CHAPTER 3

JOB COSTING AND PROCESS COSTING

- Product costing is the process of accumulating and classifying costs and then assigning those
costs to products.
- Product cost information is used for various purposes.
- The choice of a product -costing system depends on many factors, including the type of
industry, the needs of management, and the nature of the product or service. Three basic
characteristics distinguish product-costing and service costing system
1. Whether actual or estimated costs are used:
• Actual costing― assigns actual DL, DM and FOH to cost objects.
• Normal costing― assigns actual DM, DL and estimated FOH to cost objects.
• Standard costing―assigns estimated cost of DM, DL, & FOH to cost objects
2. The treatment of fixed-overhead costs
• Absorption costing― all manufacturing costs are inventoried.
• Variable costing― only variable mfg costs are inventoried. Fixed FOH period cost.
3. The procedures by which costs are accumulated and assigned.
• Job-order costing― costs are accumulated and assigned individually on a per-job
basis.
• Process costing―accumulates costs by department and processes.

From these points you can see that there are twelve possible costing systems
{actual, normal, standard} {absorption, variable} {job order, process }
3 × 2 × 2 = 12
Operation Costing is a hybrid-costing system. It is used in situations where products have
some common as well as individual characteristics. TVs, for example, have some common
characteristics in that all models must be assembled and tested following the same basic
steps. However, each model has different components with different costs. The costs of the
components (materials) would be charged to a batch of a particular model individually, as in
job-order costing, but the conversion costs may be assigned using process costing.

Cost Systems
- The two extremes of product costing are usually termed job costing and process costing
1. Job Costing
- It is used by entities that make relatively small quantities or distinct batches of identifiable
unique products (services).
- Businesses using job costing include: Printing jobs at a printing Co., Ship-builders, Custom
furniture manufacturers, Construction companies, Film-producing companies, Accounting
and law firms, Advertising agencies, Medical clinics, etc
- Here an individual job is considered as a cost object. Sometimes a job consists of an
individual product, and sometimes it consists of a batch of products.

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- Job cost information is used (a) to determine the profitability of individual jobs, (b) to assist
in bidding on future jobs, and (c) to evaluate professionals who are in charge of managing
individual jobs.
- Service organizations would most likely use job-order costing to assign and track costs to
each client’s job.

2. Process Costing
- Process costing is used for production processes that produce mass quantities of identical
units that use the same amounts and types of direct labor, direct materials, and overhead.
- All costs are accumulated by departments, operations, or processes. The accumulated costs
can be averaged over the entire production since each unit is essentially identical.
- Businesses using Process Costing: Chemical plants, Food processors, Household appliance
manufacturers, Textile companies, Petroleum products manufacturers, Paper, Lumber and
pulp mills, Glass factories, soft-drink industries, beverage companies, cement factories, food
processing, ceramics, oil, etc

Building–Block Concepts of Costing Systems

- Cost object (cost objective) - anything for which a measurement of cost is desired
e.g. product, department , branch ,a service, a job, a customer etc
- Cost Accumulation
• The collection of cost data in some organized way by means of an accounting system.
• We may collect costs by some natural classification such as materials or labor or by
activities performed such as order processing or machine processing costs.
- Cost Pool
• A group of individual costs that is allocated to cost objects using a single cost driver.
• Cost pools can range from broad, such as all costs of the manufacturing plant, to narrow,
such as the cost of operating metal-cutting machine.
- Cost Allocation
• The assignment of indirect costs to a cost object.
- Cost Allocation Base
• Indirect mfg costs are assigned to cost objects by allocation. Cost allocation base is the
factor that links in a systematic way an indirect cost or group of indirect costs to a cost
object.
• Companies often use the cost driver of indirect costs because of the existence of cause
and effect link.
• A cost allocation base can be financial (DL cost, material costs) or nonfinancial (number
of machine hours, DL hours, units of production). But it has to be one that can easily be
measured for each cost object.
• In machine intensive operations a large part of the FOH cost is associated with operating
the machinery making probably machine hour a proper base. For similarly reason, in
labor intensive operations the proper base is probably DL cost or DL hours. If OH is
mainly material oriented, dominated by costs associated with procuring and handling
material, then materials cost may be a suitable base.

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 Job Costing in Manufacturing Firms
- Let us examine the basic records (documents) used in a job costing system.
Job-cost sheet
- It is a document that records and accumulates all costs assigned to a specific job, starting
when work begins. The job may be a product, service, or batch of products.
- The job-cost sheet can be in paper or electronic form. A simplified job-cost sheet follows:
ABC Co. Job Cost Record
Job No. 160 Customer: X Co.
Date Started: May5,09 Date Finished: May 9, 09
Description: Office Eqt.
Machining Assembly Total
DM xx xx xxx
DL xx xx xxx
FOH xx xx xxx
Total xxx xxx xxx
- DM and DL costs are
traced to the job, and FOH costs are allocated to the job.
- A file of job cost sheets for partially completed jobs makes up the subsidiary ledger for the
WIP control.
- The output of a job can be a single unit or multiple similar or dissimilar units. With multiple
outputs, a unit cost can be computed only if the units are similar or if costs are accumulated
for each separate unit (such as through an ID no.).
- Costs entered onto the job cost sheet are obtained from:
Materials Requisition:
• It is a form which enables each department to take the material they want from stores and
is the basis for recording the amount of material used by each department for a job.
• This form identifies the job to which the materials are to be charged. Care must be taken
when charging materials to distinguish between direct and indirect materials. An example
of a materials requisition form is shown below.

