Job-Order Costing and Overhead Application: Seventh Edition

Examples of Managerial Accounting
Seventh Edition
Chapter 4
Job-Order Costing
and Overhead
Application
© 2019 Cengage. All rights reserved.

Learning Objectives (1 of 2)
1. Describe the differences between job-order costing

and process costing, and identify the types of firms
that would use each method
2. Compute the predetermined overhead rate, and use
the rate to assign overhead to units or services
produced
3. Identify and set up the source documents used in job-
order costing
4. Describe the cost flows associated with job-order
costing

Learning Objectives (2 of 2)
5. (Appendix 4A) Prepare the journal entries associated

with job-order costing
6. (Appendix 4B) Allocate support department costs to
producing departments

The Differences Between Job-Order and
Process Costing (1 of 2)
• Companies can be divided into two major types
– If a company’s products/ services are unique, they
require a job-order accounting system
– On the other hand, those firms producing similar
products or services can use a process-costing
accounting system

Job-Order Production and Costing
• Customized or built-to-order products fit into this

category, as do services that vary from customer to
customer
– A job is one distinct unit or set of units
– Examples: printing, construction, furniture making,
medical and dental services, automobile repair, and
beautician services
• For job-order production systems, costs are
accumulated by job
• This approach to assigning costs is called a job-order
costing system

Here’s How It’s Used: AT KICKER (1 of 2)
In the 1970s, Kicker began operations in Steve Irby’s garage.

Steve was an engineering student at Oklahoma State University
and a keyboard player with a local band. The band needed
speakers but couldn’t afford new ones. Steve and his father built
wooden boxes and fitted them with secondhand components.
Word spread, and other bands asked for speakers. Steve
partnered with a friend to fill the orders. Then, an oil-field worker
asked if Steve could rig up speakers for his pickup truck. Long
days bouncing over rough fields went more smoothly with
music, but the built-in audio systems at the time were awful.

Here’s How It’s Used: AT KICKER (2 of 2)
Steve designed and built a speaker to fit behind the driver’s

seat, and Kicker was born. At first, each job was made to order
to fit a particular truck or car. The price Steve charged
depended heavily on the cost of the job. Since each job was
different, the various costs had to be computed individually.
Clearly, the costs of wood, fabric, glue, and components were
traceable to each job. Steve could also trace labor time. But the
other costs of design time, use of power tools, and space were
combined to create an overhead rate. To the extent that the
price of a job was greater than its costs, Steve earned a profit.

Process Production and Costing (1 of 2)
• Firms in process industries mass-produce large

quantities of similar or homogeneous products
• Examples of process manufacturers include:
– Food canning and manufacturing
– Cement
– Petroleum
– Pharmaceutical and chemical manufacturing

Process Production and Costing (2 of 2)
• Process firms accumulate production costs by process

or by department for a given period of time
• This approach to cost accumulation is known as a
process-costing system
• Unit costs are measured using the following equation:
Process Costs
Unit Costs 
Output

The Differences Between Job-Order and
Process Costing (2 of 2)
Job-Order Costing Process Costing

• Wide variety of distinct • Homogeneous products
products
• Costs accumulated by job • Costs accumulated by process or
department
• Unit Cost = Total Job • Unit Cost = Process Costs/Output
Costs/Output

Normal Costing and Overhead Application
• Unit costs are important because managers need

accurate cost information on materials, labor, and
overhead when making decisions
• For example, when a construction company bills a
client at set points throughout the construction, it is
important that unit cost be generated in a timely
manner
• Job-order costing using a normal cost system will give
the company the unit cost information it needs

Actual Costing versus Normal Costing
• Two ways are commonly used to measure the costs

associated with production: actual costing and normal
costing
• In an actual cost system, only actual costs of direct
materials, direct labor, and overhead are used to
determine unit cost
• In normal costing, overhead is estimated and applied

