CHAPTER THREE

JOB ORDER COSTING SYSTEM

Introduction
Accurate product costing is vital for business success. It is used for planning, product costing, cost control, and
decision making. With a well setup product costing system, the price of products can be precisely determined.
The product costing system can therefore be used by manufacturers to select products for maximum
profitability. The following points need to be remembered in connection with costing systems:
1. The cost benefit approach: The costs of a complex costing system, including the costs of educating
managers and other personnel to use it, can be high. Managers should install a more complex system only if
they believe that its additional benefits - such as making better informed decisions - will outweigh the
additional costs.
2. Costing systems should be tailored to the underlying operations; the operations should not be
tailored to fit the costing systems. Any significant change in operations is likely to justify a corresponding
change in the costing system. Designing the best system begins with a study of how operations are
conducted and then determining from that study what information to gather and report.
3. Costing systems accumulate costs to facilitate decisions. Because it's not always possible to foresee
specific decisions that might be necessary, costing systems are designed to fulfill several general needs of
managers. Managers use product-costing information to make decisions and strategy, and for planning and
control, cost management, and inventory valuation.
4. Costing systems are only one source of information for managers. When making decisions, managers
combine information on costs with other non-cost information, such as personal observation of operations,
and no financial performance measures, such as setup times, absentee rates, and number of customer
complaints.
Cost System Basics
Cost system is a collective term for the policies, procedures, and functional hardware that a company uses to
provide the value of the unit costs of its products or services. The cost system includes, but may not be limited
to, the following components: cost objects; cost pools; cost accumulation method (e.g., job costing or process
costing); cost measurement method (e.g., actual, normal, or standard costing); overhead allocation procedure
(cost drivers, choice of capacity measure, and overhead rates) for service departments, joint process costs, and
other overhead costs; cost reporting format (e.g., absorption or variable costing); hardware design (e.g., central
mainframe or site workstations); accessibility (manager or financial analyst only or full accessibility); and
reporting frequency.
 Organizations choose among costing systems by considering two things. First, how detailed and
specialized must costs of each product be? Second, must periodic costs be accumulated from the
beginning of the life of a product until it is sold? Answering these questions helps managers to choose
from different types of costing systems.
 A cost object is any entity or activity for which costs are accumulated for management purposes (e.g.,
financial reporting, decision-making, or performance evaluation). Examples include physical
products, service products (such as the processing of an insurance claim), customers, product lines,
and organizational units. In any analysis of a cost system, it is important to consider whether the cost
objects are appropriate for the decision(s) at hand.
 If the manager is interested in customer profitability, then the appropriate cost objects are individual
customers. If the decision involves product mix, then products are the appropriate cost objects. If the
decision involves outsourcing a service function, then the organizational unit that is the service
department in question is the appropriate cost object.
 Cost pools are meaningful groups into which costs are aggregated. The most common cost pool is an
organizational unit, such as a production or service department. Cost pools are intermediate
accumulations of costs that help clarify the process of assigning and allocating costs to cost objects.
Cost Pools can be production departments, service departments, or organizational activities. The costs
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 of the resources they consume are collected in each cost pool. Some are directly traced; others (such
as service department costs in a manufacturing plant) may be allocated.
 Cost Objects (as it is discussed in CH-2) can be products, customers, services, or organizational units.
Ideally, we assign costs to each cost object in proportion to the value of the resources they consume.
Costs are transferred from cost pools to cost objects using cost drivers.
 Cost Drivers ideally reflect the indirect resources consumed in the production of a cost object.
Traditional cost drivers include material costs, labor hours, and machine hours.
These assume that production of cost objects consumes overhead costs such as set-ups, maintenance,
engineering, quality control, etc., in proportion to production volume.
Activity-based cost drivers, such as the number of set-ups or engineering change orders, assume that production
of cost objects consumes overhead resources in proportion to the amount of a particular activity required.
Cost Accumulation Method
The cost accumulation method typically depends on the characteristics of the production process of the
organization. The accumulation method describes the procedures by which costs are recorded as incurred,
tracked with cost objects through the production process, and expensed when products are sold. It is possible to
think of cost accumulation methods as lying along a spectrum: The next few paragraphs provide a brief
description of these cost systems.
Process Costing
Process Costing is appropriate for production environments that involve high volumes of homogeneous
products. Costs accumulated by department and are assigned to units of products by dividing the total costs
incurred by the equivalent units of production. The equivalent unit concept accounts for the costs of beginning
and ending work-in-process inventory. Examples of settings that might use process costing include chemical
processing, oil refining, and paper production.
Job Order (or Job) Costing
What is Job-Order Costing?
Job-order costing is used when different types of products, jobs, or batches are produced, typically over a rather
short period of time to the customer's specifications. As a result, each job tends to be different. In job-order
costing, each distinct batch of production is called a job or job order. The cost-accounting procedures are
designed to assign costs to each job. Then the costs assigned to each job are averaged over the units of
production in the job to obtain an average cost per unit.
Examples of industries in which job-order costing is used include printing presses, construction, automobile
repairs, office and household furniture, office machines, etc. In a job-order costing system, direct materials costs
and direct labor costs are usually "traced" directly to jobs. Overhead is applied to jobs using a predetermined
rate. Actual overhead costs are not "traced" to jobs. Remember that job costs consist of actual direct materials
costs, actual direct labor costs, but applied overhead costs.
Because reporting of business activity occurs periodically but completion of jobs generally does not occur at the
end of a reporting period, job cost reporting must reflect the value of jobs at interim points before they are
completed. There are two inventory accounts in which costs of jobs are accumulated. They are Work-in Process
(WIP) inventory and Finished-goods inventory (FGI).
Work-in-Process inventory accumulates all costs of resources used on jobs that have not been completed. Each
job has its own subsidiary account, where costs specific to the job are recorded.
Finished-goods inventory is an account where costs of all completed jobs are recorded. These costs are
transferred from WIP inventory when a job is completed. The costs remain in FGI until the job is sold. Once
sold, the costs of a job are transferred to an expense account called cost of goods sold.
Companies using job costing usually have many jobs being worked on at the same time. An accounting system
must allow the organization to keep track of all jobs separately and must maintain records of all jobs in
progress, completed, and sold. It must also record activity for WIP inventory, FGI, and cost of goods sold.
These three are general ledger accounts are important in a job costing system