Time Cards and Time Tickets

• Time cards collects data on how many hours have been worked by each hourly rate
employee. Manual system requires a time card for each individual, who would manually
record time. Electronic system uses magnetic cards, swiped through a card reader
• Each employee records the amount of time he or she spends on each job and each task on
a time ticket (time sheet).
• Periodically (e.g every week) an analysis (summary) of the time tickets is prepared. The
time spent on a particular job is considered direct labor and its cost is traced to that job.
The cost of time spent on other tasks, not traceable to any particular job, is usually
considered part of manufacturing overhead. Any time spent in nonmanufacturing areas is
charged to marketing or adm. Expense. An example of an employee time ticket is shown
below.

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 Job No.160
Job No. 160 Date ___
Name ________________
Dept _____
Department ___________
Wage rate ___________ Description Quantity Unit cost Amount
Time started _________
Time finished ________
DMs
Requisition No. ___

Departmental Overhead Analysis Sheet

• FOH cost is accumulated, without distinction as to job, for each department in

departmental OH analysis sheet. Then, departmental OH costs are allocated to each job
using a cost allocation base.

• Departmentalizing FOH allows departments to have different FOH rate resulting in

improved product costing. It also facilities responsibility accounting and control of OH
costs in a department.

General Approaches to Job costing

- There are seven steps to assigning costs to an individual job. They are equally applicable to
assigning costs to a job in manufacturing, merchandising and service sectors.

Step1. Identify the cost object which is a job.

Step2. Identify the direct costs. DMs and DLs can be traced to each job using materials
requisition and time tickets respectively and entered on the job-cost sheet.
Step3. Identify the indirect cost pools
• Overhead costs are accumulated in one or more cost pools. Accountants use
judgment in choosing the number and type of overhead cost pools for a given
organization.
• Some organizations use a single cost pool for all fixed and variable overhead
costs. Other organizations use separate cost pools for fixed and variable overhead
costs.
• If work is performed in separate departments or work areas, separate overhead
cost pools may be designated for each department or activity. All FOH are
determined for each department using departmental overhead analysis sheet.
Step 4. Select the cost allocation base

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 • The crucial quality of an allocation base is that it be a cost driver of the costs in the
pool to be allocated. The base must be easily measurable for each job.
• Direct labor costs and hours are the two most popular allocation bases because this
information is already captured by the payroll system.
• In a job order cost system, the units produced cannot serve as the allocation base
because each unit, or group of units, tends to be different(i.e., there is lack cause-
and-effect relationship)

Step 5. Develop allocation rate

• The overhead allocation rate expresses the relationship between overhead costs and
some activity base that can be traced directly to specific cost objects(job)
Actual costing Actual OH Actual indirect cost rate
Actual allocation base

Normal costing Budgeted OH Budgeted indirect cost rate

Budgeted allocation base (predetermined OH rate)

• Some companies use separate rate for fixed and variable FOH. Variable factory
overhead per unit of the allocation base is assumed to be constant within the
relevant range of activity. However, fixed factory overhead is assumed to be
constant in total over the relevant range.
Level of complexity in OH allocation rate:
Plant-wide OH rate: the simplest form of OH allocation is to use a single OH rate
throughout all departments of a company. Here, we treat all annual OH for the company as a
single costs pool, and allocate is based on one allocation base.
Departmental OH rate: after OH costs have been departmentalized, a different OH
allocation rate for each department may be used to have a more accurate OH cost allocation
to each cost object in each department. Multiple OH rates should be used, for example, in
sanitations where on department is machine intensive and another department is labor
intensive.
Activity Based Costing (ABC Costing): it is a more complex OH allocation system. It
recognizes that many activities within a department drive OH costs and uses multiple cost
pools and multiple cost drivers within a department. For example, a portion of the
departmental costs may be allocated on the basis of direct labor hours, another portion on the
basis of machine hours, and the remainder on the basis of the number of machine setups. This
method results in more accurate product cost information.
Step 6. Compute indirect costs allocated to the job

Actual costing Actual indirect cost rate × Actual quantity of the

cost allocation base used
Normal costing Budgeted indirect cost rate × Actual quantity of the
cost allocation base used
Step 7. Compute total cost of the job

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 Actual costing = DM + DL + OH(actual)
Normal costing = DM + DL + OH(applied)

Example 1 (Actual Job Costing Systems in Manufacturing Firms)

Robinson Company uses a job costing system with two direct cost categories (DMs and
Direct manufacturing OH) and one manufacturing cost OH pool. The company allocates
manufacturing OH costs using direct manufacturing labor hours. The year 2003 budget and
actual results are given below
Budget for Year 3 Actual results for Year 3
Mfg OH $1,120,000 $1,215,000
DL cost 500,000 550,000
DL hrs 28,000 27,000
Machine hrs 10,000 11,000
The job-cost sheet for job WPP 298 lists the following:

DMs used --------------------- $4,606

DL cost ---------------------- 1,579
DL hrs --------------------- 88
Required: Determine the cost of Job WPP 298 using actual costing
Solution
The real part of the computation starts from step 5 .
Step 5. FOH allocation rate?

Actual FOH rate = Actual OH = $1,215,000 = $45 per DL hr

Actual allocation base 27,000
Step 6. Compute OH cost allocated to the Job

FOH allocated = Actual rate x Actual quantity

to Job wpp298 $45 x 88 DL hrs
= $3,960
Step 7. Compute total cost of the Job
Cost of Job wpp298:
DMs ---------------------- $4606
DL cost ---------------- 1579
FOH ---------------- 3960
Total cost of the Job $10,145
Time Period Used To Compute Indirect-Cost Rates
- Most manufacturers use an annual period as a basis for determining FOH rates. A shorter
period for averaging costs is not satisfactory.
- There are two reasons for using longer periods to calculate indirect cost rates.