Actual Costing (1 of 2)
• There are several issues involved in using actual

costing:
– Defining Overhead Costs: Overhead items do not have
the direct relationship with units produced that direct
materials and direct labor do
– Uneven Overhead Costs: Many overhead costs are not
incurred uniformly throughout the year
 Waiting until the end of the year to total the actual
overhead costs is typically unrealistic

Actual Costing (2 of 2)
• Uneven Production: Distortions can occur when actual

costs are used with uneven production
– Strict actual cost systems are rarely used because
accurate day-to-day unit cost information is needed
on a timely basis

Normal Costing
• Normal costing solves the problems associated with

actual costing
• A normal cost system determines unit cost by adding
actual direct materials, actual direct labor, and
estimated overhead
• Overhead can be estimated by approximating the
year’s actual overhead at the beginning of the year and
then using a predetermined rate throughout the year to
obtain the needed unit cost information
• Virtually all firms use normal costing

Importance of Unit Costs to Manufacturing
Firms (1 of 2)
• Unit cost is a critical piece of information for a
manufacturer
• Unit costs are essential for valuing inventory,
determining income, and making numerous important
decisions
• Disclosing the cost of inventories and determining
income are financial reporting requirements that a firm
faces at the end of each period

Importance of Unit Costs to Manufacturing
Firms (2 of 2)
• In order to report the cost of its inventories, a firm must
know the number of units on hand and the unit cost
• The cost of goods sold (COGS), used to determine
income, requires units sold and their unit cost
• Full cost information is useful as an input for internal
decisions as well as for financial reporting
• In the long run, for any product to be viable, its price
must cover its full cost

Importance of Unit Costs to Service Firms
(1 of 2)
• Service and nonprofit firms also require unit cost
information
• Conceptually, the way companies accumulate and
assign costs is the same whether or not the firm is a
manufacturer
• The service firm must first identify the service ‘‘unit’’
being provided

Importance of Unit Costs to Service Firms
(2 of 2)
• For example, a hospital would accumulate costs by
patient, patient day, and type of procedure
• Because service firms do not produce physical
products, they do not need to value work-in-process
and finished goods inventories

Ethical Decisions (1 of 2)
• Nonprofit firms must track costs to be sure that they

provide their services in a cost-efficient way
• Governmental agencies must track costs to use the
funds wisely because they have a fiduciary
responsibility to taxpayers
• A cost accounting system measures and assigns costs
so that the unit cost of a product or service can be
determined
– It is a critical piece of information for both manufacturing
and service firms

Ethical Decisions (2 of 2)
• An important part of bidding and charging for services

under Medicaid rules impacts government agencies
and is commonly tied to the critical determination of
unit cost

Here’s How It’s Used: IN YOUR LIFE
(1 of 3)
It’s close to the end of the month and you need $400 for
your share of the rent. What do you do? If you have a
four-door car, you might consider signing up for a few
hours of driving for Uber. Part of the so-called peer-to-peer
economy, Uber matches you with people who need rides
in your area. You keep 80% of the fare, and Uber keeps
the remaining 20%. But how do you know how much profit
you are making? Profit is the difference between the price
charged and all costs of providing the ride. Let’s say you
give a ride to someone whose fare is $25. Your share is
80% of that, or $20.

(2 of 3)
So, did you just make $20? That depends on what your
costs for the trip were. Clearly, the cost of gasoline is a
direct cost. You can figure that by multiplying the miles
driven times the cost of gas per mile using the actual cost
of your most recent fill-up. However, there are many other
costs, and you may need to allocate costs between your
personal use of the car and the Uber, or business, use.
The cost of maintenance and tires can be smoothed out
over total miles driven in a year. What about the cost of
the car itself (or depreciation on it)—how much should be
allocated to business use?

