- Explain and show the flow of costs in a job order costing system
- Explain and show how to prepare the journal entries to record costs
- Explain and show how to use T-accounts to show the flow of costs in a job order costing system


[SLIDE 1]

Some key terms to remember as we discuss the flow of costs in a Job-Order Costing system:<ul>
<li>Raw materials are any materials that go into the final product.</li>
<li>Work in Process consists of units of production that are only partially complete and will require further work before they are ready to sale to the customer.</li>
<li>Finished goods are the completed units of production that have not been sold to customers.</li>
<li>Cost of Goods Manufactured includes all the manufacturing costs associated with the goods that were finished during the period.</li>
</ul>

[SLIDE 2]

A key component to properly recording costs in a Job order costing system is to understand how each cost flows into the accounting system and the financial statements.  In a manufacturing company, we have raw materials, direct labor and manufacturing overhead.  These costs are reported on the balance sheet until the finished products are sold.  When a product is sold, these costs are moved from the balance sheet to the income statement. Any period costs for selling and administrative expenses are reported to the income statement in the period they are incurred.  

We will now look at each cost in greater detail to see how these transactions flow in accounting system and are recorded on the financial statements.  


[SLIDE 3]

We will continue using the example from our previous lesson, The Surf Shop.  Let's say there was not enough materials in stock to complete the order.  The Surf Shop has to order materials.  We need to record the purchase of materials for the customer's order and issue of materials to production for the job order.

On December 1, The Surf Shop purchased $5,000.00 in raw materials for inventory.  The entry to record this purchase is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Raw Materials</td><td>$5,000.00</td><td></td></tr><tr><td>Accounts Payable</td><td></td><td>$5,000.00</td></tr></table>
On December 10, when the materials were received, a requisition for $4,837.00 in raw materials was issued for use in production for the job order.  These raw materials included $837.00 of direct and $4,000 of indirect materials.  The journal entry to record the issuance of materials to the job is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Work in Process</td><td>$837.00</td><td></td></tr><tr><td>Manufacturing overhead</td><td>4,000.00</td><td></td></tr><tr><td>Raw Materials</td><td></td><td>$4,837.00</td></tr></table>
If you are wondering why we included overhead in this entry, remember there are indirect materials that will be used in the job order that are not easily traced to the job so we have to include them in the total since we do not know exactly how much we will use to complete the job order. In this job, items that might be included would be glaze on the board, paint, sandpaper, and possibly decals.

We use the manufacturing overhead account to record these costs to accumulate all manufacturing overhead costs that are incurred during the period for all job orders that are worked.  Only direct materials are recorded to the work in process account since these costs are not allocated because they can be traced to a specific job.


[SLIDE 4]

We have recorded the materials for the job order and we now have to record the labor costs incurred on the job order.  

On December 24, The Surf Shop completed the job order for the surf board.  The time sheets show 55 hours of direct labor costs totaling $3,010.00 and incurred $1,050.00 in indirect labor costs.  The entry to record the labor is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Work in Process</td><td>$3,010.00</td><td></td></tr><tr><td>Manufacturing overhead</td><td>1,050.00</td><td></td></tr><tr><td>Salaries and Wages Payable</td><td></td><td>$4,060.00</td></tr></table>
Remember, indirect labor such as supervision is not directly related to the surf board and will need to be recorded in manufacturing overhead.  The direct labor costs are recorded to work in process for the job order.  


[SLIDE 5]

Remember that manufacturing companies have other costs than direct materials and direct labor that are necessary to run a business.  These costs are classified as manufacturing overhead costs.  These would include items such as utilities, rent on production equipment, depreciation on equipment and buildings, and other miscellaneous costs related to the manufacturing portion of the organization.  

For the month of December, the following costs for utilities of $532, rent on equipment of $150, other miscellaneous indirect costs of $1,500 and depreciation of $200 were incurred and need to be recorded. The entry to record these costs is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Manufacturing overhead</td><td>$2,382.00</td><td></td></tr><tr><td>Accounts Payable</td><td></td><td>$2,382.00</td></tr>
</table>
Since these costs are all indirect costs necessary for production, we record them to manufacturing overhead when they are incurred.


