Lesson 19--Job Order Accounting

Job Order Cost Accounting

Lessons 19 and 20 illustrate the way in which manufacturing costs (raw materials, labor costs, and manufacturing overhead) are accumulated and allocated. The distinction between the two chapters is that Lesson 19 deals with Job Order Costing and Lesson 20 is concerned with Process Costing.

Job Order Costing

Job Order Costing, the subject of Lesson 19, is used in those situations involving: 1) custom-made products that are 2) manufactured in small batches where 3) every batch is slightly different than every other one. As an example, job order costing would be used by a manufacturer of custom furniture—each customer might wish to order furniture with a particular type of wood, or of a specific style, or involving more or less finishing. The major issue is to determine the cost of the units produced, as determined by a job cost sheet. The job cost sheet is a record of the raw materials actually used in the job, the direct labor that actually went into the job, and manufacturing overhead allocated to the job. At the completion of the job, the job cost sheet would reveal the total cost for the units produced.

Cost Accumulation Accounts

The financial accounting system for a manufacturer must accomplish two tasks: 1) accumulate the manufacturing costs for a job (raw materials, factory labor, and manufacturing overhead) and 2) assign (or allocate) the costs to units of inventory. The accumulation of costs involves recording manufacturing costs in three accounts: Raw Materials Inventory, Manufacturing Wages, and Manufacturing Overhead. Keep in mind that we are building an asset, inventory. Therefore, the incurrence of these three types of costs will be recorded as debits. Here are some T-accounts that will help you to understand the flow of costs.

Raw Materials Inventory is debited when raw materials are purchased. This inventory account can be used for either large components of the final product, or for indirect materials that are less significant. At this cost accumulation stage, both types of raw materials are debited to this account. Later, when the costs are assigned, the costs of direct materials will be debited to Work in Process, and a credit will be made to Raw Materials Inventory. For indirect materials, Manufacturing Overhead will be debited, and Raw Materials Inventory will be credited.

A second account is used for the accumulation of Manufacturing Wages:


The Manufacturing Wages account is debited for all manufacturing labor costs. Some of this labor cost will be directly traceable to the final product and would be considered Direct Labor. Such costs will later be debited to Work in Process Inventory and credited to Manufacturing Wages. Indirect Labor costs will be debited to Manufacturing Overhead and credited to Manufacturing Wages.

The third account used for accumulating costs is Manufacturing Overhead. This account may have a wide variety of factory costs debited to it, as depicted below.

Some types of manufacturing overhead are debited to the Manufacturing Overhead (MO) account directly: costs such as factory heating, lighting, and depreciation are debited to MO, as well as supervisory costs and security costs in the factory. Note that Indirect Labor costs are assigned to MO, with an offsetting credit to Factory Labor. And, Indirect Materials costs are debited to MO with an offsetting credit to Raw Materials.

To summarize, there are three accounts used to accumulate manufacturing costs. These are Raw Materials Inventory, Manufacturing Wages, and Manufacturing Overhead. At this point, you might take a look at the journal entries illustrated in Chapter 19 of your text. Each entry is numbered. You should attempt to follow these costs from the accumulation stage to the allocation of each cost to units of inventory. The first three journal entries, to record Raw Materials purchases, incurrence of Manufacturing Wages, and incurrence of Manufacturing Overhead are illustrated below.

The order that I've used is slightly different than the presentation in your text. The numbers in parentheses show the corresponding entry in the text.

(1); see page 946.

General Journal

Raw Materials Inventory
       Accounts Payable  

(3); see page 947.

General Journal

Manufacturing Wages
       Wages Payable  
       Payroll Taxes Payable  

(5-8); see page 954. Your text shows the entries individually as they occur; however, if the information is available, the MO can be recorded in a summary entry:

General Journal

Manufacturing Overhead
       Utilities Payable  
       Prepaid Insurance  
       Accounts Payable  
       Accumulated Depreciation  
       Property Taxes Payable  

These three cost accumulation entries are shown below after posting. Our next step is to assign these costs to the appropriate inventory accounts. The journal entries from above are shown as they would appear after posting.

Think of these entries as providing cost pools, or resources, that will be assigned to jobs in the factory.

Cost Assignment

The cost assignment entries allocate raw materials costs, labor costs, and manufacturing overhead costs. The direct materials costs are allocated to Work in Process, while the indirect materials costs are assigned to manufacturing overhead.

Similarly, the Manufacturing Wages are assigned to Work in Process for the direct labor, and the indirect labor is allocated to manufacturing overhead.

A portion of the Manufacturing Overhead must also be allocated to Work in Process. To summarize, direct labor and direct materials costs, along with an assigned amount of Manufacturing Overhead, move to Work in Process.

