 Hello, and welcome to the session. This is Professor Farhad and the session we would look at job order costing or job costing and process costing. So the first thing is we want to discuss is when do we use job costing and when do we use process costing. And this session we're going to be focusing specifically on job costing. We will look at process costing in a separate recording, but we have to explain the difference between the two. What are they? What is job costing and what is process costing? Basically, both of them are two models to accumulate costs. As we're producing something, we need a model to accumulate the cost that's going into the product. Well, which one do we use? Is it job costing or process costing? It all depends on the product that you are manufacturing that you are producing. What does that mean? Well, if you are producing unique items and I use the word unique because nothing unique more than the word unique. Now unique, it doesn't mean it has to be only one unit, but unique item in the sense that you are not mass producing it. Let's assume you are manufacturing a specialty machine, a specialty machine to scan luggage for the local airport. That's your specialty machine. Well, how many are you going to produce? Maybe five, maybe 10. That's about it. You're not going to produce hundreds of thousands of them. Or you could be in a furniture store where you are producing furniture. You could be producing tables, chairs. You might be producing those in batches. For example, each 50 chairs, each 100 tables, they would look the same, but not in hundreds of thousands, just in batches. Under those circumstances, you would still use job costing where the product is in a sense unique. I'm going to put unique in court. Now, when do you use process costing? You would use process costing when you are producing items that are all the same or homogeneous. For example, if you are producing milk, if you are producing milk, it doesn't matter. Each gallon would look the same and will have the same input than the other gallon. Under those circumstances, we would use process costing because we don't care what is the cost of one gallon versus the other. We are mass producing the gallon versus job costing where the product is a little bit unique. This is the general idea of job costing versus process costing. On job costing, the cost of a unit or multiple unit, again, it doesn't have to be unit, of a distinct product. See, the keyword is distinct or service, which we'll call a job, which is a job, we'll call a job. Each job generally uses different amount of resources. So think about it, no two jobs are the same. Another good example for this, if you're in the construction business and you are building homes, okay? So each home is different. Home A is different than home B is different than home C. Because each customer, they want their home to be a little bit unique. Now, is it possible that you could be producing, if you are in the construction business, A, A and A, three homes that are the same? Yes, you might. Maybe in a housing development, you might build three or four homes that are the same. Matter of fact, where I live, and I'm just thinking about this, my home is built in the 1950s. If you look to my, the home to my right and the home to my left, they are exactly the same as my house. Well, there was some changes since that time, but the base, when they were originally built, I could assure you they're the same. They're the same. Exactly. But that builder, when they went to another development, they build another three homes that are different than ours, three Bs or three Cs. So this is what we mean by job order costing system. Process costing system is a little bit different. The cost object is masses of identical or similar or a similar unit of a product or service. So here masses of identical or similar unit. Okay. In this type of system, we divide the total cost of producing an identical or similar product or service by the total number of unit produced to obtain a per unit cost, which we'll talk about this later. This is what process costing is. And basically think about producing again milk. I like the example of milk. So if you are producing milk, it's being mass produced. You don't care about one specific item, one specific gallon, they all look the same. In this session, we would focus on job costing system. So let's start by familiarizing ourselves with some terminology that has to do with job costing system. The first thing we have to look at is something called a job cost sheet and we'll see one, I believe on the next slide. It recorded the cost of the job kept in the accounting system for each job will have a job cost sheet. For example, if we are many, if we are building a home, a house, well, we're going to have labor, material and overhead. Well, guess what? For each house will have will have its own, each house will have its own address. Each house will have its own address. For example, we're building 12, 12, 5, 5 main street. This is the house that we are building. Okay, so we'll have a job cost sheet for this house where we keep track of all the costs such as labor, material and overhead. Okay, subsidiary levels. Let's talk about the control account first. What is a control account? A control account and hopefully you know what a control account is an account in the general ledger that summarizes a set of subsidiary account. The best way to illustrate a control account, which you should be familiar with the control account is account receivable or accounts payable. I