CHAPTER 4

JOB COSTING

LEARNING OBJECTIVES

1. Describe the building-block concepts of costing systems

2. Distinguish between job costing and process costing

3. Outline a seven-step approach to job costing

4. Distinguish actual costing from normal costing

5. Track the flow of costs in a job-costing system

6. Account for end-of-period underallocated or overallocated indirect costs using alternative methods
7. Apply variations from normal costing

Chapter Overview

Chapter 4 describes the basics of a costing system by illustrating a normal job-costing system. The question
How much does it cost? isnt only about product cost. A well-designed costing system provides managers
with information for many different purposes. Questions of strategy, performance, product choice, and
profitability are a few of the purposes served. A costing system accumulates costs to aid and improve decision
making. Though the illustration in the chapter is primarily focused on product costing, the concept of
different costs for different purposes is evident.

Costing systems do provide information, though they are not the only source needed or used for making
decisions. Information bears a cost and a costing system is a commodity that has a cost. The cost/benefit
approach should be used in designing and choosing a costing system. Careful study of how operations are
conducted forms the basis for the design of a costing system. Costing systems should reflect the underlying
operations of an organization, and not vice versa.

Technological changes are highlighted throughout the chapter. The steps of how to cost a job can be used for
understanding the nature and role of a costing system. Whether the work is carried out on a handwritten basis
or by one in which information is gathered without human intervention, a basic understanding of how a
costing system works is necessary for any user.

The attention focused on the calculation of rates can be used to develop an appreciation of unit costs. The
admonition from Chapter 2 to beware of unit costs still holds. Attention is given to the numerator and the
denominator in several instances, highlighting the importance of each individual element as well as the
relationship between the two elements. Cost per mile or cost per unit are common expressions. The
information presented in this chapter should enable a student to recognize the complexity that can exist in
developing what appears to be a simple concept.

Job Costing 2
CHAPTER OUTLINE

I. Costing systems in general

A. Cost-benefit approach is essential in designing and choosing costing systems

1. Costing system is a commodity that has a cost

2. Costing system provides beneficial information

B. Costing system should be tailored to the underlying operations; operations should not be tailored to fit
the costing system

1. Study how the underlying operations are conducted

2. Design costing system to provide information for underlying operations

C. Costing systems accumulate costs to facilitate decisions

1. Gather for general desires that are common among most managers

2. Use for product costing in particular to be used for making decisions and develop strategy,
planning and control, cost management, and inventory valuation

Job Costing 3
 D. Costing systems are only one source of information for managers

Learning Objective 1:

Describe the building-block concepts of costing systems

II. Building-block concepts of costing systems

A. Purpose: Report cost numbers to reflect way chosen cost object uses resources of organization

B. Assignment of known costs

1. Assignment by tracing for direct costs of a cost object in an cost-effective way

2. Assignment by allocation for indirect costs of a cost object

a. Use of cost pool: a grouping of individual cost items

b. Use of cost-allocation base: a factor that systematically links indirect costs to cost object

C. Choice of cost object: to help managers make decisions

4 Chapter 4
 1. Major cost objectsproducts and responsibility centers

2. Designation of direct/indirect dependent upon cost object

Do multiple choice 1. Assign Exercise 4-21 and Problems 4-31 and 4-32.

Learning Objective 2:

Distinguish between job costing and process costing

D. Types of costing systemstwo types considered as opposite ends of a continuum

1. Job-costing systems: assign costs to distinct units of a product or service

a. Job is cost object

b. Job is individual unit, batch, or multiple units of a distinct product or service

c. Job is distinct and differs among customers and situations allowing for unique cost
accumulation

2. Process-costing systems: assign costs to masses of identical or similar units and computes unit
costs on an average basis

Job Costing 5
 a. Cost object is masses of identical or similar units

b. Product is same for each customer or situation

c. Average or per-unit cost developed

3. Combination of elements of both job and process costing for costing system to describe the
underlying operations

Do multiple choice 2. Assign Exercise 4-16.