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The distinction between the job cost and the process cost methods centers largely on how product costing is
accomplished. Job costing applies costs to specific jobs, which may consist of either a single physical unit or a
few like units in a distinct batch or job lot. In contrast, process costing deals with great masses of like units
and broad averages of unit costs. The basic distinction between job order costing and process costing is the
breadth of the denominator: in job order costing, the denominator is small; however, in process costing, the
denominator is large.
Job costing and process costing are extremes along a continuum of potential costing systems. Each company
designs its own accounting system to fit its underlying production activities. Some companies use hybrid
costing systems, which are blends of ideas of both job costing and process costing.

Job-costing Process-costing
System system

Distinct units of Masses of identical

a product or service or similar units of
a product or service
Examples of Job Costing and Process Costing in the Service, merchandising, and Manufacturing Sector

Service Sector Merchandising Sector Manufacturing

Sector
-Auditing engagements -sending special-order items by mail order -Aircraft assembly
Job -Consulting-firm engagements -Special promotion of new store products -House Construction
Costing -Advertising-agency campaigns
Used -Law cases
-Auto-repair shops

Process -Bank-check clearing

Costing -Postal delivery -Grain dealer -Oil refining
Used (standard items) -Lumber dealer -Beverage production

In this chapter, we focus on job costing systems. Chapter Four discusses process-costing systems.
The discussion below assumes that a paper-based manual system is used for recording costs. Cost and other data
are recorded on materials requisition forms, time tickets, and job cost sheets. Of course, many companies now
enter cost and other data directly into computer databases and have dispensed with these paper documents.
Nevertheless, the data residing in the computer typically consists of a "virtual" version of the manual system.
Since a manual system is easy for students to understand, we continue to rely on it when describing a job-order
costing system.
1. Job Cost Sheet.
In a job order costing system, we maintain a job cost sheet for each job. The cost sheets are like the accounts
receivable subsidiary ledger. While the accounts receivable subsidiary ledger provides a detailed listing of
individual customer accounts, the job cost sheets show a detailed listing of the costs assigned to individual jobs
in the work in process and finished goods inventories. Each job sheet breaks the costs down in terms of direct
materials, direct labor, and manufacturing overhead assigned to individual jobs. The job cost sheet will have
some code or descriptive data to identify the particular job and will contain spaces to collect costs of materials,
labor, and overhead.
2. Accounting for materials Costs.
When a job is started, materials that will be required to complete the job are withdrawn from the storeroom. The
document that authorizes these withdrawals and that specifies the types and amounts of materials withdrawn is
called the materials requisition form.
Normally the production department supervisor completes the materials requisition form and presents it to the
storeroom supervisor. The materials requisition form is prepared at least in three copies. One copy goes to the
cost accounting department. In this department this copy is used as a basis for transferring the cost of the

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requisitioned material from the “Raw Material Inventory” account to the “Work in Process Inventory” account,
and for entering the cost of the material on the job-cost sheet for the production job in process. The materials
requisition form identifies the job to which the materials are to be charged. Care must be taken when charging
materials to distinguish between direct and indirect materials.
For products and product components that are produced routinely, the required materials are known in advance.
For these products and components, material requisitions are based on a “bill of material” that lists all of the
materials needed. In complex manufacturing operations, in which production takes place in several stages,
material requirements planning (MRP) may be used. MRP is an operations-management tool that assists
managers in scheduling production in each stage of the manufacturing process. Such careful planning insures
that, at each stage in the production process, the required subassemblies, components, or partially processed
materials will be ready for the next stage. MRP system, which are generally computerized, include files that list
all of the component parts and materials in inventory and all of the parts and materials needed in each stage of
the production process.

