Job-order costing and process costing are widely used to track costs. Job-order costing is used in situations where the organization offers many different products or services, such as in furniture manufacturing, hospitals, and legal firms. Process costing is used where units of product are homogeneous, such as in flour milling or cement production.

Materials requisition forms and labor time tickets are used to assign direct materials and direct labor costs to jobs in a job-costing system. Manufacturing overhead costs are assigned to jobs using a predetermined overhead rate. The predetermined overhead rate is determined before the period begins by dividing the estimated total manufacturing cost for the period by the estimated total allocation base for the period. The most frequently used allocation bases are direct labor-hours and machine-hours. Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base used by the job.

Since the predetermined overhead rate is based on estimates, the actual overhead cost incurred during a period may be more or less than the amount of overhead cost applied to production. Such a difference is referred to as under- or overapplied overhead. The under- or overapplied overhead for a period can be either (1) closed out to Cost of Goods Sold or (2) allocated between Work in Process, Finished Goods, and Cost of Goods Sold. When overhead is underapplied, manufacturing overhead costs have been understated and therefore inventories and/or expenses must be adjusted upwards. When overhead is overapplied, manufacturing overhead costs have been overstated and therefore inventories and/or expenses must be adjusted downwards.

Learning Objectives

Distinguish between process costing and job-order costing and identify companies that would use each costing method.

Identify the documents used in a job-order costing system.

Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs.

Apply overhead cost to Work in Process using a predetermined overhead rate.

Prepare schedules of cost of goods manufactured and cost of goods sold.

Use T-accounts to show the flow of costs in a job-order costing system.

Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.

(Appendix 3A) Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.