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 a) The numerator reason (indirect-cost pool)
- A shorter period for averaging costs is not satisfactory because wide variation can occur in
the amount of FOH costs from periods to period as a result of seasonal and non-seasonal
costs.
• Seasonal costs - for example heating costs, air conditioning costs in hot seasons, which
are part of FOH costs, are incurred only during the cold season, and hot season
(months). So if monthly rate is used this cost will be charged to only units produced in
these seasons.
• Non-seasonal costs - for example repair costs may be extremely high in certain months
of the year and low in others. The fact that the repair costs were actually incurred in
certain months does not mean that products manufactured during that time should bear
all repair costs. The same is true for costs of vacation pay and holiday pay.

2. The denominator reason (quantity of the allocation base)

- The need to spread monthly fixed indirect costs over fluctuation levels of monthly output
(allocation base)(the denominator).
E.g. Assume an OH rate based on direct labor hours. If depreciation for a month is
$20,000 and expected direct labor hours that month are 40,000 hours. The OH rate
includes an amount equal to 50 cents per DL hrs for depreciation. However, if
expected DL hrs are 80,000 in the following month, the OH rate for that month will
include 25 cents per DL hr for depreciation.
The calculation of monthly indirect cost rate is affected by the number of workdays in
a month.
 Pooling all indirect costs together over the course of a full year and calculating a single
annual indirect cost rate helps to smooth the effect of the above problems on the cost of a
specific cost object.

Normal Costing: Normal Job Costing Systems in Manufacturing Firms

- Now you know an annual OH rate is preferable to OH rates calculated on a weekly or
monthly basis for the above reasons. What does this mean to a company that uses actual
costing? This means to know the actual cost of its product (job), the company will have to
wait until the end of the year.
- However, mgt cannot wait until the end of the year, or even until the end of the month, to
find out how much a particular job costs. Cost data are most useful when they are
immediately (timely) available.
- The cost accountant is usually expected to report the total cost of a job as soon as it is
finished. At this time the actual total OH costs are not available, as they would be at the end
of a fiscal period. As a solution predetermined (POR) or budgeted OH rates are calculated
for each cost pool at the beginning of a fiscal year, and OH costs are allocated to jobs as
work progresses.
- A POR is an estimate of the amount of OH expense that a company will incur for every unit
of some activity (called a cost driver) that is consumed.
- Using the budgeted OH (OH application) rate gives rise to Normal costing.
- Normalizing applies the same amount of overhead to jobs during the year, regardless of when
jobs were worked on or when overhead was incurred during the year.

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 Example 2: Refer to example 1 and compute the cost of Job WPP 298 using Normal
costing
Solution
The real part of the computation starts from step 5
Step 5 FOH allocation rate?
Budgeted FOH rate = Budgeted OH = $ 1,120,000 =$40/DL hr
Budgeted alloc. base 28000hrs
Step 6. FOH allocated (applied) to Job Wpp 298?

FOH allocated = budgeted FOH rate × actual quantity

$40 × 88hrs $3,520
Step 7. Cost of Job Wpp298?
DM 4606
DL 1579
FOH 3520
$9705

Explanation of Transactions (Cost Flows)- Perpetual System Assumed

- One of the jobs started and completed by Robinson Company during the month of February,
Year 3 was job WPP 298. But other jobs were also being made during the same month even
if we were concerned with job WPP 298. All the transactions relating to manufacturing and
nonmanufacturing activities in February, Year 3 for several jobs is given below:
a) Purchases of materials (direct and indirect) on credit $89,000
Journal entry: Materials control ------------- 89,000
Accounts payable control ------------- 89,000
Both have the word control because they are general ledger accounts.
b) Materials sent to the manufacturing plant floor: DMs $81,000 and Indirect materials
$4000
Journal entry: WIP control ------------------81,000
Mfg OH control ------------- 4000
Materials control -------------------- 85,000
The cost of RMs sent to the mfg plant and remaining in store can be determined using
the different cost flow assumptions-SI, FIFO, LIFO, WA. The LCM method should
also be applied to value RM inventory.
c) Total mfg payroll for February: direct $39000 ; indirect,$15000

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 Journal entry: WIP control ------------------39,000
Mfg OH control ------------- 15000
Materials control -------------------- 54,000

Note that total factory payroll may be charged to the factory payroll clearing account
until enough information is available to distribute these costs to the work in process
and factory overhead accounts.
Factory Payroll Clearing xx
Wages & Salaries Payable xx
Withholding Accounts xx
To record the factory payroll.

Wages & Salaries Payable xx

Cash xx
To record the payment of the factory payroll

Factory Overhead Control xx

Factory Payroll Clearing xx
To record the indirect labor costs.
Work in Process Control xx
Factory Payroll Clearing xx
To record the direct labor costs

d) Payment of total mfg payroll for februry,$54,000

Journal entry: Wages payable control --------- 54,000

Cash control ------------------------ 54,000
e) Additional mfg OH costs incurred during February, $75,000. These costs consist of
engineering and supervisory salaries, $44000; plant utilities and repairs, $4000; plant
depreciation, $18000; and plant issurance, $2000.
Journal entry: Mfg OH control ----------------- 75,000
Salaries payable control ----------------- 44,000
A/P control ----------------------------- 11,000
Accumulated depreciation control ------ 18,000
Prepaid Insurance control ----------------- 2000

f) Allocation of manufacturing OH to Jobs, $80,000

We assume 2,000 actual DL hrs were used for all jobs in February Year 3
$40 × 2,000 hrs = $80,000
From the 2,000 hours Job WPP 298 used 88 hours only. So OH cost allocated to it will be:
88 hrs × $40 = $3,520

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 Overhead cost computed is entered in the Manufacturing Overhead Applied section of the
individual job cost sheet
Manufacturing overhead is applied to Work-in Process using the predetermined rate. The
offsetting credit entry is to the Manufacturing Overhead allocated account.
Journal entry: WIP control ----------------80,000
Mfg OH allocated -----------------80,000
When predetermine OH rates are used, OH is applied at the end of the period or at
completion of production, whichever is earlier.