The cost of a manufactured product consists of the combined costs of the raw materials processed, the direct
labor of employees who processed the raw materials and the factory overhead generated by the manufacturing
process. Since materials may comprise the largest single element of cost, the control of materials cost is an
important factor in manufacturing.
Materials control Procedures
The logical step-by-step development of materials control procedures can be illustrated by using a simplified
version of what is ordinarily a complex manufacturing activity. Although the following presentation suggests
that only one job is being processed and that each step in the processing of the forms described is isolated, the
fact is that several jobs may be in production simultaneously, and the flow of paperwork would be continuous.
Control during Purchasing
On receipt of a customer’s order, the sales manager communicates to the production manager all the needed
details, such as specifications, units ordered, required delivery date, and prices. From these data, the production
manager reports a production order which authorizes the production of the required products.
Bill of materials:
The production order is given to supervisor in charge of production, who, based on knowledge of the product,
prepares a schedule of the materials required to complete the order. The form for this purpose is called bill of
materials.
A copy of the bill of materials is sent to be storeroom keeper. This person checks the quantities of the various
materials required with those on hand and on order to determine whether or not there are enough materials
available to complete the order. If there are not enough materials, the purchasing agent must be notified of the
quantity required; if there is an adequate amount of materials on hand for the order, it must be determined
whether the withdrawal of the required quantity will reduce the stock on hand to a low level. If such is the case,
the purchasing agent must be advised on the replacement needed. The bill of materials procedures are
preliminary to the actual starting of the job order through the factory. They are designed to ensure that once the
order starts into production, it will not be held up for lack of raw materials.
Purchase Requisition.
The form used by the storeroom keeper to notify the purchasing agent of the additional materials needed is
known as a purchase requisition. This requisition is an important part of the materials control process because it
is the agent’s authority to buy. A carefully designed form should be used. Purchase requisitions should originate
with the storeroom keeper or some other designated individual given similar authority and responsibility.
Purchase requisitions should be numbered serially to help detect the loss or misuse of any of these forms. They
may be prepared in duplicate or in triplicate. If prepared in duplicate, the storeroom keeper retains one copy is
sent to the purchasing agent. If the storeroom keeper has physical charge of the materials but another person in
the accounting department is in charge of the subsidiary stores ledger in which a record is kept on the materials
on hand, the requisition should be prepared in triplicate. The first copy goes to the purchasing agent; the second
copy goes to the person in charge of the subsidiary stores ledger; and the third copy is retained by the storeroom
keeper.
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Purchase order
The purchase requisition gives the purchasing agent authority to order the materials described in the
requisition. From a file of quotations and prices, the vendor may be selected from whom the materials can be
obtained at the lowest cost and with the least delay. If the file does not contain this information, the purchasing
agent may communicate with several prospective vendors and request quotations on the materials needed.
A purchase order is then completed and addressed to the chosen vendor, describing the materials wanted stating
price and terms, and fixing the date and method of delivery. This purchase order should be numbered serially
and prepared in quadruplicate. The first goes to the vendor, the second copy is retained by the purchasing agent,
the third copy goes to the accounting department where it is referred to the stores ledger clerk, and the fourth
copy goes to the receiving clerk. The stores ledger clerk makes a memo entry on the appropriate ledger sheet of
the quantity on order.
Vendor’s Invoice
The vendor’s invoice should be received before the materials arrive at the factory. As soon as it is received, it
goes to the purchasing agent, who compares it with the purchase order, noting particularly that the description
of the items is the same, that the price and the terms agree, and that the method of shipment and the date of
delivery conform to the instructions on the purchase order. When satisfied that the invoice is correct, the
purchasing agent indicates approval directly on the invoice.
Receiving Report
It was suggested that the fourth copy of the purchase order goes to the receiving clerk to give advance notice of
the arrival of the materials ordered. This is done to facilitate planning work and allotting space to incoming
materials. The receiving clerk is in charge of the receiving department where all incoming materials are
received, opened, counted or weighed, and tested for conformity with the order. If the materials received are of
too technical a nature to be tested by the receiving clerk, the inspection may be undertaken by an engineer from
the production manager’s office or the materials may be sent to the plant laboratory for testing.
As the receiving clerk counts and identified the materials, a receiving report should be prepared similar in form
to the one reproduced below. Each report is numbered serially and shows from whom the materials were
received, when they were received, what the shipment contained, and the number of the purchase order that
identifies the shipment. The report should be prepared in quadruplicate. The first and second copies go to the
purchasing agent, the third copy goes with the materials or supplies to the storeroom keeper to ensure that all of
the materials that come to the receiving department are put into the storeroom; and the fourth copy is retained
by the receiving clerk.
The purchasing agent’s first copy of the receiving report is compared with the vendor’s invoice and the
purchase order to determine that the materials received are exactly like those ordered and billed. If they are
found to be the same, the purchasing agent then attaches the receiving report to the other forms already in the
file and sends the entire file to the accounting department where a voucher is prepared and recorded in the
voucher register. To the second copy of the receiving report, the purchasing agent adds the unit prices of the
articles received and extends the figure to show the total cost. This copy then goes to the accounting department
for posting to the appropriate materials accounts in the stores ledger. The purpose of this double routing to the
accounting department of copies of the same form is to maximize internal control procedures. One accounting
clerk enters the purchase in total in the voucher register; a second clerk enters the purchase in detail in the
subsidiary stores ledger.
Debit-Credit Memorandum - occasionally, a shipment of materials does not match the order and the invoice.
When this situation occurs, comparing the receiving report with the purchase order and the invoice will disclose
the variance to the purchasing agent. Whatever the cause of the difference, it will lead to correspondence with
the vendor, and copies of the letters should be a part of the files of forms relating to the transaction. If a larger
quantity has been received than has been ordered and the excess is to be kept for future use, a credit
memorandum is prepared notifying the vendor of the amount of the increase in the invoice.
If, on the other hand, the shipment is short, one of the two courses of action may be taken. If the materials
received can be used, they may be retained and a debit memorandum prepared notifying the vendor of the

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amount of the shortage. If the materials received can not be used, a return shipping order is prepared and the
materials returned.