III. Identifying and measuring costs of a job

Learning Objective 3:

Outline the seven-step approach to job costing

A. Cost assignment process

1. Identify the job, the chosen cost object [Step 1]

2. Identify the direct costs categories of the job for tracing to cost object [Step 2]

6 Chapter 4
 3. Identify the indirect costs for allocating to cost object

a. Identify cause-and-effect relationship between indirect cost and allocation base

b. Select the cost-allocation bases [Step 3] [Surveys of Company Practice]

c. Identify the indirect costs associated with each cost-allocation base [Step 4]

i. Compute indirect-cost rate per unit of each cost-allocation base [Step 5]

ii. Compute the amount of indirect costs allocated to the job: for each individual cost-
allocation base multiply by its indirect-cost rate [Step 6]

iii. Sum individual amounts to obtain total indirect cost allocated

4. Compute the total cost of the job by adding all direct costs and indirect costs assigned to the job
[Step 7] [Exhibit 4-2] [Concepts in Action]

Do multiple choice 3. Assign Exercises 4-19, 4-20, and 4-23.

TEACHING TIP: The calculation and use of a predetermined rate is done in chronological order:

Before work in process is begun, the indirect allocation rate is computed using budgeted amounts;

During work in process, the rate is multiplied by the actual amount of allocation base used,

Job Costing 7
 which is allocated overhead, the debit to WIP and credit to Manufacturing Overhead Allocated;

After work is processed, the allocated overhead is compared to the actual amount,

Manufacturing Overhead Control, to determine the underallocated or overallocated

(Allocated Actual = Under if negative difference, Over if positive difference)

B. Cost analysis

1. Compare cost of the job to revenue for gross margin and gross margin percentage calculations

2. Compare costs and gross margins between jobs

3. Use to judge performance and make improvements

C. Source(s) for recognizing or identifying costs [Exhibit 4-3]

1. Source documents: original records that support journal entries in an accounting system

2. Necessity for accuracy and reliability

D. Role of technology

8 Chapter 4
 1. Aids in improving efficiency with quick and accurate product costs

2. Reduces costs

3. Provides instantaneous feedback for control decisions

IV. Time as a factor in job costing

A. Time frame for computation of indirect-cost rates

1. Choice of short span (weekly, monthly) or longer period (annual)

a. Numerator reason (costs) for use of annual period

i. Not overly influenced by seasonal patterns

ii. Not as affected by some erratic or period-specific costs

b. Denominator reason (quantity of allocation base) for use of annual period

i. Smoothes out the effect of monthly variations in output levels, especially for fixed costs

Job Costing 9
 ii. Smoothes out the effect of monthly variations of number of workdays

2. Timeliness consideration when using annual rates

a. Use of actual costs of job means waiting until year end to allocate

b. Use of budgeted indirect-cost rates allow close approximation to actual

Learning Objective 4:

Distinguish actual costing from normal costing

B. Managers access to job costs for various uses

1. Actual costing: actual costs calculated when known, possibly at year end

2. Normal costing: uses budgeted indirect-cost rates rather than actual indirect-cost rates

a. Traces actual direct costs to cost object [Exhibit 4-4]

b. Allocates indirect costs based upon budgeted indirect-cost rates to jobs

10 Chapter 4
 c. Adjusts for differences between indirect costs allocated on basis of budgeted rates and actual
costs at year end

Do multiple choice 4. Assign Exercises 4-17 and 4-18, Problem 4-34.

V. Accounting for the flow of costs in a normal job-costing system

Learning Objective 5:

Track the flow of costs in a job-costing system

A. Stages for making entries in a job-costing system: matching costs to the flow of operations

1. Acquisition of materials and other inputs for conversion process

a. Direct materials two journal entries

i. Purchase of materials [actual costs]

ii. Use of materials/Debit WIP [actual costs]

b. Conversion process: Direct labor two journal entries

i. Purchase of labor/Debit WIP [actual costs]

Job Costing 11
 ii. Payment for labor [actual costs]

c. Conversion process: Manufacturing overhead or indirect costs two journal entries

i. Accumulation of actual costs [actual costs]

ii. Allocation/Debit WIP

(a) Actual costs for actual costing system

(b)Budgeted-indirect rate x actual quantity of cost-allocation base for normal costing

system

TEACHING TIP: The use of two journal entries for each of the inputs to the manufacturing process is a
helpful way to remember the specific entries. One entry of each set of two is a debit to Work in Process.
Work in Process has the three debits, one for each element of manufacturing cost.

2. Completion of conversion of raw material (out of WIP) to finished good one journal entry, a
mixture of actual and normal costs in a normal costing system

3. Sale of finished good one journal entry, a mixture of actual and normal costs in a normal
costing system

B. Nonmanufacturing costs can be accounted for in similar manner to manufacturing costs by use of
individual jobs

Do multiple choice 5 7. Assign Exercises 4-24 (25) and 4-26, Problems 4-30, 4-36, and 4-37.