I suggest that you draw the T-accounts shown above, and post the remaining entries for this lesson for yourself. Entry 4 allocates direct materials costs and indirect materials costs to Work in Process and Manufacturing Overhead, respectively. This entry suggests that $24,000 of materials are directly traceable to final products; the other $6,000 are indirect materials and thus considered manufacturing overhead. The raw materials inventory is reduced from the original $42,000 to $12,000.

(2); see page 946.

General Journal

Work in Process Inventory
Manufacturing Overhead
       Raw Materials Inventory  

Take one more look at the entry above.  Note that there is no account called "Direct Materials."  Direct Materials cost is based on raw materials going into the factory and is considered Work in Process.  Likewise, there is no "Indirect Materials" account, because Indirect Materials are considered a component of Manufacturing Overhead.

A very similar entry is made to allocate direct and indirect labor. Direct Labor costs go to Work in Process; indirect labor is debited to Manufacturing Overhead. Pencil in this entry as entry 5.

(4); see page 949.

General Journal

Work in Process Inventory
Manufacturing Overhead
      Manufacturing Wages  

Notice that the effect of this entry is to clear the Manufacturing Wages account, moving all labor costs out of that account.

Allocating Manufacturing Overhead--an Estimated Cost

The third element of cost, Manufacturing Overhead, differs from materials and labor because all of it is indirect. For that reason, it must be allocated in a rational manner. The traditional approach to attaching overhead to product cost is through the use of a predetermined overhead rate. In order to calculate this rate, the company creates a budget of its estimated manufacturing overhead at the beginning of the year. Additionally, an activity base is chosen that correlates closely with the incurrence of overhead cost.

Suppose a company thinks that next year's manufacturing overhead will be $1,000,000. Additionally, the company feels that overhead can legitimately be applied based upon the number of machine hours required to perform a manufacturing job. Assuming that the company expects 100,000 hours of machine usage in the next year, the predetermined overhead rate would be calculated as follows:

Overhead rate = (Overhead budget)/(Estimated number of machine hours)
= $1,000,000/100,000 = $10.00 per machine hour

Job Cost Sheets

For each job that is performed, the company would keep track of the hours of machine time actually used, and multiply that figure by $10.00 to determine overhead for the job. In the Chapter 19 example, uses a different activity base, direct labor cost. At the beginning of the year, they estimated that total Manufacturing Overhead for the year would be approximately $280,000. They also estimated that the Direct Labor cost for the year would be $350,000. The Predetermined Overhead Rate was calculated as:

Predetermined Overhead Rate = $280,000/$350,000 = .80 or 80%

This means that if the direct labor for a job were, say, $4,000, an additional $3200 (.80*$4,000) would be added for Manufacturing Overhead for that job. This allocation assumes that the incurrence of direct labor costs is a good indicator of the incurrence of overhead. In journal entry 5, above, $28,000 of direct labor was debited to Work in Process Inventory.

In entry 6, the Manufacturing Overhead is now debited to Work in Process at 80% of the direct labor cost:

 (9); see page 956.

General Journal
Work in Process Inventory
       Manufacturing Overhead  
(MO applied = .80*$28,000)    

Note that all manufacturing costs (direct material, direct labor, and manufacturing overhead) come together in the Work in Process Inventory account. Additionally, as each individual job begins, a Job Cost Sheet is prepared, to track the costs for the job. All direct materials costs for the job are recorded on the sheet, as are costs for direct labor. Labor and materials costs are actual costs for the job. Manufacturing Overhead, however, is estimated, using the rate of 80% of direct labor cost. Verify your understanding of this idea by analyzing the job cost sheet in Exhibit 19-7 on page 956. Note that for each entry of direct labor, there is a corresponding entry for manufacturing overhead at the rate of 80% of direct labor.

Over- or Under-Applied Overhead

As you may notice, the actual overhead is recorded with debit entries to the Manufacturing Overhead account. The overhead is transferred to Work in Process at the predetermined overhead rate. If the company errs in its prediction, the overhead will likely be over- or under-applied. This is a common situation, and at the end of the year, any over- or under-applied overhead is simply closed to Cost of Goods Sold. (Your textbook uses the term "over-allocated" or "under-allocated" overhead.)

Clearly, the choice of an appropriate activity base (or cost driver) has major consequences. If a company bases its prices on product cost (including overhead), the success or continuation of that business may very well depend upon skillful estimation of that overhead. In less competitive times, one rate (called a plant-wide rate) was sufficient for overhead calculation. In recent times, this approach has been considered too crude to arrive at a precise product cost estimation.