mean, we could have many control account, but I would like to use account receivable. So for example, our account receivable might have a balance of $100,000. That's the total receivable. Now, within that receivable, we could have customer A, customer B, and customer C, and customer A owes us $40,000, customer B owes us $30,000, and customer C owes us $30,000. So the $100,000, we call it the control account because it's a summary of those three accounts, customer A, customer B, and customer C. Customer A, customer B, and customer C, we call them subsidiary ledger account. An account that records financial transaction for a specific job, customer, or vendor. For example, for our purpose, for our purpose for the purpose of this session, we are going to be working with work and process. We're going to have an account called work and process. And this is basically the large account. Work and process could have a million dollar, one million in work and process, which is an asset. Then we could have, with one work and process two, we could have many jobs, many different jobs, many different units. And when you add them all up, one, two, three, four, all of them, they will add up to the million dollar, which is the control account. So the subsidiary ledgers is a breakdown of the control account, which is the general ledger. And this is what a cost sheet would look like. And a cost sheet, for example, here, the customer is Eastern State College. The description, assemble and test athletic equipment. That's the description of the product. This is the job number, 1201. This is when we started the job. This is when we completed the job. And here we'll put the date, the cost of material, then we add them up. The date, when did we incur labor? We add them up. The date, the cost of the overhead when we incurred them. And notice we have direct material, direct labor and overhead. And when we add those three together, this is equal to the total cost. And we will have a job cost sheet for each job that we are working with. Now let's take a look at how cost flow in a job cost system. And hopefully we should be familiar with this picture. What goes into the product? You remember we talked about product cost or inventoriable cost, product cost or inventoriable cost. Well, direct material when we purchase direct material, direct manufacturing labor, which is direct labor and manufacturing overhead that include indirect material, indirect labor and all other overhead. What we do will take labor, material and overhead and they get transferred into something called work and process inventory. Then after we are done, work and process is unfinished goods, goods that we started the process for, but we have not completed it 100%. Then from work and process, once the product is done, it goes into finished goods. Well, guess what? Once it goes into finished goods, it's done. It's basically inventory. Then it stays in inventory until it's sold. Once it's sold, it turns into cost of goods sold. So notice these here are balance sheet account, which are inventory account. And these here are expenses, which is cost of goods sold, finished goods cost turned into cost of goods sold. Any period cost incurred, it goes directly to the income statement such as marketing, selling, anything that has to do with supporting our selling effort. So to illustrate this job costing system, we're going to work a quick example. And I will work another example just to kind of make sure I cover a good example, a more comprehensive example. So we're going to be working with a company called InShape that manufacture custom. Notice custom workout and training equipment for schools and gyms. So that's what they do. So here's a picture of again what happened. We have raw material. Some of the raw material is considered direct material. We talked about direct material. Some of it will be considered indirect material. Indirect material goes into considered overhead. The direct material is allocated to job order one, job order two and job order three, which is we have three work in process. So we have three different jobs, you know, Eastern High School, Western High School and Central High School. We have three different high schools that we are working for or three different type of gym equipment. We have three different work in process, whatever it is. Okay. And this is total work in process right here. Then also we incur labor. Again, labor could be direct labor, which will go directly into work in process or indirect labor, which will go into manufacturing overhead. Now you're saying, hold on a second, what happened to manufacturing overhead? Manufacturing overhead eventually will be allocated to work in process, which I will show you on the next screen. So the overhead is also allocated to work in process. So simply put, just kind of to complete this picture, overhead, then overhead, overhead goes into the various work. So this is what this slide is showing. Then the overhead is allocated. Overhead costs are applied to each job using POHR predetermined overhead rate, which we talked about in the past. On January 1st, in shape has the following balances in each of the three inventory accounts. So we have three inventory accounts. Think of it this way. We're going to see it on the next slide, but this is what we have. We have direct material. We have work in process number three and work in process number two. And in direct material, we have 30,000. In work in process, we have 41,000. And in work in process two, we have three and work in process two, we