Horngren Chapter 4 Outline

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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 !uestion

"#ow much does it cost$% isn&t only about product cost A well-designed costing system provides managers

with information for many different purposes 'uestions 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 )nformation 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 organi+ation( 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 ,hether 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 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 e.pressions The

information presented in this chapter should enable a student to recogni+e the comple.ity that can e.ist in

developing what appears to be a simple concept

Job Costing 2



CHAPTER OUTLINE

) Costing systems in general

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

A

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 fitthe costing system

1. 0tudy 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. 1ather for general desires that are common among most managers

2. 2se 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

)) 3uilding-block concepts of costing systems

A. urpose5 6eport cost numbers to reflect way chosen cost object uses resources of organi+ation

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. 2se of cost pool5 a grouping of individual cost items

b. 2se of cost-allocation base5 a factor that systematically links indirect costs to cost object

C. Choice of cost object5 to help managers make decisions

4 Chapter 4



1. 7ajor cost objects8products 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.


Distinguish between job costing and process costing

D. Types of costing systems8two types considered as opposite ends of a continuum

1. Job-costing sstems5 assign costs to distinct units of a product or service

a. 9ob is cost object

b. 9ob is individual unit( batch( or multiple units of a distinct product or service

c. 9ob is distinct and differs among customers and situations allowing for uni!ue cost

accumulation

2. Process-costing sstems5 assign costs to masses of identical or similar units and computes unit

costs on an average basis

Job Costing !



a. Cost object is masses of identical or similar units

b. roduct 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 4-1".

))) )dentifying and measuring costs of a job


Outline the seven-step approach to job costing

A. Cost assignment process

1. )dentify the job( the chosen cost object #$tep 1%

2. )dentify the direct costs categories of the job for tracing to cost object #$tep 2%

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3. )dentify the indirect costs for allocating to cost object

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

b. 0elect the cost-allocation bases #$tep 3% [Surveys of Company Practice]

c. )dentify the indirect costs associated with each cost-allocation base #$tep 4%

i. Compute indirect-cost rate per unit of each cost-allocation base #$tep !%

ii Compute the amount of indirect costs allocated to the job5 for each individual cost-

allocation base multiply by its indirect-cost rate #$tep "%

iii. 0um 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

#$tep &% [Exhibit 4-2] [Concepts in Action]

Do multiple choice 3. Assign Exercises 4-1'( 4-2)( and 4-23.

T:AC#);1 T)* The calculation and use of a predetermined rate is done in chronological order5

3efore 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 &



which is allocated o+erhead( the debit to ,) and credit to 7anufacturing Overhead Allocated/

After work is processed( the allocated o+erhead is compared to the actual amount(

7anufacturing Overhead Control( to determine the underallocated or overallocated

<Allocated = Actual > 2nder 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. 2se to judge performance and make improvements

C. 0ource<s? for recogni+ing or identifying costs [Exhibit 4-3]

1. $ource documents5 original records that support journal entries in an accounting system

2. ;ecessity for accuracy and reliability

D. 6ole of technology

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1. Aids in improving efficiency with !uick and accurate product costs

2. 6educes costs

3. rovides 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. ;umerator reason <costs? for use of annual period

i ;ot overly influenced by seasonal patterns

ii. ;ot as affected by some erratic or period-specific costs

b. Denominator reason <!uantity of allocation base? for use of annual period

i. 0moothes out the effect of monthly variations in output levels( especially for fi.ed costs

Job Costing '



ii 0moothes out the effect of monthly variations of number of workdays

2. Timeliness consideration when using annual rates

a. 2se of actual costs of job means waiting until year end to allocate

b 2se of budgeted indirect-cost rates allow close appro.imation to actual


Distinguish actual costing from normal costing

B. 7anagers& access to job costs for various uses

1. Actual costing5 actual costs calculated when known( possibly at year end

2. ormal costing5 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

1) Chapter 4



c. Adjusts for differences between indirect costs allocated on basis of budgeted rates and actualcosts at year end

Do multiple choice 4. Assign Exercises 4-1& and 4-1,( Problem 4-34.