The return shipping order is usually made out in triplicate. The first copy goes to the vendor, the second copy
goes to the receiving or shipping clerk, and the third copy is filed with other forms relating to the transaction.
Debit or credit memorandums should be prepared in duplicate. The first copy goes to the vendor and the second
copy is filed with documents relating with the transaction.
Not until all variances or disagreements have been resolved will the transaction be complete. When they are
resolved, the purchasing agent sends the file to the accounting department.
Control During storage and Issuances
The proceeding discussion applies to the control of materials during the process of procurement. The routine
that has been suggested and the forms described have traced the ordering and the arrival of the materials and
their transfer to the storeroom. The next problem to be considered is the storage and issuance of materials and
supplies.
Materials inventories usually represent a considerable investment of money; therefore, care should be taken to
devise an adequate control system to protect these assets. The problem is how this control can best be achieved.
The importance of knowing the quantities of materials on hand at any time has already been emphasized; it is
equally important that the cost of materials on hand be known.
Materials Requisition
No material should be issued from the storeroom except on written authorization so that there is less chance of
theft, carelessness, or misuse. The form used to provide this control is known as the material requisition or
stores requisition and is prepared by the person or persons in the factory authorized to withdraw materials from
the storeroom. The individuals who are authorized to perform this function may differ from company to
company, but such authority must be given to someone. The most satisfactory arrangement would be to have
the production manager prepare all of the materials requisitions, but this is not usually feasible. Another
arrangement is to require that the supervisor of the department sign all materials requisitions. When a properly
signed requisition is presented to the storeroom keeper, the requisitioned materials are released. The employee
to whom materials are issued should be required to sign the requisition.
The material requisition, which is numbered serially, is usually prepared in quadruplicate. The first and second
copy goes to the accounting department. One copy, after pricing, provides the information needed in posting the
cost of requisitioned materials to the appropriate accounts in the job cost and factory overhead ledgers. Direct
materials are charged to the proper jobs and indirect materials are charged to the factory overhead accounts. The
other copy provides the information needed in posting the quantities and costs of issued materials to the credit
of the proper materials accounts in the stores ledger. This copy also serves as a source of the information needed
in preparing a summary of the total direct and indirect materials issued during the month. The third copy is
given to the storeroom keeper and serves as the authority for issuing the materials requisitioned. The fourth
copy is retained by the production manager or supervisor who prepared it.
Identification continues to be the most important factor in the control of materials. From the time materials are
issued for use in the factory until they are removed as finished products, they are identified by number as
applying to a particular job. For this reason, one of the most important items of information that should appear
on the materials requisition is a job or production order number.
3. Accounting for Labor Costs.
Labor costs are recorded on a document called a time ticket or a time sheet. Each employee records the
amount of time he or she spends on each job and each task on a time ticket. The time ticket is the source
document used in the cost accounting department as the basis for adding direct-labor cost to “Work in
Process Inventory” and to the job-cost sheets for the various jobs in process. In some factories a
computerized time-clock system may be used. Employees enter the time they begin and stop work on each
job into the time clock. The time clock is connected to a computer, which records the time spent on various
jobs and transmits the information to the accounting department. The time spent on a particular job is
considered direct labor and its cost is "traced" to that job. The cost of time spent on other tasks, not traceable
to any particular job, is usually considered part of manufacturing overhead.
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Allocation of Factory Overhead
Why Allocation?
As discussed in the previous chapter, manufacturing overhead includes all of those costs incurred in the
manufacturing process which are not directly "traced" to a particular cost object. In practice, manufacturing
overhead usually consists of all manufacturing costs other than direct materials and direct labor. Compared to
direct materials and direct labor, manufacturing overhead costs are not as easy to assign to particular job.
Besides, for most overhead costs actual cost is known after a long period of time, say, after a year, a month, etc.
So, since manufacturing overhead costs are also costs of a job, we assign (allocate) manufacturing overhead to
jobs based on a predetermined overhead rate, which is estimated at the beginning of the year. Otherwise, we
would have to wait until the end of the year to calculate the cost of jobs.
Selection of Allocation Base
In order to allocate overhead costs, some type of allocation base common to all products being produced must
be identified. The most widely used allocation bases are direct labor-hours, direct labor costs, and machine-
hours. (These bases have been severely criticized in recent years since allegedly there is little relationship
between machine-hours or direct labor-hours and overhead.). A predetermined overhead rate is computed by
dividing the estimated total overhead for the upcoming period by the estimated total amount of the allocation
base.
Ideally overhead cost should be strictly proportional to the allocation base; in other words, for example a 10%
change in the allocation base should cause a 10 % change in the overhead cost. Only then will the allocated
overhead costs be useful in decision-making and in performance evaluation. However, much of the overhead
typically consists of costs that are not proportional to any allocation base that could be devised for products and
hence any scheme for allocating such costs will inevitably lead to costs that are biased and unreliable for
decision-making and performance evaluation. In practice, the overriding concern is to select some bases for
allocating all overhead costs and hardly any (scant) attention is paid to questions of causality.
The predetermined cost-driver rate may be referred to as a predetermined overhead rate or a burden rate.
Developing predetermined cost-driver rates requires a lot of estimation, described below.
For estimating cost-driver rates, all activities must be defined and categorized.
Then the overhead costs of all of the categories must be estimated. These cost estimates are usually based on
past experience, current conditions, and expected changes.
Next, cost-driver bases must be chosen and the quantity of the base must be estimated. Sometimes a cost-driver
base is obvious for some overhead costs. At other times, a valid cost-driver base cannot be identified. Cause and
effect relationship between the driver and the cost must be investigated.
Finally, the predetermined cost-driver rate can be calculated by dividing the estimated cost of a resource by the
estimated quantity of the chosen cost-driver base. These rates are then used to apply costs to jobs based on the
actual amount of use of the cost driver.
At any rate, the actual amount of the allocation base incurred by a job is recorded on the job cost sheet. The
actual amount of the allocation base is then multiplied by the predetermined overhead rate to determine the
amount of overhead that is applied to the job.
The following bases can be used to compute the factory overhead application rate:
1. Physical output per unit of production base
2. Direct materials cost base
3. Direct labor (DL) cost base
4. Direct labor hours base
5. Machine hours base
The bases used differ not only from company to company but also from one department or cost center to
another within the same company.
1. Physical output per unit of production base
This method applies factory overhead equally to each unit produced and is appropriate when a company
or department manufactures only one type/kind of product. This method is very simple since data on the
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 units produced are readily available for applying factory overhead. The factory overhead rate is
computed as follows:
Factory overhead rate per unit of production = Estimated factory overhead costs
Estimated units of production
2. Direct materials cost:
If factory overhead consists mainly of the labor and equipment costs needed for material handling, a
direct relationship is established and this base is used. A problem arises when more than one product is
made, because each product requires its own quantities and types of materials, therefore accuracy would
dictate a separate computation of factory overhead application rates for each product. This, however,
violates the goal of simplicity.
 The factory overhead rate is computed as follows:
FOH rate as a percentage of direct material cost = Estimated factory overhead cost X100%
Estimated direct material costs
 This method has limited use because in most cases no logical relationship exists between
direct material cost of a product and factory overhead used in its production.
3. Direct labor cost base:
This is the most widely used base because direct labor costs are generally closely related to factory
overhead costs and payroll data are readily available. It therefore meets the objectives of having a
direct relationship to factory overhead cost, being simple to compute and apply and requiring little, if
any, additional cost to compute. The formula is as follows:
FOH rate as a percentage of direct cost = Estimated factory overhead cost X 100%
Estimated direct labor cost
 This method would not be appropriate:
a) If there is a direct relationship between factories overhead cost and direct labor cost but wage
rates vary greatly within departments.
b) If factory overhead costs are composed largely of depreciation and equipment related costs.
4. Direct labor hours:
This method is appropriate when there is a direct relationship between factory overhead costs and direct
labor hours and when there is significant disparity in hourly wage rates. Time keeping records must be
accumulated to provide the data necessary for applying this rate.
 The rate computed as follows:
Factory overhead rate per direct labor hours = Estimated factory overhead cost
Estimated direct labor hours
 This method like direct labor cost method would be inappropriate if factory overhead cost
were composed of costs unrelated to labor activity.
5. The machine hours:
This method uses the time required for machines to perform similar operations as a base in computing
the factory overhead application rate. This method is appropriate in organizations or departments that
are largely automated so that the majority of factory overhead costs consist of department and other
equipment related costs.
 The formula is as follows:
Factory overhead rate per machine hours =Estimated factory overhead cost
Estimated machine hours
In general, Factory overhead application rate per unit\dollars = Estimated factory overhead costs
Estimated base at denominator activity
Note that in any case, the numerator remains constant; only the denominator or base activity varies.
General Approach to Job Costing
There are seven steps to assigning costs to an individual job. This seven-step procedure applies equally to
assigning costs to a job in the manufacturing, merchandising, and service sectors.

