Job-order Costing Principles of Managerial Accounting

When the product is sold, the costs move from the finished goods inventory into the cost of goods sold. Direct labor is manufacturing labor costs that can be easily and economically traced to the production of the product. Once a product is sold, it is no longer an asset in the organization’s possession. At that point, the costs to manufacture the product are moved from the Finished Goods inventory asset account to the Cost of Goods Sold account. At the same time, the revenue collected from the sale is recorded in the Sales revenue account.

  1. No matter who the customer is, they all end up receiving the same product.
  2. Returning to the example of Dinosaur Vinyl’s order for Macs & Cheese’s stadium sign, Figure 4.7 shows the materials requisition form for Job MAC001.
  3. The work-in-process  inventory account tracks manufacturing costs in total.

However, product costs can be further broken down into direct and indirect labor costs. Thus each job will be assigned $30 in overhead costs for every direct labor hour charged to the job. The assignment of overhead costs to jobs based on a predetermined overhead rate is called overhead applied9. Remember that overhead applied does not represent actual overhead costs incurred by the job—nor does it represent direct labor or direct material costs. Instead, overhead applied represents a portion of estimated overhead costs that is assigned to a particular job.

Applied Manufacturing Overhead to All Production Departments

An organization-wide predetermined manufacturing overhead rate is computed by dividing the total estimated manufacturing overhead amount by the total estimated allocation base or cost driver. An allocation base or cost driver is a production activity that drives costs such as direct labor hours, machine hours, direct labor dollars, or direct material dollars. Organizations that produce unique or custom products or services typically use a job-order costing system. For example, a construction company specializing in new home construction uses a job-order costing system. The costs for direct material, direct labor, and manufacturing overhead is assigned directly to the homes using the materials or labor.

Determining the Costs of an Individual Job Using Job Order Costing

In some cases, organizations choose not to use a single, organization-wide predetermined manufacturing overhead rate to apply manufacturing overhead to the products or services produced. In the preceding sections, an organization-wide predetermined manufacturing overhead rate was calculated. Many organizations have multiple departments or processes that consume different amounts of manufacturing overhead resources at different rates. In these intuit credit card organizations, a single manufacturing overhead rate, while more simplistic, may not accurately apply overhead to the final product. An organization with multiple departments or processes may choose to apply manufacturing overhead using multiple predetermined manufacturing overhead rates. Before multiple predetermined manufacturing overhead rates can be computed, manufacturing overhead costs must be assigned to departments or processes.

Direct Vs Indirect Labor Cost: An Expert Accounting Guide

These are especially significant in businesses with high human resource labor expenses, such as construction, manufacturing, and other partially or fully automated activities. Sales revenue is the income received by a company from its sales of goods or the provision of services. As she posted the transaction to the ledger, she created a new account for Raw Materials that would be used directly to make boards and a new account to track bills that she had to pay (Accounts Payable). Direct labor can be assigned to a cost center or charged entirely to it. If a worker works solely on a product’s assembly line, his income will be directly attributed to the cost of that product.

Standard Costing Outline

Common allocation bases are direct labor hours, machine hours, direct labor dollars, or direct materials dollars. At the end of the year, the estimated applied overhead costs and actual overhead costs incurred are reconciled and any difference is adjusted. To summarize the job order cost system, the cost of each job includes direct materials, direct labor, and manufacturing overhead. While the product is in production, the direct materials and direct labor costs are included in the work in process inventory. The direct materials are requested by the production department, and the direct material cost is directly attached to each individual job, as the materials are released from raw materials inventory. The cost of direct labor is recorded by the employees and assigned to each individual job.

To achieve this, management needs an accounting system that can accurately assign and document the costs for each product. Product costs (direct materials, direct labor and overhead) are not expensed until the item is sold when the product costs are recorded as cost of goods sold. Period costs are selling and administrative expenses, not related to creating a product, that are shown in the income statement in the period in which they are incurred.

Video Illustration 2-3: Applying manufacturing overhead to jobs LO4

Examples of common liability accounts include, Accounts Payable, Salaries Payable, or Taxes Payable. An expense is a cost of operations that a company incurs to generate revenue. Generally, the benefit of the cost is used in the same period in which the corresponding revenue is reported. On July 25th, Jackie purchased deluxe trucks and wheels for $100 for Job 2 and paid her worker $600 for completing the job. She made the journal entry, posted it to the ledger, and updated the job card. Notice again that the total of the job cards matches the ledger account called Work in Process.