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


Track the flow of costs in a job-costing system

A. 0tages for making entries in a job-costing system5 matching costs to the flow of operations

1. Ac!uisition of materials and other inputs for conversion process

a. Direct materials = two journal entries

i. urchase of materials @actual costs

ii. 2se of materials*Debit ,) @actual costs

b. Conversion process5 Direct labor = two journal entries

i. urchase of labor*Debit ,) @actual costs

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ii. ayment for labor @actual costs

c. Conversion process5 7anufacturing overhead or indirect costs = two journal entries

i. Accumulation of actual costs @actual costs

ii. Allocation*Debit ,)

(a) Actual costs for actual costing system

(b) 3udgeted-indirect rate . actual !uantity of cost-allocation base for normal costing

system

T:AC#);1 T)5 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 ,ork in rocess

,ork in rocess has the three debits( one for each element of manufacturing cost

2. Completion of conversion of raw material <out of ,)? to finished good = one journal entry( ami.ture of actual and normal costs in a normal costing system

3. 0ale of finished good = one journal entry( a mi.ture of actual and normal costs in a normalcosting system

B. ;onmanufacturing costs can be accounted for in similar manner to manufacturing costs by use ofindividual jobs

Do multiple choice ! / &. Assign Exercises 4-24 02! and 4-2"( Problems 4-3)( 4-3"( and 4-3&.

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VI.Other normal costing issues

A. A timeliness issue

1. )ndirect 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. )naccuracies of rates may e.ist from use budgeted indirect rates because estimates used

a. nderallocated indirect costs5 allocated amount of indirect costs in accounting period is lessthan actual <incurred? amount

b. +erallocated indirect costs5 allocated amount of indirect costs in accounting period is morethan actual <incurred? amount


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

3. Adjustment made at end of year = three approaches

a. Adusted allocation-rate approach <theoretical approach?

i. Actual cost rate calculated at end of year

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ii. :ach job has indirect costs recomputed with actual rate

iii. 3enefit 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. 2nderallocated or overallocated overhead cost divided between work in process( finishedgoods( 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 overheadamounts in ending balances

iii. 3enefit of less comple.ity

c. )mmediate write-off to cost of goods sold approach <practical approach?

4. Choice among approaches

a. Decision should be guided by use of resulting information

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b. Cost*benefit test favors the simplest approach

Do multiple choice , and '. Assign Exercise 4-2& and Problems 4-33 and 4-3!.

B. 7ultiple overhead cost pools used if additional information is more beneficial then cost


Apply variations from normal costing

C. Bariation of normal costing

1. 2sing budgeted rates for direct costs as well as indirect costs

2. Calculating rates in the same manner

Do multiple choice 1). Assign Exercises 4-2, and 4-2'.

CHAPTER QUIZ SOLUTIONS* b d c 4c Ea Fa Gd Ha Ic Jd

Job Costing 1!



CHAPTER QUIZ

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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 !uantity

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 1&



d. identify the indirect-cost pools associated with the job

4. 2sing normal costing rather than actual costing re!uires 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. journali+ed only at year end when adjusting entries are normally made

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

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

5. ,hat is the best design for costing systems$

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

b. )n 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 )nstitute of 7anagement Accountants for aiding

management decision making

6. ,hich of the following accounts is not classified as an asset$

a. 7anufacturing overhead control

b. 7aterials control

c. ,ork-in-process control

d. Kinished goods control

7.