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Step 1: Identify the job that is the chosen cost Object.
Step 2: Identify the Direct costs of the Job. Direct material and direct labor:
Direct materials costs are calculated by multiplying the quantity of each material used for a particular job by
its unit cost (the direct-cost rate) and adding together the costs of all the materials. Similarly, direct
manufacturing labor costs are calculated by multiplying the hours worked by each employee on a particular
job by his or her wage rate and adding these costs together.
Step 3: Select the cost-Allocation Bases to Use for Allocating Indirect Costs to the Job. Indirect
manufacturing costs are necessary costs to do a job that cannot be traced to a specific job. It would be
impossible to complete a job without incurring indirect costs such as supervision, manufacturing engineering,
utilities, and repairs. Because these costs cannot be traced to a specific job, they must be allocated to all jobs
but not in a blanket way, different jobs require different quantities of indirect resources. The objective is to
allocate the costs of indirect resources in a systematic way to their related jobs. Companies often use multiple
cost-allocation bases to allocate indirect costs.
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base: i.e. FOH.
Step 5: Compute the Rate per Unit of Each cost-Allocation Base Used to Allocate Indirect costs to the
Job. For each cost pool, the indirect-cost rate is calculated by dividing total overhead costs in the pool
(determined in step 4 above) by the total quantity of the cost-allocation base (determined in step 3 above).
Step 6: compute the Indirect costs Allocated to the Job. The indirect costs of a job are computed by
multiplying the actual quantity of each different allocation base (one allocation base for each cost pool)
associated with the job by the indirect cost rate of each allocation base.
Step 7: Compute the Total Cost of the Job by Adding all direct and Indirect costs Assigned to the Job.
Examples 1
1. The following budgeted data is given for XYZ Textile Factory for the year 2001.
 Estimated factory overhead for the year………………………………$450,000
 Estimated number of shirts to be produced in the year…………………200,000
 Estimated direct material cost for the year…………………………….$300,000
 Estimated direct labor cost…………………………………………….$900,000
 Estimated direct labor hours………….……………………………… 300,000 hrs
 Estimated machine hours……………………………………………… 90,000 hrs
Instruction: Compute the predetermined factory overhead rate based on the following bases.
A. Physical output method
B. Direct materials cost base
C. Direct labor cost base
D. Direct labor hours base
E. machine hours base
Example-2
Assume all information in example 1 above and the following additional information:
 Actual data for job 201 is give is given below
o Actual shirts completed for job 201………………2,000 shirts
o Actual direct material cost used………………...$30,000
o Actual direct cost incurred……………………...$20,000
o Actual direct labor hours used…………………. 400 hours
o Actual machine hours…………………………. 240 hours
Instruction: Record the applied factory overhead and determine the total cost of job 201 under each of the five
bases.
A. Physical output method
B. Direct materials cost base
C. Direct labor cost base
D. Direct labor hours base
E. Machine hours base
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The Manufacturing Overhead Control Account
Actual overhead costs are recorded by debiting “Manufacturing Overhead Control” account. Overhead costs
applied to jobs in Work in Process using predetermined rates are recorded on the credit side of the
Manufacturing Overhead Applied account with a debit to ‘Work in Process’ account.
Time Period Used To Compute Indirect-Cost Rates
Indirect cost rates should be calculated for a long period of time (usually for a year) and not for short periods
(such as a week, a month, etc). This is so because of the following reasons:
1. The numerator reason (indirect-cost pool). The shorter the period, the greater the influence of seasonal
patterns on the amount of costs. For example, if indirect- cost rates were calculated each month, costs of
heating (included in the numerator) would be charged only to production during the winter months. But an
annual period incorporates the effect of all four seasons into a single, annual indirect-cost rate.
Levels of total indirect costs are also affected by nonseasonal erratic costs. Examples of nonseasonal erratic
costs include costs incurred in a particular month that benefit operations during future months, costs of repairs
and maintenance of equipment, and costs of vacation and holiday pay. Pooling all indirect costs together over
the course of a full year and calculating a single annual indirect-cost rate helps to smooth some of the erratic
bumps in costs associated with specific periods.
2. The denominator reason (quantity of the allocation base). Another reason for longer periods is the
need to spread monthly fixed indirect costs over fluctuating levels of monthly output. Some indirect costs
may be variable each month with respect to the cost allocation base (for example, supplies). Whereas other
indirect costs are fixed each month (for example, property, taxes, and rent).
Normal Costing
The difficulty of calculating actual indirect cost rates on a weekly or monthly basis means managers cannot
calculate the actual costs of jobs as they are completed. However, managers want a close approximation of the
manufacturing costs of various jobs regularly during the year, not just at the end of the year. Managers want
manufacturing costs (and other costs, in fact) for ongoing uses, including pricing jobs, managing costs and
preparing interim financial statements. Because of these benefits of immediate access to job costs, few
companies wait until the actual manufacturing overhead is finally known (at year end) before allocating
overhead costs to compute job costs. Instead, a predetermined or budgeted indirect-cost rate is calculated for
each cost pool at the beginning of a fiscal year, and overhead costs are allocated to jobs as work progresses.
For the numerator and denominator reasons already described, the budgeted indirect-cost rate is computed for
each cost pool by dividing the budgeted annual indirect cost by the budgeted annual quantity of the cost
allocation base. Using budgeted indirect-cost rates gives rise to normal costing.
Normal costing is a costing method that traces direct costs to a cost object by using the actual direct-cost
rates times the actual quantity of the direct cost inputs, and allocates indirect costs based on the budgeted
indirect-cost rates times the actual quantity of the cost allocation base(s). Both actual costing and normal
costing trace direct costs to jobs in the same way. The actual quantities and actual rates of direct materials and
direct manufacturing labor used on a job are known from the source documents as the work is done. The only
difference between actual costing and normal costing is that actual costing uses actual indirect-cost rates,
whereas normal costing uses budgeted indirect-cost rates to cost jobs.
Example-3 (taken from your text book, page 123, exercise 4-18)
Anderso construction assembles residential houses. It uses a job costing system with two direct cost categories
(direct materials and direct labor) and one indirect cost pool (assembly support). A direct labour hours is the
allocation base for assembly support costs. In December 2003, Anderson budgets 2004 assembly support costs
to be $8,000,000 and 2004 direct labor hours to be 160,000.
At the end of 2004, Anderson is comparing the cost of several jobs that were started and completed in 2004.
Laguna Model Mission Model
Construction period Feb – June 2004 May – Oct 2004
Direct materials $106,450 $127,604
Direct labor $36,276 $41,410
Direct labor hours 900 1,010

