Chapter 4 - Job Order Costing

Group 9:

Lin Wang Bichloan Nguyen Hank Liu Keye Su Jeff Tsai

Case 4-1

COMPANY OVERVIEW

Constructo is a manufacturer of furnishings for infants and children. The company uses a job cost system and employs a full absorption accounting method for cost accumulation.

Q1: Describe when it is appropriate for a company to use a job cost system?

Job cost system is used in situations where the organization offers many different products or services, such as in furniture manufacturing, commercial aircraft manufacturing, hospitals, and law firms. In a job cost system, costs are traced and allocated to jobs.

Flow of Documents in a Job-Order Costing System

Sales

order

Production order

Materials requisition form

Direct labor time ticket

Predetermined overhead rates

Job cost sheet

A General Model of Cost Flows in Job-order Costing System

Raw Materials

Cost of materials purchased

Direct materials

Indirect materials

Salaries and Wages Payable

Direct labor

Indirect labor

Manufacturing Overhead

Actual overhead Applied overhead

Underapplied overhead cost

Overapplied overhead cost

Work in Process

Direct materials

Direct labor

Overhead applied

Cost of goods manufactured

Finished Goods

Cost of goods manufactured

Cost of goods sold

Cost of Goods Sold

Cost of goods sold

Constructo’s work in process inventory on April 30, 2001

Job No Items Units Accumulated Cost

CBS102 Cribs 20,000 $900,000

PLP086 Playpens 25,000 $420,000

DRS114 Dressers 25,000 $250,000

TOTAL $1,570,000

The Company’s finished goods inventory,

using the FIFO method on April 30, 2001

Item Quantity Unit cost Accumulated Cost

Cribs 7,500 64 480000

Strollers 13,000 23 299000

Carriages 11,200 102 1142400

Dressers 21,000 55 1155000

Palypens 19,400 35 679000

3755400

Materials Inventory on April 30,2001

At the end of April, the balance in Constructo’s Materials Inventory account, which includes both raw materials and purchased parts, was $668,000

Additions to and requisitions from the inventory during the month of May

Raw Materials Purchased Parts

Additions 242,000 396,000

Requisitions

Job CBS102 51,000 104,000

Job PLP086 3,000 10,800

Job DRS114 124,000 87,000

Job STR077 62,000 81,000

(10,000 strollers)

Job CRG098 65,000 187,000

(5,000 carriages)

Labor costs during the month of May

Account Hours Cost

CBS102 12,000 122,400

PLP086 4,400 43,200

DRS114 19,500 200,500

STR077 3,500 30,000

CRG098 14,000 138,000

Indirect 3,000 29,400

Supervision 57,600

621,100

Jobs completed for May

Job No Items Quantity Complete

CBS102 Cribs 20,000

PLP086 Playpens 15,000

STR077 Strollers 10,000

CRG098 Carriages 5,000

Unit sales for May

Items Quantity shipped

Cribs 17,500

Playpens 21,000

Strollers 14,000

Dressers 18,000

Carriages 6,000

OVERHEAD COST

Constructo applies factory overhead on the basis of direct labor hours.

The company’s factory overhead budget for the fiscal year ending May 31, 2001 total $4,500,000

The company plans to expend 600,000 Direct Labor Hours (DLH) during the period

Predetermined overhead rate

= $4,500,000 / 600,000 DHL

= $7.5 per DLH

The flow of costs through the accounts

presented in T-account form (1)

Raw Materials

Bal. 668,000

Raw Materials additions 242,000

Purchased Parts additions 396,000

Requisitions:

Cribs: 51,000+104,000=155,000

Playpens: 3,000+10,800=13,800

Dressers: 124,000+87,000=211,000

Strollers: 62,000+81,000=143,000

Carriages: 65,000+187,000=252,000

Bal. 531,200

The flow of costs through the accounts presented in T-account form (2)

Work in Process

Bal. 1,570,000

Direct Materials: 774,800 (155,000+13,800+211,000+ 143,000+252,000)

Direct labor: 534,100

(621,100-29,400-57,600)

Overhead Applied: 400,500 ((12,000+4,400+19,500+3,500 +14,000)*7.5)

Finished Goods:

Cribs: 1,267,400 900,000+51,000+104,000+122,400+12,000*7.5

Playpens: 336,480 (420,000+3,000+10,800)*15,000/25,000+43,200+4,400*7.5

Strollers: 199,250 62,000+81,000+30,000+3,500*7.5

Carriages: 495,000 65,000+187,000+138,000+14,000*7.5

Bal. 981,270

(Answer to Q2)

The flow of costs through the accounts presented in T-account form (3)

Bal. 3,755,400

Cribs: 1,267,400 Playpens: 336,480 Strollers: 199,250 Carriages: 495,000

Cost of Goods Sold:

Cribs: 1,113,700

7,500*64+(17,500-7,500)*1,267,400/20,000

Playpens: 714,891

19,400*35+(21,000-19,400)*336,480/15,000

Strollers: 318,925

13,000*23+(14,000-13,000)*199,250/10,000

Dressers: 990,000

18,000*55

Carriages: 612,000

6,000*102

Finished Goods

Bal. 2,304,014

The flow of costs through the accounts presented in T-account form (4)

Cost of Goods Sold

3,749,516

(1,113,700+714,891 +318,925+990,000+612,000)

The flow of costs through the accounts presented in T-account form (5)

Manufacturing Overhead

Actual Overhead Costs:

Indirect materials: ?

Indirect labor: 29,400

Supervision: 57,600 Utilities: ?

Rent on factory equipment: ?

Miscellaneous factory costs: ?

Depreciation on factory equipment: ?

Applied Overhead Costs:

400,500

(12,000+4,400+19,500+3,500 +14,000)*7.5

Bal. ? (underapplied overhead)

? (overapplied overhead)

Price per unit of finished goods for May

Job No. Item Quantity Finished

Finished goods cost

Price

Per unit

CBS102 Cribs 20,000 1,267,400 $63

PLP086 Playpens 15,000 336,480 $22.4

DRS114 Dressers 0 0

STR077 Strollers 10,000 199,250 $20

CRG098 Carriages 5,000 495,000 $99

Total 2,298,130

Q3: The dollar amount related to the playpens in Constructo’s finished goods inventory as of May 31,2001

Playpens in Finished Goods

Bal. 679,000

336,480

714,891

Bal. 300,589

Answer to Q3: The dollar amount related to the playpens in Constructo’s finished goods inventory as of May 31,2001 was $300,589.

Another method for calculating the answer to Q3

Beginning Inventory + Quantity Added = Quantity shipped + Ending Inventory

19,400 + 15,000 = 21,000 + Ending Inventory

Ending Inventory = 34,400 – 21,000 = 13,400

Dollar amount = 13,400 * 22.432 = $300,589

Overapplied or underapplied overhead can be treated in two ways:

1. Closed out to Cost of Goods Sold.

Unadjusted Cost of goods sold + Underapplied overhead Adjusted Cost of goods sold

Unadjusted Cost of goods sold - Overapplied overhead Adjusted Cost of goods sold

2. Allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the current period in the ending balances of these accounts.

Q4: Explain the proper accounting treatment for overapplied or underapplied overhead

balances when using a job cost system Since actual production costs should be

reported in the period they were incurred, total product costs at the accounting period should be based on actual rather than applied overhead.

Underapplied or Overapplied overhead can be disposed of in 2 ways

Closed out to Cost of Goods Sold : the more expedient of the two methods for disposing of overhead discrepancies:

For Example:Suppose… Unadjusted Cost of Goods Sold = 3,749,516 Manufactory Overhead Applied = 4,500,000 Actual Manufactory Overhead = 4,674,000 Underapplied Overhead = 4,674,000 – 4,500,000 = 174,000

Then the adjusted cost of goods sold = 3,749,516 +174,000 = 3,923,516

Proration: the process of allocating Underapplied or overapplied overhead to Work-In-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold

accounts at the end of period.

For Example:

Assume that a company’s accounts has the following applied overhead balances for the end of period:

Ending W-I-P Inventory $20,000 Ending Finished goods Inventory $30,000 Cost of Goods Sold $150,000 Total Manufactory Overhead applied $200,000 Actual Manufactory Overhead $205,000

The proration of the $5,000 underapplied factory overhead among the W-I-P Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts is computed as follows:

Amount Applied OverheadUnderapplied % of

TotalOverhead Prorated

Work In process Inventory $20,000 10% $500

Finished Goods Inventory $30,000 15% $750

Cost of Goods Sold $150,000 75% $3,750

TOTAL $200,000 100% $5,000

The appropriate adjusting entry is:

Factory Overhead Applied 200,000 W-I-P Inventory 500 Finished Goods Inventory 750 Cost of Goods Sold 3,750 Factory Overhead 205,000

Case 4-2Power Services Industries

1

4

2

5

3

6

987

Three plants in the U.S. East River Plant

• Industrial manufacturer of power-generating equipment since 1907

• PSI also produces after market and original-equipment parts

• East River Plant – one of three manufacturing firms, located in Illinois

• Major products: coal-fired boilers

Competitive EnvironmentPre-1980s era high demand for electricity low # of competitors low # of manufacturers for OEM and replacement parts low fuel price Original-equipment market (OEM) made up 60% of East River’s revenues Replacement orders made up about 40% of revenues