(3 of 3)
Here we can take a page from normal costing and
overhead application. Total indirect costs will be in the
numerator, and total miles driven in the denominator. This
will give you a cost per mile. Multiply that cost times the
miles driven for Uber and you get a sense of the part of
your costs that are applicable to the Uber use. Different
Uber drivers will get different cost amounts, depending on
their car’s model and make, fuel economy, and so on. In
the end, is it worth it? That’s something you can determine
once you know all the costs and benefits.

Normal Costing and Estimating Overhead
(1 of 2)
• In normal costing, overhead is estimated and applied to
production. The basics of overhead application can be
described in three steps:
• Step 1: Calculate the predetermined overhead rate
• Step 2: Apply overhead to production throughout the
year
• Step 3: Reconcile the difference between the total
actual overhead incurred during the year and the total
overhead applied to production

Normal Costing and Estimating Overhead
(2 of 2)
• Predetermined overhead rates help companies
maintain a constant application of overhead throughout
the year
• These rates do not allow seasonality or variations in
production to affect unit cost

Step 1: Calculating the Predetermined
Overhead Rate (1 of 3)
• The predetermined overhead rate is calculated at the
beginning of the year by dividing the total estimated annual
overhead by the total estimated level of associated activity
or cost driver:
Estimated Annual Overhead

Predetermined Overhead Rate 
Estimated Annual Activity Level
• Notice that the predetermined overhead rate includes

estimated amounts in both the numerator and the
denominator

• This estimation is necessary because the
predetermined overhead rate is calculated in advance,
usually at the beginning of the year
• Estimated overhead is the firm’s best estimate of the
amount of overhead (utilities, indirect labor,
depreciation, etc.) to be incurred in the coming year
– Estimates may be based on last year’s figures adjusted
for anticipated changes in the coming year

• The associated activity level depends on which activity
is best associated with overhead
– The number of machine hours could be a good choice of
activity level for the overhead of a company that has
automated production

Step 2: Applying Overhead to
Production (1 of 2)
• Once the overhead rate has been computed, the
company can begin to apply overhead to production
• Applied overhead is found by multiplying the
predetermined overhead rate by the actual use of the
associated activity for the period:
Applied Overhead = Predetermined Overhead Rate x
Actual Activity Level

Step 2: Applying Overhead to
Production (2 of 2)
• Once this is calculated, the total cost of the product for
the period is the actual direct materials and direct labor,
plus the applied overhead:
Total Normal Product Costs = Actual Direct Materials +
Actual Direct Labor+ Applied Overhead

Exercise 4.1: How to Calculate the
Predetermined Overhead Rate and Apply
Overhead to Production (1 of 2)
At the beginning of the year, Argus Company estimated
the following costs:
Overhead $360,000
Direct labor cost 720,000
Argus uses normal costing and applies overhead on the

basis of direct labor cost. (Direct labor cost equals total
direct labor hours worked multiplied by the wage rate.)
For the month of February, direct labor cost was
$56,000.
Exercise 4.1: How to Calculate the
Predetermined Overhead Rate and Apply
Overhead to Production (2 of 2)
Required:
1. Calculate the predetermined overhead rate for the year.
2. Calculate the overhead applied to production in February.
Solution :
$360,000
1. Predetermi ned Overhead Rate 
$720,000
 0.50, or 50% of direct labor hour
2. Overhead Applied to February Production = 0.50 ×

$56,000 = $28,000
Step 3: Reconciling Actual Overhead with
Applied Overhead (1 of 4)
• Remember that two types of overhead are recorded:
– Actual overhead: Costs are tracked throughout the year
in the overhead account
– Applied overhead: Costs are computed throughout the
year and added to actual direct materials and actual
direct labor to get total product cost
– At the end of the year, however, it is time to reconcile
any difference between actual and applied overhead and
to correct the cost of goods sold account to reflect actual
overhead spending
– Applied overhead will rarely equal actual overhead

• The difference between actual overhead and applied
overhead is called an overhead variance
• If actual overhead is $400,000 for the year but $390,000
was applied to production, we would say that the
variance is underapplied overhead by $10,000
• If actual overhead is $400,000 for the year but $410,000
was applied to production, we would say that the
variance is overapplied overhead by $10,000
• If overhead has been underapplied, then product cost
has been understated