12 Chapter 4
VI. Other normal costing issues

A. A timeliness issue

1. Indirect costs assigned to individual jobs on an ongoing and timely basis with normal costing
instead of only at end of accounting period when actual costs known using actual costing

2. Inaccuracies of rates may exist from use budgeted indirect rates because estimates used

a. Underallocated indirect costs: allocated amount of indirect costs in accounting period is less
than actual (incurred) amount

b. Overallocated indirect costs: allocated amount of indirect costs in accounting period is more
than actual (incurred) amount

Learning Objective 6:

Account for end-of-period underallocated or overallocated indirect costs using alternative methods

3. Adjustment made at end of year three approaches

a. Adjusted allocation-rate approach (theoretical approach)

i. Actual cost rate calculated at end of year

Job Costing 13
 ii. Each job has indirect costs recomputed with actual rate

iii. Benefit of both timeliness and convenience during year and accuracy of actual costing at
end of year

iv. After-the-fact analysis provides useful insights for future decisions

b. Proration approach (theoretical approach)

i. Underallocated or overallocated overhead cost divided between work in process, finished

goods, and cost of goods sold

ii. Division of cost based upon overhead amounts (before proration) in work in process,
finished goods, and cost of goods sold [or on ending balances rather than overhead
amounts in ending balances]

iii. Benefit of less complexity

c. Immediate write-off to cost of goods sold approach (practical approach)

4. Choice among approaches

a. Decision should be guided by use of resulting information

14 Chapter 4
 b. Cost/benefit test favors the simplest approach

Do multiple choice 8 and 9. Assign Exercise 4-27 and Problems 4-33 and 4-35.

B. Multiple overhead cost pools used if additional information is more beneficial then cost

Learning Objective 7:

Apply variations from normal costing

C. Variation of normal costing

1. Using budgeted rates for direct costs as well as indirect costs

2. Calculating rates in the same manner

Do multiple choice 10. Assign Exercises 4-28 and 4-29.

CHAPTER QUIZ SOLUTIONS: 1. b 2. d 3.c 4.c 5.a 6.a 7.d 8.a 9.c 10.d

Job Costing 15
CHAPTER QUIZ

16 Chapter 4
1. A cost-allocation base may be any of the following except a

a. cost driver.

b. cost pool.

c. way to link indirect costs to a cost object.

d. nonfinancial quantity.

2. A company that manufactures dentures for use by local dentists would use

a. process costing.

b. personal costing.

c. operations costing.

d. job costing.

3. The first step in the seven-step approach to job costing is to

a. select the cost-allocation base to use in assigning indirect costs to the job.

b. identify the direct costs of the job.

c. identify the job that is the chosen cost object.

Job Costing 17
 d. identify the indirect-cost pools associated with the job.

4. Using normal costing rather than actual costing requires that the allocating of indirect manufacturing
costs to work in process be

a. done on a more timely basis, such as every two weeks rather than every month.

b. journalized only at year end when adjusting entries are normally made.

c. calculated by using the budgeted rate times actual quantity of allocation base.

d. calculated by using the budgeted rate times the budgeted quantity of allocation base.

5. What is the best design for costing systems?

a. To be tailored to the underlying operations of the company.

b. In accordance with generally accepted accounting principles for financial accounting reporting.

c. To be compatible with the latest technology for data collection regardless of the cost.

d. According to guidelines established by the Institute of Management Accountants for aiding

management decision making.

6. Which of the following accounts is not classified as an asset?

a. Manufacturing overhead control

b. Materials control

c. Work-in-process control

d. Finished goods control

7.

18 Chapter 4
The costs incurred on jobs which are currently in production but are not yet complete would appear in

Job Costing 19
 a. the materials control account.

b. the finished goods control account.

c. the manufacturing overhead control account.

d. the work-in-process control account.

8. The Precision Widget Company had the following balances in their accounts at the end of the accounting
period:

Work in Process$ 5,000

Finished Goods 20,000

Cost of Goods Sold 200,000

If their manufacturing overhead was overallocated by $8,000 and Precision Widget adjusts their accounts
using a proration based on total ending balances, the revised ending balance for Cost of Goods Sold
would be

a. $192,880. b. $200,00. c. $207,120. d. $208,000.

