Managerial Accounting, 10th Edition Susan V. Crosson Belverd E. Needles Solutions manual and test bank

Managerial Accounting, 10th Edition Susan V. Crosson Belverd E. Needles Solutions manual and test bank

Chapter 2

Costing Systems: Job Order Costing

Learning Objectives

1. Distinguish between the two basic types of product costing systems, and identify the information that each provides.

2. Explain the cost flow in a manufacturer’s job order costing system.

3. Prepare a job order cost card, and compute a job order’s product or service unit cost.

4. Explain cost allocation, and describe how allocating overhead costs figures into calculating product or service unit cost.

5. Explain why unit cost measurement is important to the management process in producing business results.

Section 1: Concepts

Concepts

• Cost measurement
• Cost recognition
• Matching rule (accrual accounting)

Lecture Outline

I. A product costing system is used to account for an organization’s product costs and to provide timely and accurate unit cost information for pricing, cost planning and control, inventory valuation, and financial statement preparation.

II. Two basic types of product costing systems have been developed:

A. Job order costing systems:

1. Measure and recognize the costs of direct materials, direct labor, and overhead to a specific batch of products or a specific job order.

2. Use job order cost cards.

B. Process costing systems:

1. Are used by companies that produce large amounts of similar products or that have long, continuous production runs of identical products.

2. Use process cost reports.

C. More typical is the operations costing system, which is a hybrid that combines parts of the job order and process costing systems.

Summary

There are two basic types of product costing systems. A job order costing system is used by companies that make unique, custom, or special-order products. Such a system traces the costs of direct materials, direct labor, and overhead to a specific batch of products or to a specific job order. It measures the cost of each complete unit and summarizes the cost of all jobs in a single Work in Process Inventory account that is supported by job order cost cards.

A process costing system is used by companies that produce large amounts of similar products or liquid products or that have long, continuous production runs of identical products. Such a system first traces the costs of direct materials, direct labor, and overhead to processes, departments, or work cells and then assigns the costs to the products manufactured by those processes, departments, or work cells. A process costing system uses several Work in Process Inventory accounts—one for each department, process, or work cell. It assigns costs to products each period using a process cost report.

The typical product costing system, however, combines parts of job order costing and process costing to create a hybrid system known as an operations costing system.

Relevant Examples and Exhibits

· Exhibit 1 Characteristics of Job Order Costing and Process Costing Systems

Teaching Strategy

A good place to begin is by comparing and contrasting job order costing to process costing using Exhibit 1. One approach would be to discuss the exhibit as it pertains to the products or services in Short Exercise 1. Emphasize the key terms of job order, job order cost card, process costing system, process cost report, and operations costing system as you discuss this section.

Section 2: Accounting Applications

Accounting Applications

· Prepare a job order cost card

• Compute a job order’s product or service unit cost

Lecture Outline

I. The basic parts of a job order costing system are the:

A. Cost measurement and recognition procedures.

B. Electronic documents.

C. Accounts that a company uses when it incurs costs for direct materials, direct labor, and overhead.

II. Accounting for materials requires three types of entries.

A. With the purchase of materials, debit Materials Inventory and credit Accounts Payable.

B. With the transfer of direct materials to production, debit Work in Process Inventory and credit Materials Inventory.

C. With the transfer of indirect materials to production, debit Overhead and credit Materials Inventory.

III. Accounting for labor requires two types of entries.

A. For payroll costs incurred for direct labor, debit Work in Process Inventory and credit Payroll Payable.

B. For payroll costs incurred for indirect labor, debit Overhead and credit Payroll Payable.

IV. Accounting for other overhead requires two types of entries.

A. Other overhead includes plant utilities, property taxes, insurance, and depreciation.

B. To record actual overhead costs, debit Overhead and credit Cash or Accumulated Depreciation.

C. To record estimated overhead costs, debit Work in Process Inventory and credit Overhead.

D. The actual (debits) and estimated (credits) overhead costs are compared at the end of the period to determine the accuracy of overhead cost recognition.

V. To record the transfer of completed units, debit Finished Goods Inventory and credit Work in Process Inventory.

VI. When a company uses a perpetual inventory system, two accounting entries are made when products are sold.

A. To record the sold product’s sales price, debit Accounts Receivable (or Cash) and credit Sales.

B. To record the sold product’s associated costs, debit Cost of Goods Sold and credit Finished Goods Inventory.

VII. Each job in production has a job order cost card.

A. Has space for direct materials, direct labor, and overhead costs.

B. Includes the job order number, product specifications, customer name, date of order, projected completion date, and a cost summary.

