in the Robinson Company example. Assume

the following actual results for Robinson Company in 2017:
The $135,000 underallocated overhead is prorated over the three accounts in
proportion to the total amount of manufacturing overhead allocated (before
proration).

First proration way: proration rates based on the amount of manufacturing

overhead allocated to WIP, FG and COGS accounts.

The journal entry to record this proration is:

If manufacturing overhead had been overallocated, the Work-in-Process
Control, Finished Goods Control, and Cost of Goods Sold accounts would be
decreased (credited) instead of increased (debited).

This journal entry closes (brings to zero) the manufacturing overhead-related accounts and
restates the 2017 ending balances for Work-in-Process Control, Finished Goods Control, and
Cost of Goods Sold to what they would have been if actual manufacturing overhead rates had
been used rather than budgeted manufacturing overhead rates.

This method reports the same 2017 ending balances in the general ledger as the adjusted
allocation-rate approach.

However, unlike the adjusted allocation-rate approach, the sum of the amounts shown in the
subsidiary ledgers will not match the amounts shown in the general ledger after proration
because no adjustments from budgeted to actual manufacturing overhead rates are made in
the individual job-cost records. The objective of the proration approach is to only adjust the
general ledger to actual manufacturing overhead rates for purposes of financial reporting.
The increase in cost of goods sold expense by $129,060 as a result of the proration causes
Robinson’s reported operating income to decrease by the same amount.

Second proration way: Proration rates based on the ending balances of WIP, FG and COGS.

(3) write-off to cost of goods sold approach.

Under the write-off approach, the total under- or overallocated manufacturing

overhead is included in this year’s Cost of Goods Sold. For Robinson, the
journal entry would be as follows:
Robinson’s two Manufacturing Overhead accounts—Manufacturing Overhead
Control and Manufacturing Overhead Allocated—are closed with the difference
between them included in Cost of Goods Sold.

The Cost of Goods Sold account after the write-off equals $2,510,000, the
balance before the write-off of $2,375,000 plus the underallocated
manufacturing overhead amount of $135,000. This results in operating income
decreasing by $135,000.