9. Liberty Box Company calculated an indirect-cost rate of $12.50 per labor hour for fringe benefits for use
in their normal costing system. At the end of the year, the actual costs of fringe benefits was $105,000
more than the budgeted amount used to compute the indirect-cost rate. The total of labor hours worked
for the year was the same amount as budgeted, 70,000 hours. If Job #640 required the use of 15 labor
hours and the company used the adjusted allocation rate approach, by what amount would the cost of Job
#640 change?

a. $560.00 b. $281.25 c. $22.50 d. $20.50

20 Chapter 4
10. If each professional in a service company is paid on an annual salary basis, why might the firm want
to use a predetermined or budgeted rate for direct or professional labor?

a. A predetermined or budgeted rate is easier to justify to a client who might question a billing rate.

b. Professional staff persons do not keep accurate records of the jobs on which they work.

c. Professional staff incurs more client costs, such as travel, lodging, and out-of-town meals, while
working on a job.

d. Year-end bonuses paid to the professional staff are difficult to trace to individual jobs.

Job Costing 21
WRITING/DISCUSSION EXERCISES

1. Describe the building-block concepts of costing systems

Who determines the cost-allocation base and how do they do this? The accountants are involved in the
determination of the cost-allocation base but are not alone in the process. The need for costing systems to be
tailored to the underlying operations requires that the accountants understand the process and system for
which they are accounting. The design of the costing system should have begun with careful study of how
operations are conducted and what information is needed for reports. Also, from performing the functions of
scorekeeping and attention directing, the accountants would develop information useful for suggesting cause-
and-effect relationships between costs and other activities. Those who work in the system (the line managers)
would have a different kind of knowledge of relationships providing insight about the suggestions of the
accountants. Through teamwork, effective cost-allocation bases could be developed. Careful observation
from a variety of perspectives is helpful in recognizing relationships. Continued study and observation are
needed to understand if the relationships persist. Most relationships change somewhat over time and use.

2. Distinguish between job costing and process costing

Compare and contrast job costing to process costing by focusing on the underlying
structure of a companys operations. Costing systems are developed according to the underlying
structure of operations for a company. Exhibit 4-1 is helpful in considering the type of structure in place for
either job costing or process costing. In the service sector, the jobs are assigned to particular people or
specialists who spend their time working on that particular job. Much of the operational structure would
center on the persons involved. For process costing types of environments, the emphasis would be more on
the process rather than the people.

Source documents would differ between the two types of operations. Operations conducive to job costing
would probably require attention to more detail about the product, whereas operations suited for process
costing would detail the process.

22 Chapter 4
3. Outline the seven-step approach to job costing

Should there be an eight-step approach, another step to consider profitability? Notice that in
the text, the discussion following the computation of step seven is that of profitability, relating the cost of the
job to revenue that the job would generate. The last stage in job costing is Sale of Finished Goods because
that is the reason for manufacturing a product, its sale.

The text defines cost (Chapter 2) as a resource sacrificed or forgone to achieve a specific objective. The
double entry system of accounting requires that sacrifices be matched to benefits (rights to responsibilities),
the give-and-take of each transaction. Costs are incurred to generate revenue. A question to ask about each
cost object: How is this object providing benefit in proportion to the amount of cost assigned?

4.

Job Costing 23
Distinguish actual costing from normal costing

How did the term normal costing originate? Normal costing differs from actual costing in that the
indirect costs are allocated using a predetermined allocation rate rather than the actual rate. Calculating a rate
or average requires division, often displayed as numerator/denominator. The numerator is the budgeted cost
when using a predetermined rate because the actual costs are not yet known. The choice of the allocation
base requires thoughtful judgment. In the early stages of using predetermined rates, the concept of normal
capacity was most prevalent. Normal capacity (introduced in Chapter 9) is the amount of average demand
over several time periods, two to five years, that would consider seasonal, cyclical, and trend factors. Use of a
normal amount would yield a rate that would be useful over a longer period of time because it would not be
so affected by short-term conditions. Normal capacity as the denominator in the predetermined ratethat
which differentiated this type of costing from actualbecame known as normal costing as opposed to
actual costing.

5. Track the flow of costs in a job-costing system

Explain the underlying operations structure of a manufacturing company by explaining the

journal entries, in order and in detail, of a jo- costing system. Costing systems should be tailored
to the underlying operations; the operations should not be tailored to fit the costing systems. In later
chapters, even more different accounting systems for the manufacturing process are illustrated because the
manufacturing process differs from what has been illustrated or described thus far.