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

Job Costing 1'



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 recision ,idget Company had the following balances in their accounts at the end of the accounting

period5

,ork in rocessL E(JJJ

Kinished 1oods J(JJJ

Cost of 1oods 0old JJ(JJJ

)f their manufacturing overhead was overallocated by LH(JJJ and recision ,idget adjusts their accounts

using a proration based on total ending balances( the revised ending balance for Cost of 1oods 0old

would be

a LI(HHJ b LJJ(JJ c LJG(J d LJH(JJJ

9. Miberty 3o. Company calculated an indirect-cost rate of LEJ 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 LJE(JJJ

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( GJ(JJJ hours )f 9ob NF4J re!uired the use of E labor

hours and the company used the adjusted allocation rate approach( by what amount would the cost of 9ob

NF4J change$

a. LEFJJJ b LHE c LEJ d LJEJ

2) Chapter 4



10. )f 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 !uestion a billing rate

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

c. rofessional staff incurs more client costs( such as travel( lodging( and out-of-town meals( while

working on a job

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

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WRITING/DISCUSSION EXERCISES

1. De!ri"e the "#i$%i&'("$)!* !)&!ept )+ !)ti&' ,te-

Who determines the cost-allocation base and how do the do this! The accountants are involved in thedetermination of the cost-allocation base but are not alone in the process The need for costing systems to betailored to the underlying operations re!uires that the accountants understand the process and system forwhich they are accounting The design of the costing system should have begun with careful study of howoperations are conducted and what information is needed for reports Also( from performing the functions ofscorekeeping 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 theaccountants Through teamwork( effective cost-allocation bases could be developed Careful observationfrom a variety of perspectives is helpful in recogni+ing relationships Continued study and observation areneeded to understand if the relationships persist 7ost relationships change somewhat over time and use

2. Diti&'#ih "etwee& .)" !)ti&' a&% pr)!e !)ti&'

Compare and contrast job costing to process costing by focusing on the underlyingstructure of a company’s operations. Costing systems are developed according to the underlyingstructure of operations for a company :.hibit 4- is helpful in considering the type of structure in place foreither job costing or process costing )n the service sector( the jobs are assigned to particular people orspecialists who spend their time working on that particular job 7uch of the operational structure wouldcenter on the persons involved Kor process costing types of environments( the emphasis would be more on

the process rather than the people

0ource documents would differ between the two types of operations Operations conducive to job costingwould probably re!uire attention to more detail about the product( whereas operations suited for processcosting would detail the process

22 Chapter 4



3. O#t$i&e the eve&(tep appr)a!h t) .)" !)ti&'

Should there be an eight-step approach, another step to consider profitability? ;otice that in

the te.t( 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 "0ale of Kinished 1oods% because

that is the reason for manufacturing a product( its sale

The te.t defines cost <Chapter ? as a resource sacrificed or forgone to achieve a specific objective The

double entry system of accounting re!uires that sacrifices be matched to benefits <rights to responsibilities?(

the give-and-take of each transaction Costs are incurred to generate revenue A !uestion to ask about each

cost object5 #ow is this "object% providing benefit in proportion to the amount of cost assigned$

4.

Job Costing 23



Distinguish actual csting !"# n"#al csting

How did the term “normal costing originate? ;ormal 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 re!uires 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 re!uires thoughtful judgment )n the early stages of using predetermined rates( the concept of "normal%

capacity was most prevalent ;ormal capacity <introduced in Chapter I? is the amount of average demand

over several time periods( two to five years( that would consider seasonal( cyclical( and trend factors 2se 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 ;ormal capacity as the denominator in the predetermined rate8that

which differentiated this type of costing from actual8became known as "normal costing% as opposed to

actual costing

5. Tra!* the +$)w )+ !)t i& a .)"(!)ti&' ,te-

!"plain the underlying operations structure of a manufacturing company by e"plaining the journal entries, in order and in detail, of a jo- costing system. "Costing systems should be tailoredto the underlying operations/ the operations should not be tailored to fit the costing systems% )n laterchapters( even more different accounting systems for the manufacturing process are illustrated because themanufacturing process differs from what has been illustrated or described thus far

The "story% or accounting of the manufacturing process described in this chapter5

7aterials

<1? urchase of raw materials <pay the <2? 2se of raw materials to begin the work ofsupplier of materials? conversion into a finished good that can be sold

,ork in rocess

<2? )ntroduction of materials<3? urchase and use of labor to work on <&? Completion of the conversion process intomaterial to convert into a finished good finished goods now available for salethat can be sold @4-aying the workers<"? 2se-allocation of many varied goods

and services to enable the conversion process to occur <!-buying the goods andservices?

