CHAPTER 1



CHAPTER 17

Costing Systems: Job Order and Process Costing

reviewing the chapter

Objective 1: Discuss the role that information about costs plays in the management process, and explain why unit cost is important.

1. Throughout the management process, managers rely on the cost information that management accounting provides. When managers plan, they use information about unit costs to estimate product or service costs, set reasonable selling prices, establish performance goals, and develop budgets. In performing daily operations, managers use timely cost and volume information to support decisions about controlling costs, managing volume, ensuring product or service quality, and negotiating prices. When managers evaluate performance, they watch for changes in costs and quality. They compare actual and targeted costs and monitor relevant price and volume information. This enables them to make necessary adjustments to their plans and decision-making strategies. When managers communicate results to shareholders, they use unit costs in preparing financial statements and performance evaluation reports.

Objective 2: Distinguish between the two basic types of product costing systems, and identify the information each provides.

2. A product costing system is a set of procedures used to account for an organization’s product costs and to provide timely and accurate unit cost information for pricing, cost planning and control, inventory valuation, and financial statement preparation. Job order costing and process costing are the two basic types of product costing systems.

3. Companies that make one-of-a-kind, special-order products or that provide custom services, such as shipyards, makers of custom cabinets, or wedding planners, use a job order costing system. Such a system traces the costs of direct materials, direct labor, and overhead to a specific batch of products or job order. A job order is a customer order for a specific number of specially designed, custom-made products or services. A job order costing system measures the cost of each complete unit and summarizes the costs of all jobs in a single Work in Process Inventory account that is supported by job order cost cards. A job order cost card is a record of all costs incurred in the production of a particular job order.

4. Companies that produce large amounts of similar products or liquid products or that have a continuous production flow—for example, makers of paint, cars, or breakfast cereal—typically use a process costing system. Such a system first traces the costs of direct materials, direct labor, and overhead to processes, departments, or work cells and then assigns the costs to the products manufactured by those processes, departments, or work cells. A process costing system uses several Work in Process Inventory accounts, one for each department, process, or work cell.

5. Production processes are rarely a perfect match for either a job order costing system or a process costing system. The typical product costing system therefore combines features of job order costing and process costing to create a hybrid system designed specifically for a company’s production processes.

Objective 3: Explain cost flow in a job order costing system, prepare a job order cost card, and compute product unit cost.

6. A job order costing system, which traces the costs of a specific order or batch of products, provides timely, accurate cost information and facilitates the smooth and continuous flow of that information. This cost flow, along with the job order cost cards and subsidiary ledgers for materials and finished goods inventories, forms the core of a job order costing system.

7. Because a job order costing system emphasizes cost flow, it is important to understand how costs are incurred, recorded, and transferred within the system.

a. In a manufacturer’s job order costing system, the purchase of materials is recorded by increasing Materials Inventory and decreasing Cash or increasing Accounts Payable. When materials are issued into production, Work in Process Inventory is increased for the direct materials portion, Overhead is increased for the indirect materials portion, and Materials Inventory is reduced.

b. The total cost of wages earned during the period is debited to the Factory Payroll account. The payroll is distributed to the production accounts by increasing the Work in Process Inventory for direct labor, increasing Overhead for indirect labor, and decreasing Factory Payroll for the amount of direct labor.

c. Overhead costs, other than indirect materials and indirect labor costs, increase Overhead, and an appropriate account, such as Cash or Accounts Payable, is also recognized. Overhead is applied to specific jobs by recording it in the Work in Process Inventory account and Overhead account.

d. Upon completion of a specific job, Finished Goods Inventory is increased, and Work in Process Inventory is decreased.

e. When the finished goods are sold, two accounting entries are made. First, the sale is recorded by increasing Cash or Accounts Receivable and increasing Sales for the total sales price. Second, Cost of Goods Sold is recognized, and Finished Goods Inventory is reduced for the cost attached to the goods sold.

f. At the end of the period, an adjustment must be made for under- or overapplied overhead.

8. Because all manufacturing costs are accumulated in one Work in Process Inventory account, a separate accounting procedure is needed to trace those costs to specific jobs. The solution is the subsidiary ledger made up of job order cost cards. Each job being worked on has a job order cost card, which records the costs of direct materials used, direct labor, and overhead assigned to the job. When the job is completed, the product unit cost is computed by dividing the total costs for the job by the total number of units produced.