[SLIDE 6]

We have recorded the direct materials and direct labor from the Job cost sheet. Now we have to record the manufacturing overhead cost to the job using the predetermined overhead rate of $30.00 we calculated in the previous lesson. To apply the overhead rate to the job cost sheet, we take the predetermined overhead rate and multiply by the number of direct labor hours that were worked on the job.  

For the example, The Surf Shop charged 55 hours of direct labor in producing the surfboard. So, the calculation for overhead application would be:
<span style="color: red;">$30.00 overhead rate x 55 hours of direct labor
= $1,650.00 in overhead for the job</span>

The entry to record the manufacturing overhead costs is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Work in Process</td><td>$1,650.00</td><td></td></tr><tr><td>Manufacturing overhead</td><td></td><td>$1,650.00</td></tr></table>
The journal entry to record the manufacturing overhead costs involves transferring the cost from the overhead account to the work in process account. Once this entry is completed the balance in the work in process account should equal the cost on our job cost sheet for the job order of the surf board.  Our job cost sheet showed $5,497.00 in job cost and our work in process account is also showing $5,497.00 in job costs. The balance in the work in process account should be equal to all the job orders that are completed but not yet transferred to finished goods.

The manufacturing overhead account acts as a clearing account.  As costs are incurred throughout the year, we debit the overhead account and as we apply the predetermined overhead rate to jobs, we credit the overhead account.  At the end of the period there will usually be a balance.  We will discuss how that balance is handled in a later lesson.


[SLIDE 7]

Companies incur more than manufacturing costs. They incur selling and administrative costs, which are classified as non-manufacturing costs.

The Surf Shop incurred the following expenses in December that were not related to the manufacturing operation of the company.<ul>
<li>Selling and Administrative salaries of $4,500</li>
<li>Depreciation on office equipment of $100</li>
<li>Advertising costs of $500</li>
<li>Office Supplies of $100</li>
</ul>
The journal entry to record these costs is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Salaries Expense</td><td>$4,500.00</td><td></td></tr><tr><td>Depreciation Expense</td><td>100.00</td><td></td></tr><tr><td>Advertising Expense</td><td>500.00</td><td></td></tr><tr><td>Office Supplies Expense</td><td>100.00</td><td></td></tr><tr><td>Salaries and Wages Payable</td><td></td><td>$4,500.00</td></tr><tr><td>Accumulated Depreciation</td><td></td><td>100.00</td></tr><tr><td>Accounts Payable</td><td></td><td>600.00</td></tr></table>
As you can see, these costs are treated as period costs and expensed directly to the income statement. These costs should never be recorded in manufacturing overhead.  


[SLIDE 8]

We have booked all the entries for the cost of the finished surfboard.  We need to transfer the completed job to finished goods.  

The Surf Shop completed the job order surfboard on December 24 with a final cost of $5,497. The journal entry to record the completion of the job and move the product to finished goods is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Finished Goods</td><td>$5,497.00</td><td></td></tr><tr><td>Work in Process</td><td></td><td>$5,497.00</td></tr></table>
As you can see, we are clearing the work in process account for the total cost of the surfboard and transferring it to the finished goods account, where it is ready to be delivered to the customer.


[SLIDE 9]

The Surf Shop has now completed the surfboard and delivered it to the customer.  We need to record the sale of the surfboard to the customer on the financial statements.

The Surf Shop delivered the completed surfboard on December 26 and billed the customer for $6,000. The journal entry to record the sale is:

<table border=1 cellpadding=5><tr><td></td><td>Debit</td><td>Credit</td></tr><tr><td>Accounts Receivable</td><td>$6,000.00</td><td></td></tr><tr><td>Cost of Goods Sold</td><td>5,497.00</td><td></td></tr>
<tr><td>Finished Goods</td><td></td><td>$5,497.00</td></tr><tr><td>Sales</td><td></td><td>6,000.00</td></tr></table>
As you can see, we credit sales for the delivery of the product to the customer and debit accounts receivable, and we debit cost of goods sold for the cost and credit finished goods to clear the cost for the transfer of the product to the customer.  In the next lesson, we will discuss how all of these entries are used to create the financial schedules for management.