A more precise method is the Activity Based Costing method (ABC), which focuses on activities that are performed on the product. Machine setups, inspections, material handling, shipping, receiving etc., may be cost drivers for various products. Each of these is studied to determine its contribution to overhead. Obviously, this method will lead to multiple overhead rates, and is somewhat complex to implement.

The definition of Work in Process is the cost of jobs that have not yet been completed. When a job is completed, the cost of the job is transferred from Work in Process to Finished Goods Inventory. Journal entry 7 demonstrates this entry.

(10); see page 958.

General Journal

Finished Goods Inventory
      Work in Process Inventory  

This entry of $39,000 represents the Cost of Goods Manufactured; the goods are ready for sale.Entry 8 shows the entries to be recorded when goods are sold:

(11); see page 958.

General Journal

Accounts Receivable
Cost of Goods Sold
       Finished Goods Inventory


Period Costs

Notice that I’ve included a T-account for expenses. Keep in mind that Lesson 19 is aimed at determining the cost of inventory manufactured. There will be various expenses not related to manufacturing—selling, advertising, and administrative costs. These costs are considered period costs and are expensed immediately. They do not become inventory and do not follow the cost flow illustrated in this lesson. And, they appear on the income statement as expenses.

You may be bothered by the fact that Manufacturing Overhead is applied to Work in Process is arrived at by estimate. However, some elements of overhead fluctuate from month to month, such as heating and lighting costs. If new equipment is purchased during the year, depreciation costs might increase. If the factory superintendent is granted a raise, factory overhead will go up. Most companies find that using a predetermined overhead rate tends to smooth out the cost of overhead charged to jobs. More importantly, use of a predetermined overhead rate allows faster decision-making in bidding on jobs and arriving at a cost figure for each job.

At the end of a month, the Manufacturing Overhead account will end up with a debit or credit balance.  Your text recommends reporting this balance as a prepaid expense or an unearned revenue on the balance sheet.

Closing the Over- or Under-Applied Overhead

At the end of the year, however, any balance left in the Manufacturing Overhead account should be closed to Cost of Goods Sold.

If MO ends up with a debit balance, we say that overhead was "underapplied"; if MO ends up with a credit balance, we say that overhead was "overapplied." At the end of the year, the Manufacturing Overhead account is closed to Cost of Goods Sold.   This closing will require a debit to COGS and a credit to MO if the overhead was underapplied.  If overapplied, debit MO to bring it to zero, and then credit COGS.

Assignment for Lesson 19

Discussion Questions

1. Which of the following are characteristics of job order costing? Which ones are characteristics of process costing?

a. small batches of products

b. products customized to the customer's specifications

c. large batches of products

d. homogeneous products (all exactly the same, and no customization)

2. Which type of costing would each of the following types of companies use (job order or process)?

a. Kellogg's, when manufacturing corn flakes

b. a custom home builder

c. Budweiser Beer

d. a manufacturer of custom yachts

3. Draw a picture of the flow of costs for a company using job order costing.

4. Job 101 used direct materials of $500. The direct labor was 4 hours at a rate of $20 per hour. MO is applied at the rate of $50 per direct labor hour. Create a job cost sheet.

5. Sally believes that each job should be charged based on the actual manufacturing overhead incurred by the company. Why would this practice be impractical?

6. Robbins Company estimates that its manufacturing overhead for next year will be $900,000. Robbins' direct labor cost for next year is estimated to be 30,000 direct labor hours at $20 per hour. Robbins also estimates that its factory will require 60,000 machine hours of usage for the year. Compute three alternative Predetermined Overhead Rates that Robbins might use for the year, using each of the following as the cost driver:

a. Based on DL Cost

b. Based on DL Hours

c. Based on Machine Hours

7. Smith Manufacturing has three jobs in the factory, with the following costs assigned: Job 101=$3500; Job 102=$4200; Job 103 =$1,000. What is the current balance of the WIP account?

8. Tony's Repair Shop had actual MO at the end of 2008 of $30,000. Tony used 12,000 direct labor hours. The POR (based on direct labor hours) was $2.75 per direct labor hour. Was MO overapplied or underapplied, and by how much?

9. What entry would be made at the end of 2008 to close MO at Tony's Repair Shop?

10. What is a requisition?

Exercises and Problems for Lesson 19

S19-8, S19-9, S19-10

E19-16, E19-17


Hints and Check Figures for Lesson 19

S19-8: 3. COGM =$125,000

S19-9: Overallocated by $2,000

S19-10: Overallocated by $10,000

E19-16: Transaction g: Debit WIP for $18,000, credit MO for $18,000

P19-25: Finished Goods: 402: $116,800, 404: $138,000

Chapter 19 Self Quiz

Try this quiz for Chapter 19.
Chapter 21 Self Quiz


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