• If overhead has been overapplied, then product cost
has been overstated
• Something must be done with the overhead variance
at year-end to report costs at actual amounts on the
financial statements
• Generally, the entire overhead variance is assigned to
Cost of Goods Sold, since the amount is usually small
or immaterial
– Underapplied overhead is added to Cost of Goods Sold
– Overapplied overhead is subtracted from Cost of Goods
Sold

• If the overhead variance is material, or large, the
variance would be allocated among the ending
balances of Work in Process, Finished Goods, and
Cost of Goods Sold

Actual Overhead and Applied Overhead
(1 of 2)
• This exhibit illustrates the concepts of over- and
underapplied overhead

Actual Overhead and Applied Overhead
(2 of 2)
• The costs of units sold and of units kept in inventory
are carried at historical cost, the difference between
actual and applied overhead must be recognized and
total cost must be adjusted

Example 4.2: How to Reconcile Actual
Overhead with Applied Overhead (1 of 2)
Recall that Argus Company’s predetermined overhead rate
was 0.50 or 50% of direct labor cost. By the end of the year,
actual data are:
Overhead $375,400
Direct labor cost 750,000
Cost of Goods Sold (before adjusting for any overhead

variance) is $632,000.
Required:
1. Calculate the overhead variance for the year.
2. Dispose of the overhead variance by adjusting Cost of
Goods Sold.
Example 4.2: How to Reconcile Actual
Overhead with Applied Overhead (2 of 2)
Solution:
1. Overhead Applied for the Year = 0.50 × $750,000 =
$375,000
Actual overhead $375,400
Applied overhead 375,000
Overhead variance— $ 400
underapplied
2. Unadjusted cost of goods $632,000
sold
Add: Overhead variance— 400
underapplied
Adjusted cost of goods sold $632,400

Departmental Overhead Rates (1 of 3)
• A plantwide overhead rate or single overhead rate

has been explained by dividing all estimated overhead
for a factory by the estimated activity level across the
entire factory
• Some manufacturers and service firms believe that
multiple overhead rates give more accurate costing
information
• Departmental overhead rates are a widely used type of
multiple overhead rate

• A departmental overhead rate is estimated overhead

for a department divided by the estimated activity level
for that same department
Estimated Department Overhead

Department al Overhead Rate 
Estimated Department al Activity Level

• The steps involved in calculating and applying

overhead are the same as those involved for one
plantwide overhead rate
• Departmental overhead rates allow companies to
recognize that different producing departments have
different overhead costs
• These rates allow more precise application of overhead
as units pass through one or more departments

Example 4.3: How to Calculate
Predetermined Dept. Overhead Rates and
Apply Overhead to Production (1 of 4)
At the beginning of the year, Sorrel Company estimated the
following:
Machining Assembly Department Total
Department
Overhead $240,000 $360,000 $600,000
Direct labor hours 135,000 240,000 375,000
Machine hours 200,000 — 200,000
Sorrel uses departmental overhead rates. In the machining

department, overhead is applied on the basis of machine hours. In
the assembly department, overhead is applied on the basis of direct
labor hours. Actual data for the month of June are as follows:

Machining Assembly Department Total
Department
Overhead $22,500 $30,750 $53,250
Direct labor hours 11,000 20,000 31,000
Machine hours 17,000 — 17,000
Required:
1. Calculate the predetermined overhead rates for the
machining and assembly departments.
2. Calculate the overhead applied to production in each
department for the month of June.
3. By how much has each department’s overhead been
overapplied? Underapplied?
Example 4.3: How to Calculate Predetermined Dept.
Overhead Rates and Apply Overhead to Production (3 of 4)
Solution :
$240,000
1. Machining Department Overhead Rate 
200,000mhrs
 $1.20 per machine hour
$360,000
Assembly Department Overhead Rate 
240,000 DLH
 $1.50 per direct labor hour
2. Overhead Applied to Machining in June = $1.20 ×