FOH can be recorded either in a separate accounts for actual and applied OH or in a single
account. If actual and applied accounts are separate, the applied account is a contra account
to the actual OH account and is closed against it at year-end. Both are temporary accounts.

g) Completion and transfer to finished goods of 12 individual jobs, $188,800. Job no.
298 was one of the jobs completed in February at a cost of $9705
Journal entry: Finished Goods Control ----------188,800
WIP Control ------------------ 188,800

Job order-cost sheet for completed jobs are removed from the WIP subsidiary ledger and
become the subsidiary ledger for the finished goods inventory control account.

h) Cost of goods sold, $180,000. Job 298 was one of the jobs sold and delivered to
customers in February.
Journal Entry: COGS ----------------------- 180,000
Finished goods --------- 180,000

i) Marketing and customer service payroll and advertising costs accrued for February :

Mktg dept. salaries ----- $35000

Advertising costs ------- 10,000
Customer-service costs -- 15000
$60,000
Journal entries:

Mktg and advertising costs ------ 45,000

Customer service costs ------------ 15,000
Salaries payable ------------ 50,000
A/P control ------------------ 10,000
Nonmanufacturing Costs and Job Costing
- In chapter two we pointed out that companies use product costs for different purposes.
- For external reporting purpose product costs include only manufacturing costs. But for
pricing, product-mix, and cost management decisions product costs include
nonmanufacturing costs such as marketing and customer service costs. For the latter purpose

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 we can trace direct nonmanufacturing costs to the job and use a budgeted cost rate to allocate
indirect nonmanufacturing costs to the job. This is the same approach to job costing we
followed for manufacturing costs.
- By assigning both manufacturing costs and nonmanufacturing cost to jobs, we can compare
all costs of the different jobs against the revenues they generate and evaluate their
contribution to the overall profit.

Budgeted Indirect Costs and End-Of Period Adjustments: The Three Approaches In
Accounting for Under-allocated And Over-allocated Mfg OH

- Though budgeted rates have advantages of obtaining timely cost of products, it is likely to be
inaccurate because they are based on estimates. So inevitably, FOH costs applied to the Work
in Process account and actual FOH costs incurred during a particular period will differ.
- The difference between actual overhead for the period, and estimated overhead for the period
is called the Overhead Variance.
If Estimated (applied) < Actual:
 Overhead is Under-applied (meaning the actual overhead costs for the period exceed the
amount of overhead added to jobs.)
If Estimated (applied) > Actual:
 Overhead is Over-applied (meaning the amount of overhead applied to jobs is greater
than the actual overhead incurred by the company.)
- Two separate Mfg OH accounts and their related balance in our example are as follows:

Mfg OH Control Mfg OH Applied

Dec.31 Dec.31, Year 3

Year 3 1,215,000 $1,080,000

The $135000 difference (1,215,000 – 1,080,000) net credit is under-applied amount.

Why are Actual and Applied Overhead Costs Different?
- The reasons actual and applied overhead costs are different are frequently separated into two
categories.
1) The numerator reason-- The actual quantities used and actual prices paid for the
various indirect resources are different from the prices and quantities estimated or
budgeted for the overhead rate calculation. This causes the spending variance (or
Budget Variance)
Inefficient use and control of FOH (Inefficiency in production) or inability to
accurately forecast overhead costs (poor estimation of the budget may be the reasons
for this. For example, overestimating of factory overhead will result in over-applied
OH. Over-applied OH can also result when actual overhead costs are lower than
expected.

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 2) The denominator reason- The actual level of activity is different from the activity
level used to calculate the overhead rates. This causes the production volume variance
(Overhead Activity Variance).
For example, overestimating the activity base used in the denominator of the
predetermined rate will result in under-applied OH. Underestimating the cost allocation
base will result in over-applied overhead.
- Accumulation of a larger under-applied balance is more serious than a trend in the opposite
direction any may indicate: inefficiency in production methods, excessive expenditures or a
combination of factors.
- Small under applied overhead balance would also seem to indicate that the cost allocation
base (cost driver) was a good one.
Disposition Of Under/Over applied FOH Balance
- At the end of each month the amount of over applied OH/under-applied OH is transferred to
the following month, being reported in the interim balance sheet in deferred charge if under
applied under prepaid expenses. And any over applied balance as deferred credit or in the
interim income statement as a line item below COGS. An under applied balance in one
period will be offset by over applied by another month.
- But as this balance is applicable to the operations of the year just ended, the balance will not
appear on the end-of-year balance sheet. The ending balances in Mfg OH Control and Mfg
OH allocated are temporary accounts which should be closed at the end of the year.
- Three approaches to close the under/over applied OH balance:
i) The adjusted allocation-rate
ii) The proration approach and
iii) The write-off to COGS(Immediate write-off)

i) Adjusted Allocation-Rate Approach

- Restates all OH entries in the general ledger and subsidiary ledgers using actual cost rates
rather than budgeted cost rates.
- The effect is that job-cost sheets (records), the inventory accounts(except RM inventory), and
cost of goods sold are accurately stated with respect to actual overhead.
- This means of disposing of variances is costly but has the advantage of improving the
analysis of product profitability. But the improvements in information technology and
decreases in its cost have made this method more appealing.