10
Direct material and direct labor are paid for on a contract basis. The costs of each are known when direct
materials are used or direct labor hours are worked. The 2004 actual assembly – support costs were $6,888,000,
and actual direct labor hours were 164,000.
Required:
i) Computethe (a) budgeted and (b) actual indirect cost rates. Why do they differ?
ii) What is the job cost of the Laguna Model and the Mission Model using:
(a) Normal costing and (b) Actual costing
iii) Why might Anderson construction prefer normal costing over actual costing?

Example-4
Zigba Furniture is a furniture manufacturing firm that uses job order costing. The company’s inventory balances
on January 1, the beginning of its fiscal year were as follows:
Raw materials............................................. Br 40,000
Work in process......................................... 30,000
Finished goods ........................................... 60,000
The company applies overhead cost to jobs on the basis of machine-hours worked. For the current year, the
company estimated that it would work 150,000 machine-hours and incur a manufacturing overhead cost of Br
900,000. The following transactions were recorded for the year:
a. Raw materials were purchased on account, Br 820,000.
b. Raw materials were requisitioned for use in production, Br 760,000 (Br 720,000 direct
material and Br 40,000 indirect material).
c. The following costs were incurred for employee services; direct labor Br 150,000: indirect
labor Br 220,000; sales commission, Br 180,000; administrative salaries, Br 400,000.
d. Sales travel costs were incurred, Br 34,000.
e. Utility costs were incurred in the factory, Br 86,000.
f. Advertising costs incurred; Br 360,000.
g. Depreciation for the year, Br 700,000 (80% relates to factory operations and 20% to selling
and administrative activities)
h. Insurance expired during the year, Br 20,000 (70% relates to factory operations and the
remaining 30% relates to selling and administrative activities)
i. Manufacturing overhead was applied to production. Due to greater than expected demand for
its products, the company worked 160,000 machine hours during the year.
j. Goods costing Br 1,800,000 to manufacture, according to their job cost sheets, were completed
during the year.
k. Goods were sold on account to customers during the year at a total selling price of Br
3,000,000. The goods cost Br 1,740,000 to manufacture according to their job cost sheets.
Instruction:
Prepare journal entries to record the preceding transactions.
Budgeted Indirect Costs and End-Of-Period Adjustments
Since the predetermined overhead rate is based entirely on estimated data, there will almost always be a
difference between the actual amount of overhead cost incurred and the amount of overhead cost that is applied
to the Work In Process account. This difference is termed under applied or over applied overhead and can be
determined by the comparing these two accounts. An under applied balance occurs when more overhead cost is
actually incurred than is applied to the Work in Process account. An over applied balance results from applying
more overhead to Work in Process than is actually incurred. In another word, when the total FOH Applied
exceeds the FOH Control account the difference is over applied and when the total FOH Applied is lower than
the FOH Control account the difference is under applied.
Cause of under- and over applied overhead
When a predetermined overhead rate is used, it is implicitly assumed that the overhead cost is variable with
(i.e., proportional to) the allocation base. For example, if the predetermined overhead rate is Br 80 per direct