The story or accounting of the manufacturing process described in this chapter:

Materials
(1) Purchase of raw materials (pay the (2) Use of raw materials to begin the work of
supplier of materials) conversion into a finished good that can be sold

Work in Process
(2) Introduction of materials
(3) Purchase and use of labor to work on (7) Completion of the conversion process into
material to convert into a finished good finished goods now available for sale
that can be sold [4-Paying the workers]
(6) Use-allocation of many varied goods
and services to enable the conversion
process to occur (5-buying the goods and
services)

24 Chapter 4
 Finished Goods
(7) Gathering the goods for sale (8) Selling the goods

6.

Job Costing 25
Account for end-of-period underallocated or overallocated indirect costs using alternative methods

Because normal costing uses budgeted rates rather than actual rates in computing amounts
used in the accounting system, wont financial statements prepared from that system be
inaccurate? Accuracy is used in the text to refer to the use of actual cost, so the term is appropriate in
questioning the financial statements. The end-of-period treatment of underallocated or overallocated indirect
costs is done for the purpose of approximating actual costs. By definition, underallocated or overallocated
indirect costs are the difference computed in comparing allocated costs to actual cost. The disposing of that
difference results in the use of actual costs. The approaches to disposing of the differences range from
substituting the actual indirect cost for the allocated indirect cost (adjusted allocation rate approach) to
approximating actual cost (immediate write-off to cost of goods sold).

7. Apply variations from normal costing

The use of budgeted or predetermined rates allows decision makers to have more timely
information. Does the use of budgeted rates afford the decision maker any other benefit?
Timeliness is a key reason for the use of budgeted indirect cost rates in normal costing. Their use, however,
does require adjustment at the end of the period to approximate or substitute actual costs for allocated costs.
A decision maker can benefit from knowing the reasons for the differences that have occurred requiring the
adjustment. Comparisons are created between the allocated and the actual costs, the predictions used for the
budgeted numbers and the actualities behind the actual numbers, and the way in which a relationship was
thought to exist and how it actually did work. After-the-fact analysis of actual versus allocated provides
managers with useful insights for future decisions, a primary role of feedback. Extending the use of budgeted
or predetermined rates through variations of normal costing extends the feedback available to managers.

26 Chapter 4
Job Costing 27
 GENERAL APPROACH OF COST ASSIGNMENT TO COST OBJECT

{Seven-Step Approach}

Step 4: Identify the

indirect costs

associated with Indirect Cost Pool

each allocation base

Step 3: Select the cost-

allocation base to

use in allocating Cost Allocation Base

indirect costs to

the cost object

Step 5: Compute the rate

per unit of each Allocation Rate =

cost-allocation base

used to allocate Indirect cost

indirect costs to the Cost allocation base

cost object

28 Chapter 4
 Step 6: Compute the

indirect costs Allocated costs

allocated to the

cost object

Step 7: Add all indirect

and direct costs

assigned to cost object $ Indirect Costs Allocated

Step 1: (Identify) the $ Direct Costs Traced Cost object

chosen cost object

Step 2: Identify the

direct costs of the job Direct costs

SUGGESTED READINGS

Job Costing 29
Boer, G., Management Accounting Education: Yesterday, Today, and Tomorrow, Issues in Accounting
Education (May 2000) p.313 [22p].

Briers, M., Chow, C., Hwang, N. & Luckett, P., The Effects of Alternative Types of Feedback on Product-
Related Decision Performance: A Research Note, Journal of Management Accounting Research
(1999) p.75 [18p].

Cooper, R. and Kaplan, R., Measure Costs Right: Make the Right Decisions, Harvard Business Review
(September-October 1988) p. 96 [10p].

Johnson, H. T. and R. Kaplan, Relevance Lost: The Rise and Fall of Management Accounting, Harvard
Business School Press, 1987.

Kaplan, R. and Johnson, H. T., The Rise and Fall of Management Accounting, Management Accounting
(January 1987) p.22 [9p].

Ting, P.K., Zhang, C., Wang, B., Deshmukh, A. & Dubrosky, B., Product and Process Cost Estimation with
Fuzzy Multi-Attribute Utility Theory, Engineering Economist (1999) p.303 [29p].

30 Chapter 4