have 27,000. All these are balance sheet account to be more specific inventory accounts. That's what we have. Now let's start the process. Let's start the process and in shape purchased 135,000 of raw material. If we purchase raw material, we're going to debit material. We're going to add to our material account. We already had 30,000. Now we're going to add 35 and credit accounts. Payable. We bought them on account. So this is the first journal entry. Now in shape used 12,000 of direct material for job number three. They also started job number one and job number two and used 102 and 15,000. Of direct material, respectively. So they transferred some material to job number three and they started job number one and they started job number two and they used some material. Let's see what this looks like. So we credit. Material inventory, which is 12. Plus. Whoops. 12. Let me just show you 12 plus 15 plus 102 equal to 129. So we credit raw material 129, transfer some of it to work in process three, started work in process one. Notice the balance was zero and transfer some of it to work in process two, which the balance was zero because we started those jobs. Now we also update our work in process inventory, which is for the full amount 129. Notice those accounts right here. This one, this one and this one work in process one, work in process two and work in process three. Work in process two and work in process three are subsidiary account, subsidiary account. Direct labor of 98,000 was incurred. 16,000 for job three, 71,000 to job one and 11,000 for job two. So we're going to take 98,000 of wages payable. We're going to credit wages payable and we're going to debit. Work is work in process three, 16,000 work in process one, 71,000 and work in process to 11,000. Then obviously we also debit the control account to work in process inventory. Okay, because we have three different accounts. So what we are doing, we are, we are allocating labor, direct labor to the various work and process three different jobs we have in shape incurred the following actual overhead costs in January. So this is what we incurred in January. Indirect material requisition 12,000 indirect labor, indirect labor of 9,500 utilities and other expenses credit. They were on credit prepaid factory expense used 5,000 factory depreciation 11,200 total actual overhead expenses 51,000 for 450. Now what do we do with this? This is actual overhead. We debit an account called manufacturing overhead control. Notice this is a control account. And you're saying what type of account is this? Basically, this is a nominal account that's going to go away. Just keep track of it for now. So we debit those, the amount for those account, for example, for the 12,000, we debit manufacturing overhead and we credit material inventory because we used inventory indirect material. For the 9,500, we debit manufacturing overhead and we credit wages payable. This is for indirect labor for the 13,750, we credit prepaid expense. And for the now actually for the 13,750, we credited accounts payable those were the utilities and for the 5,000 that was the prepaid we credited the prepaid and for the 11,200 it was for depreciation. So what we did is we debited the manufacturing overhead and we credited the various accounts. Well, we talked about predetermined overhead before and how we compute predetermined overhead because it's easy to keep track of direct material and direct labor. The overhead is the tough part to keep track of. So what we do is we estimate manufacturing, the predetermined overhead rate using the estimated manufacturing overhead. So the estimated manufacturing overhead predetermined rate is the estimated overhead divided by the estimated activity for the allocation base. So we're going to see how we compute this in a moment. InShape uses estimates based on the annual manufacturing overhead and most companies do so because especially if it's a seasonal work because you might have incurred more overhead inserting time of the year and less and other times of the year because it goes up and down. What you do is you use the whole, the average for the whole year in order to compute your predetermined overhead rate because we don't want erratic or monthly cost production volume to affect long term production costs. So we'll try to find the average cost for the whole year. Okay, overhead is allocated to jobs using direct labor costs at its base. So here we go. So how do they allocate overhead? They use a driver. They believe the more labor costs we incurred, the more overhead is incurred for a specific job. Okay. So first let's determine the predetermined overhead rate. Notice predetermined. It's determined beforehand. It's determined beforehand as we discussed. InShape estimated that any manufacturing overhead for the coming year will be 600,000 and the direct labor cost will be 1.2 million. What's that going to give us? It's going to give us the predetermined overhead rate by taking the dollar amount, 1.2 million, dividing it by 600,000, the allocation base. It's going to give us, I'm sorry, it's actually it's the opposite. The 600,000, dividing it by the labor cost because the labor cost is the driver. This is the driver. The driver is in the denominator, which is going to give us 50 pennies per direct labor cost. So what's going to happen is we're going to take the estimated 600,000, the estimated overhead. This is the total overhead divided by the driver. It happens to be direct labor cost. It could be the direct labor hour. Here it's the direct labor