Adjustment = Actual FOH - Applied FOH = Actual OH rate - Budgeted OH rate

FOH applied Budgeted OH rate

. = 1,215,000 - 1,080,000 = $45 - $40

1,080,000 $40

= 0.125 or 12.5%
Actual OH exceeds the FOH applied by 12.5%

Now return to our example job No. 298

Under normal costing the Mfg OH allocated to the job is $3,520 .

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 Adjustment: (1 + 0.125) $3520 = $3,960

So the adjusted amount of Mfg OH allocated to job No.298 equals $3,960. Note that under
actual costing, mfg OH allocated on this job is $3,960

ii) Proration Approach

- This involves allocation of the balance among WIP, Finished goods and COGS accounts on
the basis of the total amount of applied FOH included in those accounts at the end of the
year.
- Note that the proration approach does not adjust individual job-cost records (sheets)
- Material inventories are not included in this proration.

E.g Assume actual results for Year 3:

A/C balance Mfg OH
before proration included
WIP Control $50,000 $16,200
FDG Control 75,000 31,320
COGS 2,375,000 1,032,480
$2,500,000 $1,080,000
 The proration of the under applied FOH is done as follows:

 Journal entry to record the proration and close the under allocated OH:
WIP Control ------------------------ 2,025
Finished goods Control ----------- 3,915
COGS ------------------------------- 129,060
Mfg OH allocated ----------------- 1,080,000
Mfg OH Control --------------- 1,215,000
 Account balance after proration(adjustment) :
WIP Control = $50,000 + $2,025 = $52,025
FDG Control = $75,000 + $3,915 = $78915
COGS = $2,375,000 + $129,060 $2,504,060
- If FOH had been over allocated, the four accounts would have been decreased (credited)
instead of increased.
- The above journal entry restates the Year 3 ending balances for WIP, Finished goods, and
COGS to what they would have been, if actual indirect-cost rates had been used rather than

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 budgeted indirect-costs rates. This method reports the same ending balance in the general
ledger as the adjusted allocation-rate approach.
- Some companies prorate based on the total ending account balances in work in process,
finished goods, and cost of goods sold. But this method gives the same result as the previous
proration only if the proportions of FOH costs to total costs, and therefore direct costs, are
the same in WIP, FDG, and COGS accounts which is rarely true. But its use is justified as
being less complex way of approximating the more accurate results from using indirect costs
allocated particularly when the FOH applied component in each account is not readily
available.

iii) Write-off to COGS

- This is the simplest approach. Any over/under applied FOH cost is written off as an
adjustment to COGS as long as the difference is not material.
- If OH has been under applied, less OH was charged to production than was incurred.
Therefore, COGS is understated, and the amount of the understated OH is added to COGS on
the income statement.
- If OH has been over applied, the opposite is true and COGS is overstated, and the amount of
overstated OH is subtracted from COGS.
Journal Entry:

COGS ---------------------- 135,000

Mfg OH applied --------- 1,080,000
Mfg OH control ----- 1,215,000
The companies two Mfg OH accounts are closed with the difference between them included
in COGS.

Choice Among Approaches

- Which of these three approaches is the best one to use? In making this decision, managers
should be guided by how the resulting information will be used.
- If mangers intend to develop the most accurate record of individual job costs for profitability
analysis purposes, the adjusted allocation-rate approach is preferred. If the purpose is
confined to reporting the most accurate inventory and cost of goods sold figures in the
financial statements, proration based on the manufacturing overhead-allocated components in
the ending balances should be used because it adjusts balances to what they would have been
under actual costing.
- If the amount of under-allocated or over allocated is small- in comparison to total operating
income or some other measuring of materiality- the write-off to COGS approach yields a
good approximation to more accurate, but more complex, approaches. In this case the use of
this approach is justified by the cost benefit approach.

Multiple Overhead Cost Pools

- A plant-wide overhead rate is a single overhead rate used throughout all departments of a
company. If all production departments in a manufacturing business have the same mix of

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 labor and machine, and all jobs require the same amount of work in a given department, then
it is appropriate to use a single, plant-wide overhead rate.
- However, if some departments are machine intensive and some are labor intensive, then the
amount of overhead applied will not approximate the overhead used in all departments. If we
use DL hours as the activity base in a labor intensive department, this will give a good result
but if we use DL hours in a machine intensive environment that has few labor hours actually
worked, the result will be very unsatisfactory. Machine-intensive departments typically use a
lot of overhead cost but if there are few labor hours and the rate is applied on the basis of DL
hours, little overhead will be applied.
- Even if all departments are labor intensive, the amount of labor time required for each job
might vary from one department to another. This could still result in imprecise application of
OH costs to a given job if a single labor based plant-wide rate was used for all departments.
- By using separate departmental overhead rates, the OH applied can be tailored to the specific
needs of a particular job. This will lead to more precise costing of products, which can be
critical if the business has to bid for jobs. But remember an important point: cost-benefit
guideline. The benefit of having this system to have more accurate information should
exceed the costing system adopted.

