Manufacturing Companies

There are 3 major categories of manufacturing costs:

Direct Materials
Raw material, parts, and components that can be observed being used to make a specific product.

Direct Labor
The cost of paying employees who convert direct materials into finished product.

Overheads
Indirect material Indirect labor Other overhead

Manufacturing Companies
Prime Costs include:

Direct Materials

Direct Labor

Manufacturing Overhead

Manufacturing Companies
Conversion Costs include:

Direct Materials

Direct Labor

Manufacturing Overhead

Process Costing

Job Order Costing

Used for production of large, unique, highcost items.

Built to order (MTO) rather than mass produced (MTS).

Many costs can be directly traced to each job.

Process Costing

Job Order Costing

Typical job order cost applications: Special-order printing Building construction

Also used in service industry Hospitals Law firms

Job-Order Costing:Examples
1) A manufacturer of luxury yachts
2) An automobile service centre (e.g. Honda

workshop)
3) A professional services firm (e.g. Accountancy firms like E&Y) 4) A landscape garden contractor, house builder etc.

Process Costing

Job Order Costing

Used for production of small, identical, low-cost items.

Mass produced in automated continuous production process.

Costs cannot be directly traced to each unit of product.

Process Costing

Job Order Costing

Typical process cost applications: Petrochemical refinery Paint manufacturer Paper mill

Job-Order Costing
The primary document for tracking the costs associated with a given job is the job cost sheet.

Lets investigate

Job-Order Costing
In Job-Order Costing systems the primary document is called a job-cost sheet. It is used to capture costs of producing that product. Using the home builder example, a job-cost sheet would be prepared for each home. And the costs it captures are the usual suspects, materials, labor and overheads!

The Job Cost Sheet

RoseCo Job Cost Sheet Job Number A - 143 Department Assembly Item Wooden cargo crate Date Initiated 24 Sep 2013 Date Completed Units Completed

Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Cost

Units Shipped Date Number Balance

The Job Cost Sheet

RoseCo Job Cost Sheet Job Number A - 143 Department B3 Item Wooden cargo crate Date Initiated 3-4-X9 Date Completed Units Completed

Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Amount Hours Rate Amount X7-6890 $ 116

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Cost

116

Units Shipped Date Number Balance

The Job Cost Sheet

RoseCo Job Cost Sheet Job Number A - 143 Department B3 Item Wooden cargo crate Direct Materials Req. No. Amount X7-6890 $ 116 Date Initiated 3-4-X9 Date Completed Accumulate Units Completed

Direct Labor Card Hours Amount 36 8 $ 88

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Cost

$ $

116 88

direct labor costs by Manufacturing Overhead of a Hours means Rate Amount work record, such as a time card, for each Units Shipped Date Number Balance employee.

The Job Cost Sheet

Apply manufacturing overhead to jobs using a Job Number A - 143 Date Initiated 3-4-X9 predetermined overhead Date rate (OAR) based Completed 3-5-X9 on Department B3 hours Units Completed 2 direct labor
Item Wooden cargo crate Direct Materials Direct Labor Manufacturing Overhead Req. No. Amount Ticket Hours Amount Hours Rate Amount X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32 RoseCo Job Cost Sheet

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Cost

$ $ $ $ $

116 88 32 236 118

Units Shipped Date Number Balance

Job order costing

Lets summarize the cost flows we have been discussing in a job order costing system.

Cost Flow for Job Cost Components

Direct Materials
Direct allocation

Direct Labor

Direct allocation

Finished Job

Factory Overheads

Absorbed

Direct Material Cost

The document used to request the release of materials to production is called a materials requisition. This requisition indicates the type, quantity and cost of material as well as the job number to which it will be assigned.

Direct Labor Cost

The document which is used to trace direct labor cost

to production is called a time card.

The time card indicates how much time was spent on

which job.
Note that when several employees all work on the

same job, the time card data will be aggregated and then applied to each job.

Manufacturing Overheads
Unlike Direct Materials and Direct Labor which are directly traceable to the job, manufacturing overhead is added to each job in a slightly more complex manner.
Manufacturing Overhead is applied to specific

jobs as opposed to being traced.

And it is applied on some common allocation

basis.

Assigning Costs to Jobs:

A Summary
How are costs attached to jobs?
Direct Material: Material Requisition Forms. Direct Labor: Labor Time cards. Overheads: Overhead Absorption Rate.

Predetermined Overhead Rates

Most companies develop overhead absorption rates
based on:
Estimates of total overhead costs ($) and Estimated level of the activity basis as follows:

Budgeted overheads ($) OAR = Budgeted activity basis

Activity Basis
The relevant bases used for the allocation of overhead are:
1) Units of output: if just one product or a line of very

similar products is produced

2) Direct labor hours: if production is very labor intensive

and the number of workers drives activity of overheads

3) Machine hours: if production is highly automated
4) Cost percentage rates: fit very seldom

Why Budgeted OARs ?

OAR must be predetermined in order to calculate jobs near to their production time
A job to be produced on 1st Feb 2013 should not be calculated in March 2013, when historical overhead costs are known for February. It should not be calculated in January 2014 next year, when overheads for the whole year are known.

Recording overheads
Recording Manufacturing Overhead is a two-step process.
1) First, overheads are applied to production based on

the Predetermined Overhead Rate (OAR).

2) Second, actual costs are recorded in the Overhead

control account

Over-absorption or Under-absorption
As a result, unless estimates are perfect, there will be either an over-absorption or under-absorption of overheads.
1) If actual costs are more than applied overheads , we

have under - applied overhead.

2) If applied overhead is more than actual overhead,

the result is over - applied overhead.

Over-absorption or Under-absorption
There are three simple steps to compute any under/ over absorption at the end of an accounting period as follows: 1) Calculate overheads absorption rate using: OAR = Budgeted overheads ($)

Budgeted activity basis

2) Calculate Absorbed overheads using: Absorbed Overheads = OAR x Actual Activity

3) Finally, calculate under/ over absorption using: Actual Production fixed overheads x Absorbed Production fixed overheads x under/ over absorption x

Accounting for Over-absorbed or Under-absorbed Overheads

So what happens to this under-applied or over-applied amount at the end of the year?
1) Any under-absorbed overheads are deducted from

gross profit in the income statement.

2) Any over-absorbed overheads are added back to

gross profit in the income statement.

Absorption Costing Statement

Sales Full cost of Sales Opening Inventory Production Cost Closing Inventory GROSS PROFIT (under) / over absorption Period costs Admin fixed overheads Admin variable overheads Selling fixed overheads Selling variable overheads NET PROFIT (units x SP) (units x FC) (units x FC) (units x FC) x x (x) x

(x) X x (x) (x) (x) (x) X

Marginal Costing Statement

Sales Marginal cost of sales Opening Inventory Production Cost Closing Inventory Variable overheads Selling variable overheads Admin variable overheads CONTRIBUTION Fixed overheads Production fixed overheads Admin fixed overheads Selling fixed overheads (units x SP) (units x MC) (units x MC) (units x MC) x x (x) x

(x) (x) (x) X

(actual) (actual) (actual)

(x) (x) (x)

Profit Reconciliation Statement

Net profit under absorption costing x

add: Opening inventory difference

less: Closing inventory difference Net profit under marginal costing

(units x OAR)

x
x

(units x OAR) (x)