cost, whatever cost we incurred. Therefore, it's going to give us 50 cent per direct labor dollar. So for every dollar we spent in labor, for every $1 in direct labor, we assume to have incurred 50 pennies in overhead cost. So if a job incurred 2 direct labor, well, it means allocate to that job $1 of overhead because for each hour we allocate 50 pennies. So let's see how many hours we allocated for these jobs. How many direct labor dollar, not hours, dollar, not hours. We could use hours, but we're not. For job number 3, we incurred 16,000 direct labor hours, multiplied by 50 cent. We applied 8,000 of overhead. What does applied mean? It means we estimate that to have incurred 8,000 of overhead. For job number 1, we incurred 71,000. How did you know this? Well, if you looked at previous slide when we allocated the direct labor, just in case you're wondering, where is he coming with these figures? There we go. Where's the direct material? Where's the direct labor? Here's the labor. 16,000, 71,000, and 11,000. Just in case you're wondering where these figures are coming from. So now we are figuring out the overhead. So 71,000 times 50%, 11,000 times 50%, will give us 5,500. Total is 49,000. Now, what we do is we apply the overhead. We applied the overhead to the various jobs. Notice this is applied. Now you're saying, didn't we have an MOH control account? Yes, we had an MOH control account, and we have a manufacturing overhead applied. Both of these accounts are not balance sheet. They're going to go away. Just bear with me. Okay, so you're saying, what's going to happen to the MOH account? Basically, their nominal account, they're going to go away. Therefore, we're going to have 8,000 allocated to job number 3, 35,000 allocated to job number 1, and 5,500 allocated to job number 2. So what we did is we applied the overhead to the various jobs. We applied the overhead to the various jobs. Okay, so let's take a look at what happened next. In shape completed, job number 3 and job number 1. You remember we started one this period and it's completed, and they are transferred out. So job number 3, this is how much job number 3 cost us. When we started the period, the first slide, we had 41,000. In the beginning inventory of job number 3, then we incurred direct labor of 12,000 in January. We incurred direct labor of 16,000, and we incurred overhead applied of 8,000. So job number 3 in total cost us 77,000. Job number 1, we started this job. Therefore, the beginning balance was 0. We incurred material of 102. We incurred labor of 71,000, and we incurred overhead of 35,500 in total. The total cost for job number 1 is 208,500. It was a big job, and we finished it. Notice it's, wow, that's a big job. It's more than twice the size of job number 3. It seems it was a customer that really needed the work. So how do we transfer the job from work and process to finished goods? We credit work and process. So we reduce work and process. We credit work and process, which is an asset account. Notice we credited work and process number 3. Work and process number 2. Number 3 was credited 77,000. Number 2 was credited 208,500. And we debit. We increase. We increase finished goods inventory job number 3, finished goods inventory job number 1, 77,000 and 208,500 risk effectively. The next thing that happened is job number 2 and job number 3 actually were sold for 35,000 and 95,000. I think what they meant is job number 1 because job number 2 is not finished. So job number 1 and job number 3 are sold for 35,000 and 95,000. So what we do is we debit. We debit cost of goods sold. Let me just double check job number 1. We're just going to go with the whatever on the slide. So we debit cost of goods sold. We increase cost of goods sold and we credit finished goods when the jobs are sold. Then we sold them. Job number 2 was sold. We debit account receivable for 35,000. Credit revenue for job number 2, 35,000. Debit account receivable for 95,000 job number 3 and credit revenue for job number 3. So we sold two of these jobs. So after all said and done, the accounts have the following ending balances. And this is what we end up with. Ending material inventory 24,000. That's the ending balance. Ending the balance. The work in process is 31,500. Finished goods is 208,500. And cost of goods sold is 104. Those are the EBB ending balances of the various accounts. And this is what job number 1 costs us in direct material. 102 in direct labor, 71,000. And manufacturing overhead 35,500. This is the total cost. And obviously it was finished. So everything is transferred to finished goods. 102, 71 and 35,500. So job number 1 is totally done. Therefore it should not be in work in process. It was also sold. I believe it was sold. Job number was it sold? Job number 1? No, job number 1 wasn't sold. Job number 1 wasn't sold. So it's still in finished goods. Now, how else can we account for manufacturing overhead? Assume in-shape maintained 2 manufacturing overhead account. And they did in this example. Remember, we had the MOH account. We had the MOH, which is the manufacturing overhead control. We had the MOH control. And we had the MOH applied. So here what we're doing is they have two accounts. They have two manufacturing overhead control. The manufacturing overhead control, which is used to track actual. So would they have an MOH control actual? You'll have the actual and the applied, which is used to allocate the overhead to job space on the pre-determined overhead rate. So the applied one, this is the estimate based on the pre-determined