Example:
ABC Company uses Job costing system. The plant has a machining department and an
assembly department. It has two direct cost categories(DMs and Direct mfg labor) and two
mfg OH cost pools( the machining department OH, allocated to jobs based on actual
machine hours, and the assembly department OH, allocated to jobs based on actual direct
mfg labor cost
Budgeted amounts for the year:
Machining Assembly

Mfg OH ------------------------------ $48,000 $360,000

Direct mfg labor cost ---------------- 350,00 720,000
Direct mfg labor hrs ----------------- 50,000 80,000
Machine hrs ----------------------- 100,000 35,000
During October, the job cost sheet for job No.160 listed the following:
Machining Assembly
DMs used --------------- $12,000 $ 20,000
DL cost used ------------- 1400 4860
DL hrs --------------------- 200 540
Machine hrs -------------- 2000 700

The actual results for the year were as follows:

Machining Assembly
Mfg OH --------------- $390,000 $330,000
DL cost----------------- 300,000 750,000
DL hrs ------------------ 37500 78,125
Machine hrs -------------- 78,000 30,000

By: Tsegazeab Teklemariam Page 15 of 25

Required: Compute the cost of Job No. 160 using actual costing and normal costing

Solution: Actual Costing

The real part of the computation starts from step 5

Step 5. Actual FOH allocation rate?
Machining Assembly
Actual FOH rate = Actual OH = $390,000 $330,000
Actual allocation base 78,000hrs $750,000
= $5/DL hr 44%

Step 6 and 7. FOH cost allocated to the Job and total cost of the Job
Product Machining Assembly
Job No.160:
DM $12,000 $20,000
DL 14,000 4,860
FOH (actual)
($5 ×2000hrs) 10,000
(44%×4,860) 2138.40
Total $23,400 $26,998.40

Total cost of the job is $23,400 + $26,998.40 = $50,398.40

Solution: Normal Costing

Step 5. Budgeted FOH allocation rate?

Machining Assembly
Budgeted FOH rate = Budgeted OH = $ 480,000 $360,000
Budgeted alloc. base 100,000hrs $720,000
= $4.80/hr 50%
Step 6 and 7. FOH cost allocated to the Job and total cost of the Job
Product Machining Assembly Total
Job No.160:
DM $12,000 $20,000 $32,000
DL 1,400 4,860 6,260
FOH (actual)
($4.8 x2000hrs) 9,600
(50%x4860) 2,430 12,030
Total $23,000 $27290 $50,290

Note that the general ledger would contain FOH Control and FOH allocated amount for each
cost pool under normal costing not actual costing. End of period adjustments for under/over
allocated OH costs would be made separately for each cost pool.

By: Tsegazeab Teklemariam Page 16 of 25

Note also that the disposal of any under/over allocated overhead in each department is made
in a similar fashion as discussed previously but separately for each department

Process Costing
 A process costing is most commonly used in industries that produce essentially
homogeneous (i.e. uniform) products on a continuous basis.
 Firms producing distinct and unique products use job order costing where as firms
producing similar or identical units use process-costing system.
 Process costing system accumulate costs by department for a period of time, just as a
job order costing system accumulate costs by job, and the total cost then will be
assigned to the units produced during that period.
Similarities between job-Order and Process Costing
1. The same basic purposes exist in both systems, which are to assign material, labor,
and overhead cost to products and to provide a mechanism for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts, including
MO, Raw Materials, Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both
systems.
Differences between Job-Order and Process Costing

Job-Order Costing Process Costing

1. Many different jobs are worked on 1. A single product is produced either on a
during each period, with each job having continuous basis for long periods of time.
different production requirements. All units of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the
controlling the accumulation of costs by a key document showing the accumulation
job. and disposition of costs by a department.
4. Unit costs are computed by job on the 4. Unit costs are computed by department
job cost sheet. on the department production report.

 In manufacturing process costing setting, each unit is assumed to receive the same
amount of direct materials cost, direct manufacturing labor costs, and indirect
manufacturing costs. Units are computed by dividing total costs by the number of
units.
 The principal difference between process costing and job costing is the extent of
averaging used to compute unit costs of products or services. In job-costing system,
individual jobs use different quantities of production resources. Thus, it would be
incorrect to cost each job at the same average production cost.

By: Tsegazeab Teklemariam Page 17 of 25

  In contrast, when identical or similar units of products or services are mass produced,
and not processed as individual jobs, process costing averages production costs over
all units produced.
 The difference between job order and process costing system is, thus, the
extent of the averaging used to compute unit cost. In job order costing each
job differs in terms of material used, labor incurred, and manufacturing
overhead. Hence, it is impossible to assign the same cost for different jobs. On
the contrary, identical units produced in mass took equal amount of direct
material, direct labor, and manufacturing overhead. Thus, the unit cost can be
found by dividing total cost by the number of units produced.
Cost Accumulation Methods in Process Costing System
 When a firm produces identical lots of goods repetitively, maintaining a separate job
cost sheet would be unnecessarily expensive. The aggregate cost and the unit cost can
be computed without a job cost sheet, thus saving the costs associated with producing
such records.
 Costs accumulate by department over a certain period and the unit cost can be found
by dividing the total cost to the units produced during that period. Process costing
system fit among others to, paint manufacturers, oil refineries, sugar refineries, and
salt producers.
 In process costing system, manufacturing costs, direct material, direct labor, and
manufacturing overhead costs are accumulated in the same way as job order costing
system. However, the costs are accumulated by department over some period of time
than by individual jobs.
 The time period over which the cost is to be accumulated depends on the information
needs of the company. It can be a week, two weeks, but no longer than a month most
often. Cost accumulation is much simpler for a process costing system than for a job
order cost system.
Case 1: Process costing with zero beginning and zero ending work in process inventory
that is all units are started and fully completed by the end of the accounting period.
Illustrating Process Costing
Haron Chemical Company makes different chemicals and uses process costing system to
account for its operation. One of its products, namely Product A, is produced in two
processing departments: the Mixing Department and the Bottling Department. Product A is
marketed in one-liter bottles.
Part I: Mixing Department
In the Mixing Department, various ingredients are added at the start of the process and costs
are accumulated in two pools, one for direct material and another for all conversion costs.
Direct material is added at the beginning of the process and conversion costs are applied
evenly through out the process. Data for the first month of operation (September) of the
Mixing Department is given below:
Physical Units, Costs and Stages of Completion

