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Managerial Accounting Unit 2: Job-Order Costing

Job-order costing assigns costs to individual jobs, using a predetermined rate to apply overhead. You will learn to cost a job, follow costs through the accounts and fix over- or underapplied overhead.

Covers: When to use job-order costing, Predetermined overhead rate, Job cost sheets and source documents, Flow of costs through the accounts, Over- and underapplied overhead, Disposing of over/underapplied overhead, Plantwide vs. departmental rates

Study guide

Companies that make unique products or batches to order, such as print shops, custom homebuilders, law firms and repair shops, use job-order costing. Each job gets a job cost sheet that collects its direct materials, direct labor and overhead. Direct materials reach the sheet through materials requisition forms, and direct labor through time tickets showing who worked on which job and for how long. Direct costs are easy to trace. Overhead is the hard part: costs such as factory rent and supervision cannot be traced to any one job, and many arrive unevenly or are unknown until year-end.

To cost jobs while they are in progress, companies compute a predetermined overhead rate before the year starts: estimated total overhead divided by the estimated total of an allocation base, such as direct labor-hours, machine-hours or direct labor cost. A good base is a cost driver, something that actually causes overhead. During the year, overhead is applied to each job as the rate times the actual amount of the base the job used. For example, with a $20 rate per machine-hour, a job using 30 machine-hours receives $600 of overhead. Applying overhead this way gives managers a timely job cost to use in pricing and bidding.

Costs flow through the accounts in a fixed pattern. Direct materials and direct labor are debited to Work in Process. Indirect materials, indirect labor and other actual factory costs are debited to Manufacturing Overhead. Applying overhead debits Work in Process and credits Manufacturing Overhead. When a job is finished, its cost moves from Work in Process to Finished Goods, and when it is sold the cost moves to Cost of Goods Sold. Selling and administrative costs never enter these accounts; they are expensed directly as period costs. Tracing each step in T-accounts is the best way to check your work.

Because the rate is based on estimates, applied overhead rarely equals actual overhead. If actual exceeds applied, overhead is underapplied (a debit balance remains in Manufacturing Overhead); if applied exceeds actual, it is overapplied (a credit balance). At year-end, a small difference is usually closed to Cost of Goods Sold: underapplied overhead increases COGS and overapplied decreases it. A large difference may be prorated among Work in Process, Finished Goods and COGS in proportion to the overhead applied in each. Companies with very different departments may use departmental rates instead of one plantwide rate to cost jobs more accurately.

Key ideas

• Job-order costing fits custom, distinct products; process costing fits identical, continuous output.
• Predetermined overhead rate = estimated overhead ÷ estimated allocation base, set before the year.
• Applied overhead = predetermined rate × actual amount of the base used by the job.
• Costs flow from Work in Process to Finished Goods to Cost of Goods Sold.
• Actual overhead is debited to Manufacturing Overhead; applied overhead is credited to it.
• Underapplied overhead (actual > applied) increases COGS when closed; overapplied decreases it.
• Departmental rates are more accurate than a plantwide rate when departments use different cost drivers.

Formulas and rules

Common mistakes

• Applying overhead with the estimated base instead of the actual base used by the job.
• Comparing actual overhead with estimated overhead instead of with applied overhead.
• Reversing the meaning of underapplied and overapplied when closing to COGS.
• Debiting indirect materials or indirect labor directly to Work in Process.
• Including sold jobs in Finished Goods or unfinished jobs in COGS.

Before the test, make sure you can

• Identify businesses that should use job-order costing.
• Calculate a predetermined overhead rate and apply overhead to a job.
• Compute the total and per-unit cost of a job.
• Record the flow of costs from raw materials to WIP, Finished Goods and COGS.
• Calculate over- or underapplied overhead and say which it is.
• Close over/underapplied overhead to COGS or prorate it, and state the effect on income.
• Compare job costs under plantwide and departmental overhead rates.

Words to know

Job-order costing

A costing system that accumulates costs separately for each job or batch.

Job cost sheet

The record that collects direct materials, direct labor and applied overhead for one job.

Materials requisition form

A source document authorizing materials to be taken from the storeroom and charged to a job or overhead.

Time ticket

A record of the hours each worker spent on each job, used to charge direct labor.

Allocation base

A measure such as labor-hours or machine-hours used to assign overhead to jobs.

Cost driver

An activity or factor that causes overhead cost to be incurred.

Predetermined overhead rate

Estimated overhead divided by the estimated allocation base, set before the period.

Applied overhead

Overhead charged to jobs: predetermined rate times the actual base used.

Underapplied overhead

Actual overhead greater than applied overhead; a debit balance in Manufacturing Overhead.

Overapplied overhead

Applied overhead greater than actual overhead; a credit balance in Manufacturing Overhead.

Proration

Spreading over- or underapplied overhead among WIP, Finished Goods and COGS by their applied overhead.

Plantwide overhead rate

A single overhead rate used for the entire factory.

Departmental overhead rate

A separate overhead rate for each production department, often with its own base.

Cost-plus pricing

Setting price by adding a markup percentage to cost.

Sample practice questions

30 more questions like these, from level 1 to 5, are in the practice set.