17,000 = $20,400
Overhead Applied to Assembly in June = $1.50 ×
20,000 = $30,000


Example 4.4: How to Convert Dept. Data to
Plantwide Data to Calculate the Overhead
Rate, Apply Overhead to Production (1 of 2)

Example 4.4: How to Convert Dept. Data to Plantwide
Data to Calculate the Overhead Rate, Apply Overhead
to Production (2 of 2)
Solution :
$600,000
1. Predetermi ned Plantwide Overhead Rate 
375,000DLH
 $1.60 per direct labor hour
2. Overhead Applied in June = $1.60 × 31,000 = $49,600

3. Overhead Variance = Actual Overhead – Applied
Overhead
= $53,250 – $49,600
= $3,650 underapplied

Unit Costs in the Job-Order System
• The unit cost of a job is the total cost of the job

(materials used on the job, labor worked on the job,
and applied overhead) divided by the number of units
in the job:
Total Product Cost

Unit Cost 
Number of Units
• Although the concept is simple, the practical reality of

the computation can be somewhat more complex
because of the recordkeeping involved

Job-Order Cost Sheet (1 of 2)
• Accounting for job-order production begins by
preparing the source documents that are used to
keep track of the costs of jobs. The job-order cost
sheet is prepared for every job

Job-Order Cost Sheet (2 of 2)
• The job-order cost sheet is subsidiary to the work-in-

process account and is the primary document for
accumulating all costs related to a particular job
• As more and more jobs are produced, a company will
usually find it convenient to number them
• Work in process consists of all incomplete work
• In a job-order system, this will be all of the unfinished
jobs
• The balance in Work in Process at the end of the
month will be the total of all the job-order cost sheets
for the incomplete jobs

Materials Requisition Form (1 of 3)
The cost of direct materials is assigned to a job by the
use of a source document known as a materials
requisition form

• Notice that the form asks for the type, quantity, and unit
price of the direct materials issued and, most
importantly, the number of the job
• Using this form, the cost accounting department can
enter the cost of direct materials onto the correct job-
order cost sheet
• If the accounting system is automated, this posting
may entail directly entering the data into a computer,
using the materials requisition forms as source
documents

• No attempt is made to trace the cost of other materials,

such as supplies, lubricants, and the like, to a particular
job
• Indirect materials are assigned to jobs through the
predetermined overhead rate

Time Ticket (1 of 3)
• The means by which direct labor costs are assigned

to individual jobs is the source document known as a
time ticket

• Each day, the employee fills out a time ticket that

identifies his or her name, wage rate, and the hours
worked on each job
• Time tickets are collected and transferred to the cost
accounting department where the information is used
to post the cost of direct labor to individual jobs
• Again, in an automated system, posting involves
entering the data into the computer
• Time tickets are used only for direct laborers

• All completed job-order cost sheets of a firm can serve

as a subsidiary ledger for the finished goods inventory
• Then, the work-in-process account consists of all of the
job order cost sheets for the unfinished jobs

Here’s How It’s Used: TO CREATE SOURCE DOCUMENTS
FOR A PHOTOGRAPHY BUSINESS (1 of 4)
Suppose you are the cost accounting manager for a

company that provides photography services for special
events, such as weddings, bar mitzvahs, anniversary
parties, and corporate functions. The cost of the services
varies from job to job. The time of the photographers
assigned to the job is already kept track of using labor
time tickets. However, your company now wants to
reimburse the photographers for mileage and may want to
include an additional charge to clients for mileage.

What type of source document could serve to

accumulate miles driven?
In this case, your company needs to know not only the
number of miles each photographer drives, but also to
which job the mileage pertains. A relatively simple mileage
log listing the date, starting mileage, ending mileage, and
purpose of the trip should suffice. This will allow you to
compute the miles driven (ending mileage minus
beginning mileage) and assign them to the specific
photographic job.