One major issue in all of these contracts is adding too much overhead cost and fraudulent invoicing for unused materials or unperformed work by subcontractors. Management might be tempted to direct the accountant to avoid the appearance of going over the original estimate by manipulating job order costing. It is the accountant’s job to ensure that the amounts recorded in the accounting system fairly represent the economic activity of the company, and the fair and proper allocation of costs.

At a cost of less than one cent per nail, it is not worth keeping track of each nail per product. It is much more practical to track how many pounds of nails were used for the period and allocate this cost (along with other costs) to the overhead costs of the finished products. Direct labor is the total cost of wages, payroll taxes, payroll benefits, and similar expenses for the individuals who work directly on manufacturing a particular product. The direct labor costs for Dinosaur Vinyl to complete Job MAC001 occur in the production and finishing departments.

When the allocation base is known, usually when the product is completed, the overhead is allocated to the product on the basis of the predetermined overhead rate. Generally accepted accounting principles require that all product costs are included as part of the company’s inventory balance until the products are sold. Direct labor costs, because they are easily traceable to products, are recorded as a debit to the work-in-process inventory account and a credit to wages payable.

The Manufacturing Overhead inventory account is used to record actual manufacturing overhead costs incurred to produce a product. Service organizations use a job cost sheet like the one discussed earlier to track direct materials, direct labor, and overhead. The amounts in raw materials, work in process, and finished goods inventories compose the total cost for each account, whereas the job cost sheets contain the costs for each individual job. The process of tracking labor using a timesheet and recording labor costs in the journal and job cost sheet is exactly the same as for a manufacturing company. Indirect labor costs are included in overheads, such as administrative overhead, factory overheads, or sales and distribution overhead.

The labor cost per unit is obtained by multiplying the direct labor hourly rate by the time required to complete one unit of a product. For example, if the hourly rate is $16.75, and it takes 0.1 hours to manufacture one unit of a product, the direct labor cost per unit equals $1.68 ($16.75 x 0.1). When overhead is underapplied, manufacturing overhead costs have been understated and upward adjustments need to be made to inventory and/or expense accounts, depending on which method the company decides to use.

Managers use the information in the manufacturing overhead account to estimate the overhead for the next fiscal period. This estimated overhead needs to be as close to the actual value as possible, so that the allocation of costs to individual products can be accurate and the sales price can be properly determined. In a manufacturing company, overhead is generally called manufacturing overhead. (You may also see other names for manufacturing overhead, such as factory overhead, factory indirect costs, or factory burden). Service companies use service overhead, and construction companies use construction overhead. Any of these types of companies may just use the term overhead rather than specifying it as manufacturing overhead, service overhead, or construction overhead.

Manufacturing overhead costs are applied to the jobs in process using a predetermined manufacturing overhead rate. The predetermined manufacturing overhead rate is discussed in detail in subsequent sections of this chapter. When manufacturing overhead is applied to the jobs in process, it is credited from the Manufacturing Overhead account and debited to the Work In Process account. Indirect labor costs might be fixed or variable based on the circumstances. Moreover, it’s just as crucial to keep track of indirect labor expenditures as it is of direct labor costs.

We assume, in this case, that one of the marketing advantages that the bakery advertises is 100% handmade pastries. A benefit of knowing the production costs for each job in a job order costing system is the ability to set appropriate sales prices based on all the production costs, including direct materials, direct labor, and overhead. The unique nature of the products manufactured in a job order costing system makes setting a price even more difficult. For each job, management typically wants to set the price higher than its production cost. Even if management is willing to price the product as a loss leader, they still need to know how much money will be lost on each product.

It also serves as a subsidiary ledger for the work-in-process inventory account. Most companies establish a standard rate per hour that gives an estimate of what they expect to be the direct labor cost in normal conditions. For example, assume that the direct labor cost per hour for assembling baby car seats is $10, and the company expects to use 0.5 hours for the assembly of each car seat. If the company produces 1,000 units, the standard direct labor cost will be $5,000 ($10 x 0.5 x 1,000). A company can use various methods to trace employee wages to specific jobs. For example, employees may fill out time tickets that include job numbers and time per job, or workers may scan bar codes of specific jobs when they begin a job task.