C. For incomplete jobs, they make up the subsidiary ledger for the Work in Process Inventory account.

D. When a job is completed, the costs are totaled on the job order cost card.

1. Unit cost is computed to value items in inventory.

2. Product Unit Cost = Total Costs for Job ÷ Number of Good Units Produced

VIII. Job order costing systems are also used in service organizations.

A. Job order cost cards track cost-plus contracts.

IX. Overhead costs are allocated in four steps.

A. Step 1: Plan the overhead rate.

1. A predetermined overhead rate is calculated as estimated overhead costs divided by estimated cost driver activity.

B. Step 2: Apply the overhead rate.

1. Costs are assigned by multiplying the actual cost driver activity by the predetermined overhead rate.

C. Step 3: Record actual overhead costs

D. Step 4: Reconcile applied and actual overhead amounts

1. If over- or underapplied amounts are minimal, credit or debit Cost of Goods Sold.

2. If over- or underapplied amounts are material, adjustments should be made to the inventory accounts affected.

X. The traditional approach to applying overhead costs is to use a single plantwide rate.

XI. The more accurate ABC approach to applying overhead costs creates many smaller activity pools and establishes separate rates for each pool.

Summary

In a manufacturer’s job order costing system, the costs of materials are first charged to the Materials Inventory account. The actual overhead costs are debited to the Overhead account. As products are manufactured, the costs of direct materials and direct labor are debited to the Work in Process Inventory account and are recorded on each job’s job order cost card. Overhead costs are applied and debited to the Work in Process Inventory account and credited to the Overhead account using a predetermined overhead rate. They too are recorded on the job order cost card. When products and jobs are completed, their costs are transferred to the Finished Goods Inventory account. Then, when the products are sold and shipped, their costs are transferred to the Cost of Goods Sold account.

All costs of direct materials, direct labor, and overhead for a particular job are accumulated on a job order cost card. When the job has been completed, those costs are totaled. The total is then divided by the number of good units produced to find the product unit cost. The product unit cost is entered on the job order cost card and will be used to value items in inventory.

Many service organizations use a job order costing system to track the costs of labor, materials and supplies, and service overhead to specific customer jobs. Labor is an important cost for service organizations. To cover their costs and earn a profit, service organizations often base jobs on cost-plus contracts, which require the customer to pay all costs incurred plus a predetermined amount (percentage) of profit.

Cost allocation is the process of assigning indirect costs to a specific cost object using an allocation base known as a cost driver. The allocation of overhead costs requires the pooling of overhead costs that are affected by a common activity and the selection of a cost driver whose activity level causes a change in the cost pool. A cost pool is the collection of overhead costs assigned to a cost object. A cost driver is an activity base that causes the cost pool to increase in amount as the volume of activity increases. Allocating overhead is a four-step process that involves planning a rate at which overhead costs will be assigned to products or services, assigning overhead costs at this predetermined overhead rate to products or services during production, recording actual overhead costs as they are incurred, and reconciling the difference between the actual and applied overhead costs. The Cost of Goods Sold or Cost of Sales account is corrected for an amount of over- or underapplied overhead costs assigned to the products or services. In manufacturing companies, if the difference is material, adjustments are made to the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. The traditional method applies overhead costs by estimating one predetermined overhead rate and multiplying that rate by the actual cost driver level. When the activity-based costing (ABC) method is used, overhead costs are grouped into a number of cost pools related to specific activities. For each activity pool, cost drivers are identified, and cost driver levels are estimated. Overhead is applied to the product or service by multiplying the various activity rates by their actual cost driver level. The product or service unit cost is computed either by dividing the total product or service cost by the total number of units produced or by determining the cost per unit for each element of the cost and summing those per-unit costs.

Relevant Examples and Exhibits

· Exhibit 2 The Job Order Costing System—Custom Golf Carts, Inc.

· Exhibit 3 Job Order Cost Card for a Manufacturing Company

· Exhibit 4 Job Order Cost Card for a Service Organization

· Exhibit 5 Allocating Overhead Cost: A Four-Step Process

Teaching Strategy

Begin discussing the foundations of job order cost flows by explaining that the basic parts of a job order costing system are the cost measurement and recognition procedures, electronic documents, and accounts that a company uses when it incurs costs for direct materials, direct labor, and overhead. One way to approach the recording of transactions is to use Exhibit 2 and systematically follow the transactions through the T-accounts. Begin with materials and progress to labor, overhead, then completed units and sold units. Reinforce your discussion about the transactions by including Short Exercises 2, 3, and 4 as either class or group activities.

