Job order costing system is generally used by companies that manufacture a

number of different products. It is a widely used costing system in manufacturing

as well as service industries.
Manufacturing companies using job order costing system usually receive orders for
customized products and services. These customized orders are known
as jobs or batches. A clothing factory, for example, may receive an order for men
shirts with particular size, color, and design.
When companies accept orders or jobs for different products, the assignment of
cost to products becomes a difficult task. In these circumstances, the cost record
for each individual job is kept because each job have a different product and,
therefore, different cost associated with it.
The per unit cost of a particular job is computed by dividing the total cost allocated
to that job by the number of units in the job. The per unit cost formula is given
below:
Per unit cost = Total cost applicable to job / Number of units in the job
Job order costing is extensively used by companies all over the world. According
to a survey, 51.1% of manufacturing companies in United States use job order
costing.
Examples of manufacturing businesses that use job order costing system include
clothing factories, food companies, air craft manufacturing companies etc.
Examples of service businesses that use job order costing system include movie
producers, accounting firms, law firms, hospitals etc.
Job cost sheet is a document used to record manufacturing costs and is prepared
by companies that use job-order costing system to compute and allocate costs to
products and services.
The accounting department is responsible to record all manufacturing costs (direct
materials, direct labor, and manufacturing overhead) on the job cost sheet. A
separate job cost sheet is prepared for each individual job.
All necessary details about the job and costs incurred to complete the job are
written on the job cost sheet.
The information about a job or order that is shown on job cost sheet usually
includes job number, product name, starting date, completing date, number of units
completed etc.
The information about manufacturing costs that is shown on job cost sheet usually
includes materials requisition number, cost of direct materials issued, time tickets,
direct labor hours, direct labor rate per hour and total cost, manufacturing overhead
rate per direct labor or machine hour and total cost etc.
Job cost sheet is not only used to charge cost to jobs but is also a part of the
companys accounting record. It is used as a subsidiary ledger to the work in
process account because it contains all details about the job in process.

Example:
An example of a complete job cost sheet is given below:

Measuring and recording direct materials cost

After accepting a job or order, the first step in a job order costing system is to
determine the direct materials requirement to complete the job. The type and
quantity of direct materials required to manufacture a product can be determined
either by using a bill of materials or by production staff.
Bill of materials is a document that lists the type and quantity of direct materials
required to manufacture a standard product. But companies using job order costing
system frequently receive orders that require customization in design, size and
color etc. In such circumstances, the bill of materials cannot be used to determine
the type and quantity of materials required to complete the job. Therefore the
production department determines materials requirement using the information
provided by customers.

After direct materials requirement has been determined, the production process
starts with issuance of direct materials. For this purpose, production department
prepares a document known as materials requisition form. An authorized person
from production department writes the type, quantity, and job number (to which
the materials cost is to be charged) on materials requisition form. A signed copy of
this form is then sent to the storeroom clerk who completes the form by entering on
it per unit and total cost of materials to be issued. After necessary verification,
storeroom clerk issues direct materials to production department.
A complete materials requisition form is also used by accounting department to
record direct materials cost on the job cost sheet of the related job order.
An example/sample of materials requisition form is given below:

Use of computer technology for materials requisition:

The procedure described above is the manual procedure of issuing materials. In todays business
world, many companies are replacing manual procedure with computer technology. In computer
technology, automated information processing systems are used to send the requisition
information to storeroom. The material is transferred from storeroom to the production
department on the basis of this information. An entry about each requisition is made in a
computer that automatically updates the subsidiary materials record.
Journal entries to record the flow of materials:
Normally two types of journal entries are made for direct materials cost. One at the time of
purchase of direct materials from suppliers and one at the time of issuance of direct materials
from storeroom to production department. These two entries are given below:
When materials are purchased:
Materials
xxxx
Accounts payable
xxxx
When materials are issued:
Work in process
xxxx
Materials
xxxx

Measuring and recording direct labor cost

In job order costing system, the method of measuring and recording direct labor
cost is similar to measuring and recording direct materials cost.
Direct labor hours worked, direct labor rate per hour, and total amount in dollars
for each individual job or task is recorded on a document known as time
ticket or employee time ticket. A separate time ticket is prepared by each worker for
every working day.
Accounting department collects all time tickets at the end of the day. These time
tickets are used to enter direct labor cost on the job cost sheet of each individual
job order. An example/sample of complete time ticket is given below:

Employee Time Ticket

In job order costing system, any labor charges that are not directly traceable to a particular job
are known as indirect labor cost. In example of time ticket given above maintenance is indirect
labor. Other examples of indirect labor are cleanup costs and supervision etc. Indirect labor is not
included in direct labor cost and, therefore, becomes a part of the manufacturing overhead.
These days, many companies have replaced the manual process of recording direct materials cost
with the computerized approaches. They use a bar code technology to enter data into a computer.
This technology increases the speed and accuracy of the whole process.
Journal entry to record direct labor cost:
After collecting time tickets by accounting department, wages of workers are computed and
labor costs are classified as direct or indirect on the basis of information provided by time
tickets. As discussed earlier, indirect labor is a part of manufacturing overhead and its accounting
treatment has been discussed in measuring and recording manufacturing overhead article. The
journal entry of direct labor cost is made as follows:
Work in process
xxxx
Wages payable
xxxx

Measuring and recording manufacturing overhead cost

Manufacturing costs other than direct materials and direct labor are known as
manufacturing overhead (also known as factory overhead). It usually consists of
both variable and fixed components. Examples of manufacturing overhead cost
include indirect materials, indirect labor, depreciation, salary of production
manager, property taxes, fuel, electricity, grease used in machines, and insurance
etc.
Unlike direct materials and direct labor, manufacturing overhead is an indirect cost
that cannot be directly assigned to each individual job. This problem is solved by
using a rate that is computed at the beginning of each period. This rate is known
as predetermined overhead rate.
Application of manufacturing overhead:
As stated earlier, the predetermined overhead rate is computed at the beginning of
the period and is used to apply manufacturing overhead cost to jobs throughout the
period.
Manufacturing overhead cost is applied to jobs as follows:

Example:
Suppose the GX company has completed a job order. The time tickets show that
the workers have worked for 27 hours to complete the job. The predetermined
overhead rate computed at the beginning of the year is $8 per direct labor hour.
The manufacturing overhead cost would be applied to this job as follows:

The manufacturing overhead cost assigned to the job is recorded on the job cost
sheet of that particular job.

Journal entry to record manufacturing overhead cost:

The manufacturing overhead cost applied to the job is debited to work in process
account. The journal entry for the applied manufacturing overhead cost, computed
in the above example, would be made as follows:
Work in process
216
Manufacturing overhead
216
The reason of using a predetermined overhead rate rather than actual overhead
costs:

Notice that the procedure of manufacturing overhead application described above

is based on an estimated overhead rate (predetermined overhead rate). The
manufacturing overhead cost applied to the job is, therefore, not actual
manufacturing overhead cost incurred by the job. The reason is that the total actual
manufacturing overhead costs are usually not known to managers before the end of
the year. The application of manufacturing overhead based on a predetermined
overhead rate helps in computing cost of goods sold of a particular job before it is
shipped to the customer.
The use of predetermined overhead rate to apply manufacturing overhead cost to
products or job orders is known as normal cost system.

Treatment of non-manufacturing costs

Non-manufacturing expenses have no effect on the production cost of the company
because they are treated as period costs.
Non-manufacturing costs are not included in manufacturing overhead account but
are charged directly to income statement. Examples of non-manufacturing
expenses are sales commission, advertising expenses, rent of office building, and
depreciation on the equipment used in office etc.
Journal entries to record non-manufacturing costs:

To understand how entries for non-manufacturing costs are made, consider the
following example:
GX company uses job order costing system and has incurred the following nonmanufacturing expenses for the most recent period:
1. Selling and administrative salary $ 60,000
Depreciation on office expenses
furniture
3. Advertising expenses
Other selling and administrative
4.
expenses
2.

14,000
84,000
16,000

Required: make journal entries from the information provided above.

Journal entries:
1. Salaries expenses

60,000

Salaries and wages payable

2.

Depreciation expense

60,000
14,000

Accumulated depreciation
3 &
Advertising expenses
4.
Other
selling
administrative expenses
Accounts payable

14,000
84,000

and

16,000
100,000

Note: In entry 2, the depreciation on office furniture have been debited to

depreciation expense because depreciation on office furniture or equipment is
treated as period cost. If it were a depreciation on factory equipment, it would have
been debited to manufacturing overhead because depreciation on factory
equipment is treated as manufacturing or product cost.