11
labor-hour, it is implicitly assumed that the actual overhead costs will increase by Br 80 for each additional
direct labor-hour that is incurred. If, however, some of the overhead is fixed with respect to the allocation base,
this will not happen and there will be a discrepancy between the actual total amount of the overhead and the
overhead that is applied using the Br 80 rate. In addition, the actual total overhead can differ from the estimated
total overhead because of poor controls over overhead spending or because of inability to accurately forecast
overhead costs.
Disposition of under- and over applied Overhead
There are three approaches to dealing with an under- or over applied overhead balance in the accounts.
(1) the adjusted allocation-rate approach, (2) the proration approach, and (3) the write-off to cost of goods
sold approach.
1. Adjusted Allocation-Rate Approach
The adjusted allocation-rate approach restates all overhead entries in the general ledger and subsidiary ledgers
using actual cost rates rather than budgeted cost rates. First, the actual indirect-cost rate is computed at the
end of the year. Then, the indirect costs allocated to every job during the year are recomputed using the actual
indirect-cost rate (rather than the budgeted indirect-cost rate). Finally, end-of year closing entries are made.
The result is that at year-end, every job-cost record and finished goods record - as well as the ending Work-in
Process Control, Finished Goods Control, and Cost of Goods Sold accounts - accurately represents actual
indirect costs incurred. The widespread adoption of computerized accounting systems has greatly reduced the
cost of using the adjusted allocation-rate approach.
The adjusted allocation-rate approach yields the benefits of both the timeliness and convenience of normal
costing during the year and the accuracy of actual costing at the end of the year. Each individual job-cost
record and the end-of-year account balances for inventories and cost of goods sold are adjusted to actual costs.
After-the-fact analysis of actual profitability of individual jobs provides managers with accurate and useful
insights for future decisions about job pricing, which jobs to emphasize, and ways to manage costs.
2. Proration Approach
Proration spreads under allocated overhead or over allocated overhead among ending work in process,
finished goods and cost of goods sold. Materials inventories are not allocated manufacturing overhead costs,
so they are not included in this proration.
Organizations should prorate under allocated or over allocated amounts on the basis of the total amount of
manufacturing overhead allocated (before proration) in the ending balances of Work-in-Process Control,
Finished Goods Control, and Cost of Goods Sold. However, in case such information is not available, the
ending balances (before proration) of WIP, FGs and CGS accounts can be used for disposition of over or
under applied overhead.
3. Write-Off to Cost of Goods sold Approach
In this case, the total under allocated overhead or over allocated overhead is included in the current year's Cost
of Goods Sold. The simplest approach is to close out the under- or over applied overhead to Cost of Goods
Sold
Choice among Approaches
Which of these three approaches is the best one to use? In marketing this decision, managers should be
guided by how the resulting information will be used. If managers intend to develop the most accurate record
of individual job costs for profitability analysis purposes, the adjusted allocation-rate approach is preferred. If
the purpose is confined to reporting the most accurate inventory and cost of goods sold figures in the financial
statements, proration based on the manufacturing overhead-allocated component in the ending balances
should be used because it adjusts the balances to what they would have been under actual costing. Note that
the proration approach does not adjust individual job cost records.
The write-off to Cost of Goods Sold is the simplest approach for dealing with under allocated or over
allocated overhead. If the amount of under allocated or over allocated overheads is small -- in comparison to
total operating income or some other measure of materiality -- the write-off to Cost of Goods Sold approach
yields a good approximation to more accurate, but more complex, approaches. Modern companies are also
becoming increasingly conscious of inventory control. Thus, quantities of inventories are lower than they
12
were in earlier years, and Cost of Goods Sold tends to be higher in relation to the dollar amount of work-in-
process and finished goods inventories. Also, the inventory balances of job-costing companies are usually
small because goods are often made in response to customer orders. Consequently, as is true in our Robinson
example, writing off under allocated or over allocated overhead instead of prorating it is unlikely to cause
significant distortions in financial statements. For all these reasons, the cost-benefit test would favor the
simplest approach -- write-off to Cost of Goods Sold -- because the more complex attempts at accuracy
represented by the other two approaches do not appear to provide sufficient additional useful information.
The Effect of under- and over applied Overhead on Net Income
If overhead is under applied, less overhead has been applied to inventory than has actually been incurred.
Enough overhead must be applied retroactively to Cost of Goods Sold (and perhaps ending inventories) to
eliminate this discrepancy. Since Cost of Goods Sold is increased, under applied overhead reduces net income.
If overhead is over applied, more overhead has been applied to inventory than has actually been incurred.
Enough overhead must be removed retroactively from Cost of Goods Sold (and perhaps ending inventories) to
eliminate this discrepancy. Since Cost of Goods Sold is decreased, over applied overhead increases net income.
The Flow of Costs in Job Order Costing
The basic flow of costs in a job-order system begins by recording the costs of material, labor, and
manufacturing overhead. Direct material and direct labor costs are debited to the Work in Process account. Any
indirect material or indirect labor costs are debited to the Manufacturing Overhead Control account, along with
any other actual manufacturing overhead costs incurred during the period. Manufacturing overhead is applied to
Work In Process using the predetermined rate. The offsetting credit entry is to the Manufacturing Overhead
control account. The cost of finished units is credited to Work In Process and debited to the Finished Goods
inventory account. When units are sold, their costs are credited to Finished Goods and debited to Cost of Good
Sold.
Example 5
A Corporation uses a job-order cost system. The factory overhead rate estimated for the year 2001 was $8 per
DL hrs. The inventory accounts had the following balances on December 1:
Materials………………………………$7,000
Work-in-process (job 210)……………………….. 6,500
Finished Goods (job 209)………………. 7,000
During December, the following events occurred:
a) Material purchased on account $18,000
b) Direct materials and factory supplies were issued as follows:
 Job 211………………………$4,500
 Job 212……………………… 5,300
 Job 213……………………… 6,200
 Supplies (indirect materials)….1,800
c) The December direct labor costs were:
Job 210…………………150 hrs at $ 6/hr……………………..$ 900
Job 211………………… 400 hrs at $6/hr…………………….. 2,400
Job 212 ………………... 350 hrs at $6/hr……………………...2,100
Job 213 …………………100 hrs at $6/hr ……………………... 600
Total 1,000 hrs $ 6000
d) Factory indirect labor for December was $2,400.
e) Other overhead costs incurred during December:
Utilities (paid in cash)…………………. $2,500
Factory depreciation………………..…… 1,000
Repairs and maintenance (Paid in cash)… 500
Total……………………..$4,000
f) Job 210, 211, and 212 were completed and transferred to finished goods inventory.
13
g) Job 209 and 210 were sold on account for 120% of cost assumes perpetual inventory system.
Instruction:-
1. Journalize the above transactions.
2. Determine ending balance of all inventory accounts.
3. Determine the under or over applied overhead.
Example 6
Consider the following ending balances of some accounts in B Company.
Factory Overhead Control Factory Overhead Applied Cost of Good Sold