Early 1990s constant growth for electricity, significant decrease in orders government regulations – environmental concerns more manufacturers of replacement parts, raising market standard:

a. faster deliveryb. lower pricesc. higher quality

fuel price/interest rate increase

East River Plant

OEM Market

ReplacementParts Market

TotalMarket

Demand

OEM Market

ReplacementParts Market

TotalMarket

Demand

PRE-1980 BOILER MARKET POST-1980 BOILER MARKET

Decrease

Increase

Decrease

+ +

Plant Management Problems

equipment > 29 years approx. machine downtime bottlenecks plant usage = 45-50% equipment layout = unnecessary manual

process 40% manhours material handling High Inventory $7 Million

Potential Problem as-sold cost estimates &

actual contract cost

As-sold cost based on historical data which from early seventies

Cost of material has been changed the actual contract cost more than estimate

As-sold cost estimation didn’t contain defects and other material waste

Current Cost System

Contract

Direct Costs

OrderOrderOrder

Overhead

Direct materialsDirect labor

Product design engineeringMachine set up

Materials handling

Headquarter support services

General admin services (payroll, accounting)

Current Cost System cont.

Job cost system since 1950s Materials and labor costs charged directly to

contracts Overhead costs applied with predetermined

% of direct labor costs performance – compare monthly ratio –

Estimate Man to Actual Man Hours (E/A) If E/A below 100% = not good

Labor-Based vs. Activity Based

Labor cost is not majority of costs Not all costs are driven by man hours Example – increase in man hours in welding

one product does not equal increase in cost for testing (QA)

ABC – yes! Why? Inaccurate costing structure, complex manufacturing process

Recommendations for Current Cost System

update historically determined overhead/burden rate

Incorporate probability of machine downtime Use actual costs from previous jobs of similar

size for estimates vs. querying by parts Remove period costs in product costing Implement ABC

General Framework for Costing Products

Direct materials, direct labor, and factory overhead are only costs involved in product costing

All costs can be accurately traced to cost driver(s)

Accounting software used to accurately track accumulation and classify costs

Chapter 4 Reading

HOW I REENGINEERED A SMALL BUSINESS

The Company

James Street Fashions dba Latt-Greene A Knitting and Converting Operation Located in Vernon, California Knits Textiles for the Women’s and Children’s Apparel

Market Dyes and Prints Designs on the Textiles According to

Customer Instructions Delivers the Product to the Customer Ready for

Cutting and Sewing into Clothing Customers Consist of Clothing Manufacturers who

Sell to Clothing Retailers

The Problems

Severe Negative Cash Flow A Belief that Not All Sales to Customers were

being Billed or Collected A Paper-Heavy System that was being

Crushed by its Own Weight A “One-Write” Accounting System No Computer or Data Processing

The Old System “One-Write” System

Only Prepares General Ledger, Cash Receipts Journal and Customer Ledgers, and a Cash Disbursement Journal.

Does Not Attempt to Cost the Greige Goods. Customer were Billed as per the Purchase Order.

Weaknesses Unable to Cost Goods Accurately. No Matching Print-Sales Invoices. Purchase Orders with No Shipment Record. Late Delivery of Orders. Over-Filling Goods and Under-Charging the Customers.

The New System – The Changes Hardware Changes

A PC as Central Server. 10 Stations Using Novell System.

Software Changes Quattro Pro Spreadsheet Program. Develops Spreadsheet Automated Scripts.

System Changes Manual Costing System

Requires a Tremendous Amount of Time to Maintain and Keep Current.

Computerized Costing System Refines Cost Data as They Becomes Available.

Workforce Changes Trains Willing Employees and Dispatch Unwilling Employees.

The New System – The Effects

Operation Improved Services to Customers. Delivery Schedules were Met More Consistently. More Time Spent on Product Consistency and Quality. Less Time Spent on Paperwork and Trying to Track Down

Product Location. Problem Uncovered and Fixed in a More Timely and

Efficient Manner. Product Prices and Quality

Improved Product Consistency and Quality. Raised Price Caused Some Customer to Leave but

Covered the Cost of the Product.

The New System – Company ProfitYear Net Sales ROI

1985 16.5 11.3%

1986 19.8 (46%)

1987 24.8 (18%)

1988 33.6 33%

1989 39.2 11%

1990 54.8 / 31.3 (6%) / 63%

1991 54 61%

1992 30 7%

1993 32 41%

1994 38 53%

1995 31 28%

1996 30 30%

1997 36 43%

1998 30 24%

Conclusion - Lessons Learned

Be Open with All Employees Regarding the Reengineering Process.

Solicit Input from All Employees. Involve Everyone in the Implementation of

the New System. Understand the System Yourself because

This Understanding is More Important than Bringing in Consultants and Helps to Ensure that Costs are Kept Under Control.