Finished goods and cost of goods sold

Recording finished goods and cost of goods manufactured:
In a job order costing system, all manufacturing costs (i.e., direct materials, direct labor, and
applied manufacturing overhead) of the job are debited to work in process account. When a job
is completed, its cost (as shown by job cost sheet) is transferred from the work in process
account to the finished goods account.
After completion, the job becomes finished goods and is, therefore, transferred from the
production department to the finished goods storeroom (also called warehouse).
The following journal entry is made to transfer the cost of a completed job from work in process
account to finished goods account:
Finished goods
xxxx
Work in process
xxxx
The total cost transferred from the work in process account to the finished goods account during
a period is equal to the cost of goods manufactured for that period.
At the end of a period, the cost of incomplete jobs remain in the work in process account and is
shown as work in process inventory in assets section of the balance sheet. Next period, this
cost represents the opening balance of the work in process account.
Cost of goods sold:
When finished goods are shipped to customers, the cost of finished goods are transferred from
finished goods account to cost of goods sold account. If a job is completed according to
specification of a particular customer, the complete job is shipped to the customer immediately
and the manufacturing cost associated with the job (as shown by the job cost sheet) is charged to
the cost of goods sold. But in some cases, the complete job is not shipped but only a portion of
the job is sold to customers. In such circumstances, the manufacturing cost per unit is computed
and the cost of the units that have been shipped to customers is charged to cost of goods sold
account.
Sales and the transfer of cost from finished goods to cost of goods sold account are recorded by
making the following journal entries:
When sales are made:
If sales are made on account
Accounts receivables
xxxx
Sales
xxxx
If sales are made on cash
cash
xxxx
Sales
xxxx
When cost is transferred to cost of goods sold account:
Cost of goods sold
xxxx
Finished goods
xxxx

Over or under-applied manufacturing overhead

The over or under-applied manufacturing overhead is defined as the difference
between manufacturing overhead cost applied to work in process and
manufacturing overhead cost actually incurred during a period.
If the manufacturing overhead cost applied to work in process is more than the
manufacturing overhead cost actually incurred during a period, the difference is
known as over-applied manufacturing overhead. On the other hand; if the
manufacturing overhead cost applied to work in process is less than the
manufacturing overhead cost actually incurred during a period, the difference is
known as under-applied manufacturing overhead.

The occurrence of over or under-applied overhead is normal in manufacturing

businesses because overhead is applied to work in process using a predetermined
overhead rate. Predetermined overhead rate is computed at the beginning of the
period using estimated information and is used to apply manufacturing overhead
cost throughout the period.
The procedure of computing predetermined overhead rate and its use in applying
manufacturing overhead has been described in measuring and recording
manufacturing overhead cost article.
Recording actual and applied overhead cost in manufacturing overhead account:

Over or under-applied manufacturing overhead is actually the debit or credit

balance of manufacturing overhead account (also known as factory overhead
account).
Actual manufacturing overhead costs are debited and applied manufacturing
overhead costs are credited to manufacturing overhead account. Actual overhead
costs are debited as they are incurred and applied overhead costs are credited as
they are applied to work in process. At the end of a period, if manufacturing
overhead account shows a debit balance, it means the overhead is underapplied. On the other hand; if it shows a credit balance, it means the overhead is
over-applied. For further explanation of the concept, consider the following
example:

The debit or credit balance in manufacturing overhead account at the end of a month is carried
forward to the next month until the end of a particular period usually one year.
Disposition of over or under-applied manufacturing overhead:
At the end of the year, the balance in manufacturing overhead account (over or under-applied
manufacturing overhead) is disposed off by either allocating it among work in process, finished
goods and cost of goods sold accounts or transferring the entire amount to cost of goods sold
account. These two methods have been discussed below:
Allocation among work in process, finished goods and cost of goods sold account:
Under this method, the amount of over or under-applied overhead is disposed off by allocating it
among work in process, finished goods and cost of goods sold accounts on the basis of overhead
applied in each of the accounts during the period. The following journal entry is made to dispose
off an over or under-applied overhead:
When overhead is under-applied:
Work in process
xxxx
Finished goods

xxxx

Cost of goods sold

xxxx

Manufacturing overhead

xxxx

When overhead is over-applied:

Manufacturing overhead
xxxx
Work in process

xxxx

Finished goods

xxxx

Cost of goods sold

xxxx

This method is more accurate than second method. The only disadvantage of this method is that
it is more time consuming.
Transferring the entire amount of over or under-applied to cost of goods sold:
Under this method the entire amount of over or under applied overhead is transferred to cost of
goods sold. The following entry is made for this purpose:

When overhead is under-applied:

Cost of goods sold
xxxx
Manufacturing
overhead

xxxx

When overhead is over-applied:

Manufacturing overhead xxxx
Cost of goods sold

xxxx

This method is not as accurate as first method. Companies use this method because
it is less time consuming and easy to use.
Example:
During the year 2012, Beta company started two jobs job A and job B . Job A consisted of
1000 units and job B consisted of 500 units. At the end of the year 2012, job A was completed
but job B was in process. The information about manufacturing overhead cost applied to job A
and B was as follows:
Job A: $ 65,000
Job B:

35,000

Total

$ 100,000

The actual manufacturing overhead cost incurred by the company during 2012 was $108,000.
Out of 1,000 units in job A, 750 units had been sold before the end of 2012.
Required: Calculate over or under applied manufacturing overhead and make journal entries
required to dispose off over or under applied manufacturing overhead assuming:
1. It is disposed off by allocating between inventory and cost of goods sold accounts.
2. It is disposed off by transferring to cost of goods sold.
Solution:
Calculation of over or under-applied manufacturing overhead:
Total manufacturing overhead applied to work
$ 100,000
in process
Total manufacturing overhead cost actually
108,000
incurred

Under-applied manufacturing overhead

$ 8,000

Journal entries to dispose off under-applied overhead:

Allocation among work in process finished goods, and cost of goods sold accounts:
Work in process
2,800
finished goods
1,300
cost of goods sold
3,900
Manufacturing overhead
8,000
Amount Percentage
Work in process
$ 35,000 35.00%
Finished goods ($65,000 250
16250 16.25%
units)/1,000 units
Cost of goods sold ($65,000 750
48750 48.75%
units)/1000 units

Total overhead applied
100,000 100%

Transfer of entire under-applied overhead to cost of goods sold account:
Cost of goods sold
8,000
Manufacturing overhead
8,000

Predetermined overhead rate

Predetermined overhead rate is used to apply manufacturing overhead to
products or job orders and is usually computed at the beginning of each period by
dividing the estimated manufacturing overhead costby an allocation base (also
known as activity base or activity driver). Commonly used allocation bases are
direct labor hours, direct labor dollars, machine hours, and direct materials.

Example:
Suppose GX company uses direct labor hours to assign manufacturing overhead
cost to job orders. The budget of the GX company shows an estimated
manufacturing overhead cost of $8,000 for the forthcoming year. The company
estimates that 1,000 direct labors hours will be worked in the forthcoming year.
Using the above information, we can compute the predetermined overhead rate as
follows:

= $8,000 / 1,000 hours

= $8.00 per direct labor hour
Notice that the formula of predetermined overhead rate is entirely based on
estimates. The overhead applied to products or job orders would, therefore, be
different from the actual overhead incurred by jobs or products. This difference is
eliminated at the end of the period. The elimination of difference between applied
overhead and actual overhead is known as disposition of over or under applied
overhead.
Multiple Predetermined overhead rate:
The predetermined overhead rate computed above is known as single
predetermined overhead rate or plant-wide overhead rate. It is mostly used by
small companies. In large companies, each production department computes its
own predetermined overhead rate. The use of multiple predetermined overhead
rates may be complex and time consuming but is considered more accurate than a
single plant-wide overhead rate.
According to a survey 34% of the manufacturing businesses use a single plant wide
overhead rate, 44% use multiple predetermined overhead rates and rest of the
companies use activity based costing (ABC) system.

Comprehensive example of job order costing system

The Fine manufacturing company uses job order costing system. The company uses machine
hours to apply overhead cost to jobs. At the beginning of 2012, the company estimated that
150,000 machine hours would be worked and $900,000 overhead cost would be incurred during
2012.
The balances of raw materials, work in process (WIP), and finished goods at the beginning of
2012 were as follows:
Raw materials
$ 40,000
Work in process
30,000
Finished goods
60,000
The Fine manufacturing company recorded the following transactions during 2012:
a. Raw materials purchased on account, $820,000.
b. Raw materials were requisitioned for use in production, $760,000
($720,000 direct materials and $40,000 indirect materials).
c. Direct labor labor, $150,000; indirect labor, $220,000; sales
commission, $180,000; and administrative salaries, $400,000.
d. Sales travel costs were $34,000.
e. Utility costs incurred in the factory, $86,000.
f. Advertising expenses were $360,000.
g. Depreciation for the year was $700,000 ($560,000 relates to factory
and $140,000 relates to selling and administrative activities).
h. Insurance expired during the year, $20,000 ($14,000 relates to
factory operations and $6,000 relates to selling and administrative
activities).
i. Fine manufacturing company worked 160,000 machine hours.
Manufacturing overhead was applied to production.
j. Goods costing $1,800,000 were completed during the year.
k. The goods costing $1,740,000 were sold to customers for
$3,000,000.
Required:
1. Prepare journal entries, T-accounts and income statement from the above information.
2. Prepare a journal entry to close the balance in manufacturing overhead account (over or under
applied manufacturing overhead) to cost of goods sold.

Solution:
1. Journal entries:

Application of manufacturing overhead (entry 9):

Manufacturing overhead is applied to production by multiplying actual direct labor or machine
hours worked during the year and predetermined overhead rate computed at the beginning of the
year. It is shown as follows:

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