Beginning work in process 0 units

Started during the month 1,000 units
Completed during the month 1,000 units
Direct material costs Br. 80,000

By: Tsegazeab Teklemariam Page 18 of 25

 Conversion costs Br. 40,000
Ending work in process 0 units
Total cost of production for the month is computed as follows:
Direct material costs-------------------------------80,000
Conversion costs-------------------------------------40,000
Total cost--------------------------------------------120,000
Unit cost
Direct material------------------80(80,000/1000)
Conversion cost-----------------40(40,000/1000)
Total------------------------------120(120,000/1000)
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the second month of operation (October) of the Mixing Department is given
below: Physical Units, Costs and Stages of Completion
Beginning work in process 0 units
Started during the month 2,000 units
Completed during the month 800 units
Ending work in process (60% completed as to 1,200 units
conversion costs.)
Direct material costs Br. 160,000
Conversion costs Br. 91,200
How should the co. calculate the cost of fully assembled units in and the cost of partially
assembled units still in process at the end of September?
Steps:
 Summarize the flow of physical units of output.
 Compute output in terms of equivalent units.
 Compute equivalent unit costs.
 Summarize total costs to account for.
 Assign total costs to unit’s completed and to units in ending work in process.
Equivalent Units: A key Concept
 Material, labor and overhead costs are incurred at different rates in production
process. Direct material usually placed in production at one or more discreet points in
the process. In contrast, direct labor and manufacturing overhead, called conversion
costs, and usually are incurred continuously throughout the process.
 When an accounting period ends, the partially completed goods that remain in
process generally are at different stages of completion with respect to material and
conversion activity.
Physical units and Equivalent units (Step 1&2)
Equivalent units is a derived amount of output units that takes the quantity of each input
(factor of production) in units completed or in work in process, and converts it into the
amount of completed output units that could be made with that quantity of input.
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Conversion costs
Material
Beginning work in process 0 units
Started during the month 2,000 units
Total units to Account for 2,000 units

By: Tsegazeab Teklemariam Page 19 of 25

Completed during the month 800 800 800
Work in process ending 1,200 1,200 720
Total units accounted for 2,000
Work done current period 2,000 1,520

Production cost report Total Direct material Conversion cost

production cost
cost
Costs added this period 251,200 Br. 160,000 Br. 91,200
Equivalent units 2,000 1,520
Equivalent unit cost (Step-3) 80 60
Total cost to account for(st-4) 251,200
Assignment of cost (step-5)
Completed& transferred out 112,000 800*80 800*60
W/P ending: Direct material 96,000 1,200*80
Conversion cost 43,200 720*60
Total W/P ending 139,200
Total cost accounted for 251,200
Journal entries
W/P mixing department------------160,000
A/P------------------------------------------160,000
W/P mixing department-----------------91,200
Various accounts-----------------------------------------91,200
Case 3: Process costing with some beginning and some ending work in process
inventory.
Data for the third month of operation (November) of the Mixing Department is given
below:
Beginning work in process 1,200 units
Started during the month 1,000 units
Completed during the month 1,600 units
Ending work in process (50% completed as to 600 units*
conversion costs.)
Direct material costs Br. 69,000
Conversion costs Br. 70,800

Weighted-Average process costing method

 This method calculates the equivalent unit cost of the work done to date
(regardless of the period in which it was done) and assigns this cost to
equivalent units completed and transferred out of the process and to
equivalent units in ending work in process inventory.
 The weighted average cost is the total of all costs entering in the work in
process account (regardless of whether it is from the beginning work in
process or from work started during the period) divided by total equivalent
units of work done to date.

By: Tsegazeab Teklemariam Page 20 of 25

 Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in 1,200
process
Started during the month 1,000
Total units to Account for 2,200
Completed during the 1,600 1,600 1,600
month
Work in process ending 600 600 300
Total units accounted for 2,200
Work done to date 2,200 1,900

Production cost report Total Direct material Conversion cost

production cost
cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Cost incurred to date 165,000 114,000
Equivalent units 2,200 1,900
Equivalent unit cost (Step-3) 75 60
Total cost to account for(st-4) 279,000
Assignment of cost (step-5)
Completed& transferred out 216,000 1,600*75 1,600*60
W/P ending: Direct material 45,000 600*75
Conversion cost 18,000 300*60
Total W/P ending 63000
Total cost accounted for 279,000

Journal entries
W/P mixing department------------69,000
A/P------------------------------------------69,000
W/P mixing department-----------------70,800
Various accounts-----------------------------------------70,800
W/P mixing department-----------------216,000
W/P Bottling department --------------------------------216,000
First-in, First-out Method
 The FIFO process costing method assigns the cost of the previous period’s equivalent
units in beginning work-in process inventory to the first units completed and
transferred out of the process, and assigns the cost of equivalent units worked on
during the current period first to complete beginning inventory, then to start and
complete new units in ending work in process inventory.

By: Tsegazeab Teklemariam Page 21 of 25

  This method assigns that the earliest equivalent units in the work in process-
Assembly account are completed first.
 A distinct feature of the FIFO process-costing method is that work done on beginning
inventory before the current period is kept separate from work done in the current
period.
 Costs incurred in the current period and units produced in the current period are used
to calculate costs per equivalent unit of work done in the current period.
 In contrast equivalent unit and cost per equivalent unit calculations in the weighted
average method merge the units and costs in beginning inventory with units and costs
of work done in the current period.