In addition, total miles for each photographer can be computed

on a monthly basis and multiplied by your company’s mileage
reimbursement rate for purposes of reimbursing each
photographer for automotive operating costs. Some companies
might have other specific needs. For example, perhaps the
company has a fleet of different vehicles and wants to compute
different rates depending on the vehicle. Using a van might
require a higher rate than using a small automobile. In this
case, an additional column to record the type of vehicle or
vehicle’s license plate would be necessary.

Still other companies may use an overhead application

base other than direct labor hours. Perhaps machine
hours may be used to apply overhead. Then, a new
document must be developed. A source document that will
track the machine hours used by each job can be
modeled on job time tickets.
As a result, different firms may have different source
documents to support their specialized needs for
accounting information.

Flow of Costs Through a Job-Order
Costing Firm

Accounting for Materials
• Here is a summary of raw materials cost flow for
Johnson Leathergoods and its two jobs:

Accounting for Direct Labor Cost
• Here is a summary of the direct labor cost flows:

Accounting for Overhead (1 of 3)
• Overhead costs can be assigned using a single plantwide
overhead rate or departmental rates
• Typically, direct labor hours is the measure used to calculate a
plantwide overhead rate, and departmental rates are based on
drivers such as direct labor hours, machine hours, or direct
materials dollars
• In the Johnson Leathergoods example, a plantwide overhead
rate is calculated based on direct labor hours:
$9,600
Overhead rate   $4 per direct labor hour
2,400

• Here is a summary of the overhead cost flows:

• Here is a summary costs transferred to finished goods:

Schedule of Cost of Goods Manufactured

Statement of Cost of Goods Sold
• A schedule of cost of goods sold usually is prepared

at the end of each reporting period, as shown here
for Johnson Leathergoods for January

Brief Job-Order Cost Sheets
• Job-order cost sheets are crucial organizing tools.

They are the way that companies keep track of the cost
of unique jobs

Example 4.5: How to Prepare Brief
Job-Order Cost Sheets (1 of 6)
At the beginning of June, Galway Company had two jobs
in process, Job 78 and Job 79, with the following
accumulated cost information:
During June, two more jobs (80 and 81) were started.
The following direct materials and direct labor costs
were added to the four jobs during the month of June:

At the end of June, Jobs 78, 79, and 80 were

completed. Only Job 79 was sold. On June 1, the
balance in Finished Goods was zero.

Example 4.5: How to Prepare Brief Job-
Order Cost Sheets (3 of 6)
Required:
1. Calculate the overhead rate based on direct labor cost.
2. Prepare a brief job-order cost sheet for the four jobs.
Show the balance as of June 1 as well as direct
materials and direct labor added in June. Apply
overhead to the four jobs for the month of June, and
show the ending balances.
3. Calculate the ending balances of Work in Process and
Finished Goods as of June 30.
4. Calculate Cost of Goods Sold for June.

Solution:
1. While the predetermined overhead rate is calculated
using estimated overhead and estimated direct labor
cost, those figures were not given. However, we can
work backward from the applied overhead and direct
labor cost given in the June 1 balance for Job 78.
Applied Overhead = Predetermined Overhead Rate ×
Actual Activity Level for Job 78,
$750 = Predetermined Overhead Rate × $600

$750
Predetermi ned Overhead Rate 
$600
 1.25, or 125% of direct labour cost
(The predetermined overhead rate using Job 79 is

identical.)