24 Chapter 4



Kinished 1oods

<&? 1athering the goods for sale <,? 0elling the goods

6.

Job Costing 2!



Accunt !" $n%&!&'$"i% un%$"allcat$% " ($"allcat$% in%i"$ct csts using alt$"nati($ #$th%s

#ecause normal costing uses budgeted rates rather than actual rates in computing amountsused in the accounting system, won’t financial statements prepared from that system beinaccurate? Accuracy is used in the te.t to refer to the use of actual cost( so the term is appropriate in!uestioning the financial statements The end-of-period treatment of underallocated or overallocated indirectcosts is done for the purpose of appro.imating actual costs 3y definition( underallocated or overallocatedindirect costs are the difference computed in comparing allocated costs to actual cost The disposing of thatdifference results in the "use% of actual costs The approaches to disposing of the differences range fromsubstituting the actual indirect cost for the allocated indirect cost <adjusted allocation rate approach? toappro.imating actual cost <immediate write-off to cost of goods sold?

7. App$, variati)& +r)- &)r-a$ !)ti&'

$he use of budgeted or predetermined rates allows decision ma%ers to ha&e more timelyinformation. 'oes the use of budgeted rates afford the decision ma%er any other benefit?

Timeliness is a key reason for the use of budgeted indirect cost rates in normal costing Their use( however(

does re!uire adjustment at the end of the period to appro.imate or substitute actual costs for allocated costs

A decision maker can benefit from knowing the reasons for the differences that have occurred re!uiring 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 e.ist 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 :.tending the use of budgeted

or predetermined rates through variations of normal costing e.tends the feedback available to managers

2" Chapter 4



Job Costing 2&



EE5A6 APP5AC7 8 C$9 A$$:;E9 9 C$9 <JEC9

=$e+en-$tep Approach>

$tep 4* :denti? the

indirect costs

associated @ith :ndirect Cost Pool

each allocation base

$tep 3* $elect the cost-

allocation base to

use in allocating Cost Allocation <ase

indirect costs to

the cost obect

$tep !* Compute the rate

per unit o? each Allocation 5ate

cost-allocation base

used to allocate :ndirect cost

indirect costs to the Cost allocation base

cost obect

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$tep "* Compute the

indirect costs Allocated costs

allocated to the

cost obect

$tep &* Add all indirect

and direct costs

assigned to cost obect B :ndirect Costs Allocated

$tep 1* 0:denti? the B Direct Costs 9raced Cost obect

chosen cost obect

$tep 2* :denti? the

direct costs o? the ob Direct costs

SUGGESTED READINGS

Job Costing 2'



3oer( 1( "7anagement Accounting :ducation5 esterday( Today( and Tomorrow(% Issues in Accountin

E!ucation <7ay JJJ? p @p

3riers( 7( Chow( C( #wang( ; P Muckett( ( "The :ffects of Alternative Types of Keedback on roduct-6elated Decision erformance5 A 6esearch ;ote(% "ourna# of $anaement Accountin %esearch

<III? pGE @Hp

Cooper( 6 and Qaplan( 6( "7easure Costs 6ight5 7ake the 6ight Decisions(% &arvar! 'usiness %evie( <0eptember-October IHH? p IF @Jp

9ohnson( # T and 6 Qaplan( %e#evance )ost* +he %ise an! ,a## of $anaement Accountin ( #arvard3usiness 0chool ress( IHG

Qaplan( 6 and 9ohnson( # T( "The 6ise and Kall of 7anagement Accounting(% $anaement Accountin <9anuary IHG? p @Ip

Ting( Q( Rhang( C( ,ang( 3( Deshmukh( A P Dubrosky( 3( "roduct and rocess Cost :stimation withKu++y 7ulti-Attribute 2tility Theory(% Enineerin Economist <III? pJ @Ip

Horngren Chapter 4 Outline

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