This sets the stage for a discussion of the job order cost card shown in Exhibit 3. Explain that traditionally, job order cost cards were paper, but today, most cards reside electronically in a computer system. In your discussion, emphasize the fact that service organizations as well as manufacturers can use job order cost cards. The difference exists primarily with respect to direct materials. Job order cost cards for service businesses focus on recording costs by activities done for the job. The activity costs may include supplies, labor, and overhead. From a service organization perspective, information on the total cost of a service from job cost cards can be used to determine pricing in cost-plus contracts. Short Exercise 5 provides an excellent classroom activity, for discussion or group work, emphasizing the characteristics of job order cost cards. Short Exercise 6 also reinforces the use of job costing by service firms. Short Exercise 7 provides a good activity to help explain cost-plus contracts.

Review the fact that the costs of direct materials and direct labor can be easily traced to a product or service, but overhead costs are indirect costs that must be collected and allocated in some manner, since their physical flow and cost incurrence do not always match. Students may not fully appreciate the importance or understand the need for allocation of overhead. Therefore, you might consider a discussion about why financial statements require the reconciliation of overhead costs. In other words, explain that financial statements report actual cost information. As a result, estimated overhead costs applied during the accounting period must be adjusted to reflect actual overhead costs. This discussion provides the foundation for cost allocation, cost drivers, cost objects, and cost pools which then logically lead to calculating predetermined overhead rates. At this point, consider using Short Exercises 9 and 10 as class or group activities to help solidify the discussion about the overhead rate and how overhead is allocated to production.

With this knowledge, students are now ready for a discussion regarding the comparison of applied overhead costs to actual overhead costs. Remind them that if the overhead costs applied to production during the period are less than the actual overhead costs, the difference represents underapplied overhead costs. Likewise, if the overhead costs applied to production during the period are greater than the actual overhead costs, the difference in the amounts represents overapplied overhead costs. If these amounts are immaterial, they are adjusted through Cost of Goods Sold. If, instead, the differences are material for the products produced, adjustments are made to the accounts affected—that is, the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Exhibit 5 provides an excellent illustration regarding the four-step process of allocating overhead cost. Consider reinforcing the concept of overapplied and underapplied overhead costs by incorporating Short Exercise 8 and/or Problem 4 as a class activity.

Section 3: Business Applications

Business Applications

• Planning
• Performing
• Evaluating
• Communicating

Lecture Outline

I. Managers depend on relevant and reliable information about product unit costs to manage their organizations.

A. Unit cost knowledge is used for planning:

1. To help set reasonable prices.

2. To help estimate the cost of products or services.

B. Timely cost knowledge is used in day-to-day performing:

1. To manage activity volume.

2. To ensuring quality.

3. To negotiate a selling price.

C. Actual results and targets are used when evaluating:

1. To watch for changes in cost.

2. To watch for changes in quality.

D. Managers use unit costs when communicating to internal and external users:

1. Inventory balances on the balance sheet

2. Cost of goods sold/sales on the income statement.

E. Job order costing supports the management process as summarized in Exhibit 6.

Summary

When managers plan, information about unit cost helps them develop budgets, establish prices, set sales goals, plan production volumes, estimate product or service unit costs, and determine human resource needs. Daily, managers use cost information to make decisions about controlling costs, managing the company’s volume of activity, ensuring quality, and negotiating prices. When managers evaluate results, they analyze actual and targeted information to evaluate performance and make any necessary adjustments to their planning and decision-making strategies. When managers communicate with stakeholders, they use unit costs to determine inventory balances and the cost of goods or services sold for the financial statements. They also use internal reports that compare the organization’s measures of actual and targeted unit costs to determine whether the cost goals for products or services are being achieved. Reports may also contain nonfinancial measures of performance.

Relevant Examples and Exhibits

· Exhibit 6 Job Order Costing and the Management Process

Teaching Strategy

To link the concept of job order costing with the management process, refer to Exhibit 6. Section 3 of the TriLevel Problem provides a good illustration and learning tool for this concept. Additionally, consider using Short Exercise 11 as a good capstone exercise to summarize discussion for this chapter.

Student Engagement Tactics

If you are primarily presenting this material in a lecture setting, keep in mind that there are several ways to maintain student attention.

1. Make connections between the chapter material and current events or actual company examples; for example, you might choose a high profile criminal court case in the news and discuss how the attorney in a large criminal law practice would ordinarily keep separate records of the costs of advising and defending each of his/her clients.
2. Begin each class with something that is familiar and important to students; in this chapter, for example, choose the most recent movie that is popular with the students. Using movie studios as the example, discuss how a job order costing system might work to accumulate costs for accounting and billing purposes on this movie.
3. End each class by summarizing the main points. You might want to pick three or five main points for every chapter of this text. One good way would be to follow the three sections of the text to determine the three main points.