Accounting for Nonmanufacturing Costs
• Manufacturing costs are not the only costs experienced

by a firm. Nonmanufacturing, or period, costs are also
incurred
• These include selling and general administrative costs,
which are never assigned to the product; they are not
part of the manufacturing cost flows
• Controlling accounts accumulate all of the selling and
administrative expenses for a period
• At the end of the period, all of these costs flow to the
period’s income statement

Income Statement

Here’s How It’s Used: AT WASHBURN
GUITARS (1 of 3)
Creating a made-to-order guitar for an artist is demanding.
The artisans in the various Washburn departments must
execute the artist’s vision in every particular. Of course,
the materials specified are kept track of and assigned to
the job, as are the hours of labor in each department.
Overhead is assigned using predetermined overhead
rates; however, these are adjusted to take into account the
special aspects of a project. For example, the Maya guitar,
created for artist Dan Donegan, used a variety of materials
including maple, mahogany, rosewood, and abalone.

GUITARS (2 of 3)
These woods are not used in the standard guitars
Washburn makes for the mass market. Not only must the
materials be assigned to the Donegan job, but the
overhead is also adjusted due to the scrap created when
using these special materials. Think of the abalone used
to create the dot inlays—much of the rest of the sheet of
abalone is scrap. This is an overhead cost not incurred by
the mass-market guitars.

GUITARS (3 of 3)
In addition, some copies of the guitar are available for
purchase by others. As a result, these special order
guitars required more administrative and marketing (both
print and web design) resources than the mass-market
guitars. This additional cost was factored into determining
the price.

Journal Entries for Job-Order Costing
(1 of 8)
Purchased raw materials costing $2,500 on account
Description Debit Credit

1. Raw Materials 2,500
Accounts Payable 2,500

(2 of 8)
Requisitioned materials costing $1,500 for use in production

2. Work in Process 1,500
Raw Materials 1,500

(3 of 8)
Recognized direct labor costing $1,530

3. Work in Process 1,530
Wages Payable 1,530

(4 of 8 )
Applied overhead to production at the rate of $4 per
direct labor hour. A total of 85 direct labor hours were
worked

4. Work in Process 340
Overhead Control 340

(5 of 8)
Incurred actual overhead costs of $415

5. Overhead Control 415
Lease Payable 200
Utilities Payable 50
Accumulated 100
Depreciation
Wages Payable 65

(6 of 8)
Completed the backpack job and transferred it to
Finished Goods

6. Finished Goods 2,320
Work in Process 2,320

(7 of 8)
Sold the backpack job at cost plus 50%

7. Cost of Goods Sold 2,320
Finished Goods 2,320
Accounts Receivable 3,480
Sales Revenue 3,480

(8 of 8)
Closed under applied overhead to Cost of Goods Sold

8. Cost of Goods Sold 75
Overhead Control 75

Posting of Journal Entries to the
Accounts

Producing and Supporting Departments
(1 of 2)
• Nearly every company or factory has producing
departments and support departments
• Producing departments are directly responsible for
creating the products or services sold to customers
• Example: A public accounting firm might have
producing departments devoted to auditing, tax, and
management advisory services
• In a factory, producing departments are those that work
directly on the products being manufactured, such as
the grinding and assembly departments

Producing and Supporting Departments
(2 of 2)
• Support departments provide essential services for
producing departments, but they do not actually make
the product or service being sold
– Examples include the maintenance, grounds,
engineering, housekeeping, personnel, and
photocopying departments

Steps for Determining Product Costs Using
Predetermined Departmental Overhead Rates (1 of 2)
Once the direct overhead costs of each department are

determined, the next step is to assign the support
department costs to producing departments by using
causal factors (drivers)
1. Departmentalize the firm.
2. Classify each department as a support department or
a producing department.
3. Trace all overhead costs in the firm to a support
department or a producing department.

Steps for Determining Product Costs Using
Predetermined Departmental Overhead Rates (2 of 2)
4. Assign support department costs to the producing

departments using drivers that measure the consumption of
support department services.
5. Calculate predetermined overhead rates for producing
departments.
6. Assign overhead costs to the units of individual products
using the predetermined overhead rates.