overhead rate and this is the actual. Some companies, what they do, they combine both of these accounts. So some companies, what they do is this. They will have MOH and the debit balance every time they debit the account for the actual and every time they credit the account is for the applied. And another word for applied is for the estimate based on the pre-determined overhead rate. So you could use two accounts or one account. Now in this example, they have two accounts. It doesn't matter if you have one account or two accounts, you're going to end up with either under applied or over applied overhead. What is under applied? Another word for under applied is underestimated. That's not true. Or over estimated overhead. The access of actual, if you have more actual than applied, if you have more debits than credits, if you have MOH, let's assume you use one account, if you have more debits than credits, then you have more actual under applied, the access of actual. If you have more actual than estimated, you're going to under applied. You underestimate it. On the other hand, if you have more credit, more credit than debit, it means you over estimated. You over applied. The access of applied overhead costs over actual overhead incurred. Now let's take a look at some numbers. For example, for this company, what they did, they have actual of $51,450. This is the manufacturing overhead control. This is the actual. And based on their predetermined overhead rate, they estimated $49,000. So they thought it's going to cost them $49,000. It cost them $51,450. First, find the difference. $51,450 minus $49,000. There's a difference of $2,450. So you need to ask yourself, did we over-applied or under-applied? Simply put, did we over-estimated or did we under-estimated? Well, the actual was more. We actually incurred more overhead than we estimated. Then guess what? In this circumstances, we did not estimate enough. We under-applied. We under-estimated. Because we only estimated $49,000. We end up incurring $51,450,000. We under-estimated. How much did we under-estimated by? $51,450,000. And you remember the overhead will have to be closed. So we don't keep the overhead. Okay? We don't keep the overhead. So how do we close it? Well, we're going to close overhead. We're going to close overhead. Think of these accounts. If these accounts are both at the same account, just kind of keep it simple, kind of combine them. Guess what? To make this account go to zero, to make this account manufacturing overhead control, now it's the same account. To make it go down to zero, we need the credit of, well, let's keep it here. It doesn't matter. We can keep it separate. So how do you make this account? So what we do is we need to credit this account 2450. Just keep it separate, 2450. We need to credit this account 2450. Now we have $51,450 in this account. Then for every credit we need to debit, we're going to debit. We can debit cost of goods sold. So basically 2450 because we did not account for enough cost of goods sold. So we can credit applied manufacturing overhead and we debit cost of goods sold. And this is what it looks like. We debit applied manufacturing overhead and we debit cost of goods sold. Now guess what? Now if you really think about it, let's go back here. These two accounts are 51,450. You debit this account, 451,450. The manufacturing overhead control, you credit applied manufacturing overhead control for 51,450 and they're gone. They basically, they set to zero. This is what I meant to say. They're going to go away. And what happened? The difference between the two, the difference between the two, the difference between the two went to cost of goods sold. Now, is that the only thing that you can do? Close it to cost of goods sold? Any over applied or under applied? No, you could also close cost of goods sold. Close any over applied or under applied to manufacturing, to work and process finished goods and cost of goods sold. So basically what you do is this. You will add up your work and process finished goods and cost of goods sold and they're up to 344,000. What you do is you would say work and process is 9.2% of the total. 31,500 divided by the total of 344,000. It represents 9.2% of these accounts. The finished goods, 208,500 represent 60.6%, which is again, 208,500 divided by 344,000 and cost of goods sold 104 divided by 344,000 represent 30.2. So what you do rather than allocating the whole over applied or under applied to cost of goods sold, you allocate the over applied or the under applied to those three accounts based on the relative to the total, relative to the total. So if we use this method, now we're going to go ahead and remove from overhead 2450. We're going to credit overhead 2450 to close it. Now overhead equal to zero, whatever you put the zero. So we credit overhead and we debit for 1485, which is 60.6%, 60.6% of this amount goes to finished goods. Of this amount, 9.2% goes to work and process, which is 2450 times 9.2%. Out of this amount, 30.2% goes to cost of goods sold, which is 2,450 times 30.2%. So when do we use this? When do we allocate them to the three accounts? When the amount is substantial, what we do is we don't want to take everything and dump it into cost of goods sold. What we do is we'll take the amount that's either overhead applied or over applied or under applied and allocate it separately to the three accounts. If you have any questions, any comments, by all means email me or see me in class. If you're studying for your CPA or your CMA, study hard, it's worth it.