Step-1 Step-2 Equivalent units

Flow of production Physical units Direct Material Conversion costs
Beginning work in process 1,200
Started during the month 1,000
Total units to Account for 2,200
Completed during the month
From beginning 1,200 480
Started and completed 400 400 400
Work in process ending 600 600 300
Total units accounted for 2,200
Work done only current period 1,000 1,180

Production cost report Total production Direct material cost Conversion cost
cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Work done only current period 1,000 1,180
Equivalent unit cost (Step-3) 69 60
Total cost to account for(st-4) 279,000
Assignment of cost (step-5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 139,200
Cost to complete these units:
Direct Materials 0 0*69
Conversion costs 28,800 480*60
Total cost from beginning 168,000
Started and completed 51,600 400*69 400*60
Total Completed& transferred out 219,600
W/P ending: Direct material 41,400 600*69
Conversion cost 18,000 300*60
Total W/P ending 59,400
Total cost accounted for 279,000

Journal entries
W/P mixing department------------69,000
A/P------------------------------------------69,000
W/P mixing department-----------------70,800
Various accounts-----------------------------------------70,800
W/P bottling department-----------------219,600
W/P mixing department --------------------------------219,600

By: Tsegazeab Teklemariam Page 22 of 25

 Transferred-in Costs in Process Costing
 Transferred-in costs also called previous department costs are the costs
incurred in a previous department that are carried forward as the product’s
cost when it moves to a subsequent process in the production cycle. That is as
the units move from one department to the next, their costs are transferred
with them.
 Transferred in costs are treated as if they are a separate type of direct material
added at the beginning of the process. In other words, when successive
departments are involved, transferred units from one department become all or
a part of the direct materials of the next department; however they are called
transferred-in costs, not direct material costs.
Assume the following data for Haron Chemicals during the month of November in the
Bottling department
Physical units Transferred in costs Direct material costs Conversion costs
Beginning work in process 1,200 units 100% complete 0% complete 75% complete
Transferred-in during the month 1,600 units
Completed during the month 2,000 units
Ending work in process 800 units 100% complete 0% complete 50% complete

Costs
Beginning work in process:
Transferred in costs (1,200 x Br. 170) Br. 204,000
Direct material costs 0
Conversion costs 90,000
Transferred in during the month:
Weighted average 216,000
First-in, first-out 219,600
Direct material costs incurred during the month 60,000
Conversion costs incurred during the month 150,000

Transferred-in Costs and Weighted average method

Step-1 Step-2 Equivalent units
Flow of production Physical units Transferred-in costs Direct Material Conversion
costs
Beginning work in process 1,200
Transferred in during the month 1,600
Total units to Account for 2,800
Completed during the month 2,000 2,000 2,000 2,000
Work in process ending 800 800 0 400
Total units accounted for 2,800
Work done to date 2,800 2,000 2,400

Production cost report Total production cost Transferred-in costs Direct material cost Conversion cost
Beginning W/P Br294,000 204,000 0 Br. 90,000
Current period cost 426,000 216,000 60,000 150,000
Cost incurred to date 420,000 60,000 240,000
Equivalent units 2,800 2,0 00 2,400
Equivalent unit cost (Step-3) 150 30 100

By: Tsegazeab Teklemariam Page 23 of 25

 Total cost to account for(st-4) 720,000
Assignment of cost (step-5)
Completed& transferred out 560,000 2000*150 2,000*30 2,000*100
W/P ending: Transferred-in 120,00 800*150
Direct material 0 0*30
Conversion cost 40,000 400*100
Total W/P ending 160,000
Total cost accounted for 720,000

Journal entries
W/P bottling department------------60,000
A/P------------------------------------------60,000
W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
Finished goods-----------------560,00
W/P Bottling department --------------------------------560,000

Transferred-in Costs and FIFO method

Step-1 Step-2 Equivalent units

Flow of production Physical units Transferred-in costs Direct Material Conversion costs
Beginning work in process 1,200
Transferred-in during the month 1,600
Total units to Account for 2,800
Completed during the month
From beginning 1,200 0 1,200 300
Transferred-in and completed 800 800 800 800
Work in process ending 800 800 0 400
Total units accounted for 2,200
Work done only current period 1,600 2,000 1,500

Production cost report Total production cost Transferred-in costs Direct material cost Conversion cost
Beginning W/P Br294,000 Br204,000 Br. 0 Br. 90,000
Current period cost 429,600 219,600 60,000 150,000
Work done only current period 1,600 2,000 1,500
Equivalent unit cost (Step-3) 137..25 30 100
Total cost to account for(st-4) 723,600
Assignment of cost (step-5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 294,000
Cost to complete these units:
Transferred-in costs 0 0*137.25
Direct Materials 36,000 1,200*30
Conversion costs 30,000 300*100
Total cost from beginning 360,000
Started and completed 213,800 800*137.25 800*30 800*100
Total Completed& transferred out 573,800
W/P ending: Transferred-in 109,800 800*137.25
Direct material 0 0*30
Conversion cost 40,000 400*100
Total W/P ending 149,800
Total cost accounted for 723,600

By: Tsegazeab Teklemariam Page 24 of 25

Journal entries
W/P bottling department------------60,000
A/P------------------------------------------60,000
W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
Finished goods-----------------573,80
W/P Bottling department --------------------------------573,800

By: Tsegazeab Teklemariam Page 25 of 25