Assigning Costs of Multiple Support
Departments
• The three methods of assigning costs of multiple
support departments to producing departments are:
– the direct method
– the sequential method
– the reciprocal method
• Companies must determine the extent of support
department interaction and weigh the individual costs
and benefits of each method

Direct Method
• All factory costs must be included in product cost

• Since support departments do not make the product
sold, their costs would not be added to unit cost if they
were not included in the cost of producing departments
• The direct method is the quickest and easiest way to
do this

Assigning Costs of Multiple Support
Departments Using the Direct Method

Example 4.6: How to Assign Support
Department Costs by Using the Direct
Method (1 of 3)

Method (2 of 3)

Method (3 of 3)

Assigning Costs of Multiple Support Departments
Using the Sequential Method (1 of 3)
• The sequential (or step) method of allocation
recognizes that interactions among support
departments occur
• The sequential method does not fully account for
support department interaction
• Cost allocations are performed in a step-down fashion,
following a predetermined ranking procedure

Using the Sequential Method (2 of 3)
• The sequence is defined by ranking the support
departments in order of the amount of service
rendered, from the greatest to the least
• Where degree of service is measured by the direct
costs of each support department

Using the Direct Method (3 of 3)

Example 4.7: How to Assign Support Department
Costs by Using the Sequential Method (1 of 2)

Example 4.7: How to Assign Support Department
Costs by Using the Sequential Method (2 of 2)

The Reciprocal Method (1 of 2)
• The reciprocal method of allocation recognizes all

interactions among support departments
• Under the reciprocal method, one support department’s
use by another figures in determining the total cost of
each support department, where the total cost reflects
interactions among the support departments
• Then, the new total of support department costs is
allocated to the producing departments

The Reciprocal Method (2 of 2)
• This method fully accounts for support department

interaction by using a system of simultaneous linear
equations
• The reciprocal method is not widely used due to its
complexity

Technology and Support Department Cost
Allocation
• Another factor in allocating support department cost is
the rapid change in technology
• Many firms currently find that support department cost
allocation is useful for them
• The move toward activity-based costing and just-in-
time manufacturing can virtually eliminate the need for
support department cost allocation

Allocation
Trust Company applies overhead based on direct labor
hours. At the beginning of the year, Trust estimates
overhead to be $700,000, machine hours to be 200,000,
and direct labor hours to be 35,000. During February,
Trust has 5,000 direct labor hours and 10,000 machine
hours.

What is the predetermined overhead rate?

Allocation
Trust Company applies overhead based on direct labor

hours. At the beginning of the year, Trust estimates
Trust has 5,000 direct labor hours and 10,000 machine
hours.

What is the amount of overhead applied for February?

Allocation
Victryl Company applies overhead based on direct labor
hours. At the beginning of the year, Victryl estimates
Victryl has 5,000 direct labor hours and 10,000 machine
hours.

If the actual overhead for February is $98,300, what is the
overhead variance, and is it overapplied or underapplied?

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Examples of Managerial Accounting

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1. Describe the differences between job-order costing

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5. (Appendix 4A) Prepare the journal entries associated

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• Customized or built-to-order products fit into this

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In the 1970s, Kicker began operations in Steve Irby’s garage.

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Steve designed and built a speaker to fit behind the driver’s

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• Firms in process industries mass-produce large

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• Process firms accumulate production costs by process

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Job-Order Costing Process Costing

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• Unit costs are important because managers need

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• Two ways are commonly used to measure the costs

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• There are several issues involved in using actual

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• Uneven Production: Distortions can occur when actual

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• Normal costing solves the problems associated with

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• Nonprofit firms must track costs to be sure that they

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• An important part of bidding and charging for services

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Estimated Annual Overhead

• Notice that the predetermined overhead rate includes

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Argus uses normal costing and applies overhead on the

2. Overhead Applied to February Production = 0.50 ×

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Cost of Goods Sold (before adjusting for any overhead

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• A plantwide overhead rate or single overhead rate

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• A departmental overhead rate is estimated overhead

Estimated Department Overhead