9. Many service organizations use job order costing to compute the cost of rendering services. Because service organizations do not manufacture products, their materials costs are usually negligible. Their most important cost is labor.

a. Job order cost cards are used to track the costs of labor for a job, as well as the costs of materials, supplies, and service overhead. Service jobs are often based on cost-plus contracts, which require the customer to pay all costs incurred in performing a job plus a predetermined amount of profit.

b. When a job is finished, the costs on the completed job order cost card become the cost of services. The cost of services is adjusted at the end of the accounting period for the difference between the applied service overhead costs and the actual service overhead costs.

Objective 4: Explain product flow and cost flow in a process costing system.

10. During production in a process cost environment, products flow in a first-in, first-out (FIFO) fashion through several processes, departments, or work cells, and may undergo many different combinations of operations. For example, a bookcase might go through the cutting, assembling, and staining departments. As products pass through each process, department, or work cell, the process costing system accumulates their costs and passes them on to the next process, department, or work cell.

11. As noted earlier, a process costing system has a separate Work in Process Inventory account for each process, department, or work cell. These accounts are the focal point of process costing. As products move from one process, department, or work cell to the next, the costs of the direct materials, direct labor, and overhead associated with them flow to the Work in Process Inventory account of that process, department, or work cell. Once the products are completed, packaged, and ready for sale, their costs are transferred to the Finished Goods Inventory account.

12. At the end of every accounting period, a process costing system generates a process cost report that assigns the costs that have accumulated during the period to the units that have transferred out of the process, department, or work cell and to the units that are still work in process. In a process cost report that uses the FIFO costing method, cost flow follows the logical physical flow of production—that is, the costs assigned to the first materials processed are the first costs transferred out when those materials flow to the next process, department, or work cell.

13. Managers use the process cost report to track and analyze costs and to assign costs to products worked on during a period. The unit cost is computed by dividing the total cost of direct materials, direct labor, and overhead by the total number of units worked on during the period.

Objective 5: Define equivalent production, and compute equivalent units.

14. Equivalent production (also called equivalent units) is used to determine the number of units worked on during an accounting period. It applies a percentage-of-completion factor to partially completed units to calculate the equivalent number of whole units produced for each type of input (direct materials, direct labor, and overhead). The number of equivalent units produced is the sum of (a) total units started and completed during the period and (b) an amount representing the work done on partially completed products in both the beginning and the ending work in process inventories.

15. Equivalent production must be computed separately for each type of input because of differences in the ways the costs are incurred. Conversion costs, or processing costs, are the combined total costs of direct labor and overhead; they are often incurred uniformly throughout the production process. Direct materials are usually added to production at the beginning of the process. Thus, equivalent units for materials typically reflect 100 percent completion.

Objective 6: Prepare a process cost report using the FIFO costing method.

16. Preparation of a process cost report involves five steps. Steps 1 and 2 account for the physical flow of products and compute the equivalent units of production. Once equivalent production has been determined, the focus of the report shifts to accounting for costs. In Step 3, all direct materials and conversion costs are added to arrive at total costs. In Step 4, the current cost per equivalent unit for both direct materials and conversion costs is found by dividing those current costs by their respective current equivalent units. In Step 5, costs are assigned to the units completed and transferred out during the period, as well as to the ending work in process inventory. The costs assigned to units completed and transferred out include the costs incurred in the preceding period and the conversion costs needed to complete those units during the current period. That amount is added to the total cost of producing all units started and completed during the period. The result is the total cost transferred out for the units completed during the period. Step 5 also assigns costs to units still in process at the end of the period by multiplying their direct materials and conversion costs per equivalent unit by their respective equivalent units. The total equals the balance in the Work in Process Inventory account at the end of the period.

Objective 7: Evaluate operating performance using information about product cost.

17. Both the job order and the process costing systems provide information that is useful in evaluating operating performance. Such an analysis may include consideration of the cost trends of a product or product line, units produced per time period, materials usage per unit produced, labor cost per unit produced, special needs of customers, and the cost-effectiveness of changing to a more advanced production process.

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