326,000 324,000 900,000

Finished Goods Work in process

70,000 30,000

The amounts of factory overhead applied included in different accounts are as follows:
Account Factory overhead cost
Cost of goods sold…………………………$ 275,400
Finished goods…………………………….. 32,400
Work in process…………………………… 16,200
Instruction:
1. Compute over or under applied.
2. Show the disposition and the necessary journal entries to account for under or over applied OH
using:
a).Proration Approach
b). Write-Off to Cost of Goods sold Approach
Example-7
ABC Furniture Company has two departments and the following data relate to the company for the year 2008.
Inventory January 1, 2008
 Direct material---------------------------------130,000
 Work in process-------------------------------100,000
 Finished goods---------------------------------80,000
Manufacturing overhead costs budgeted for the year in both departments is given below:

Overhead item Department-A Department-B

Indirect labor 500,000 820,000
Supplies 90,000 80,000
Utilities 220,000 150,000
Repairs 280,000 220,000
Supervision 260,000 430,000
Factory rent 190,000 150,000
Depreciation-Factory 320,000 210,000
Insurance and others 120,000 140,000
Total 1,980,000 2,200,000
Machine hours 180,000
Direct labor cost 4,400,000

14
 Note: The company applies overhead using machine hours in department-A and direct labor cost in
department-B.
Summary of actual events for the year is given below for both departments and for the company as follows:
No. Items Department-A Department-B Total
A Direct material purchased 3,800,000
B Direct material requisitioned 2,200,000 1,500,000 3,700,000
C Direct labor cost incurred 1,800,000 5,600,000 7,400,000
D FOH incurred 2,200,000 2,200,000 4,400,000
E FOH Applied 1,760,000 X X
F Cost of goods manufactured 15,640,000
G Sales 26,000,000
H Cost of goods sold 15,600,000
Required
A. compute the budgeted overhead rates for both departments
B. Compute the amount of machine hours actually worked in department-A
C. Compute the factory overhead applied in department-B
D. Record transactions A through H
E. Is overhead under applied or over applied and by how much?
Example-8
Alpha limited company produces office equipments in response to its customer’s orders. The company uses
job costing system that has two direct cost categories (DM and DL) and one indirect cost category (OH).
Overhead is allocated based on manufacturing labor costs.
Budgeted data for a given period is given below:
 Direct labor cost-------------------------2,100,000
 Manufacturing overhead--------------1,260,000
Additional information
 At the end of that year, two jobs X and Y were incomplete. Total direct labor and direct material for
job X is $55,000 and $110,000 respectively and for job Y $195,000 and $210,000 respectively.
 Machine time for jobs X and Y are 1,435 and 3,235 hours respectively.
 Total manufacturing overhead incurred for the period is $1,000,000 and direct labor cost total
$2,000,000(100,000 direct labor hours)
 There were no beginning inventories and in addition to the ending work in process inventory, finished
goods has an ending balance of $780,000 out of which $200,000 is direct labor cost.
 Total sales for the period is $11,200,000 and goods are sold at 140% of their cost and operating
expense for the period is $2,200,000
Required
A. What is the balance of W/P, F/G and CGS at the end of the period before adjustment?
B. Compute the cost of goods manufactured
C. Is overhead under or over applied and by how much?
D. Prorate the under or over applied overhead among W/P, F/G and CGS based on
I. Their ending balance before proration
II. The FOH in each item before adjustment
E. Prepare a partial income statement for the period ( use I in E)

15
Example-9
XYZ Company has two departments in one of its plants: Machining and assembly. Its job costing
system has two direct cost categories (DM and DL) and two manufacturing overhead categories
(Machining department OH allocated using machine hours and Assembly department overheads
allocated using direct labor cost). The following is a budget for the year 2009:
Items Machining department Assembly department
Manufacturing overhead $1,800,000 $3,600,000
Direct labor cost 1,400,000 2,000,000
Machine hours 50,000 hrs 200,000 hrs
Direct labor hours 100,000 hrs 200,000 hrs
Required
A. During the month of February, the job cost record of Job-494 contained the following

Items Machining department Assembly department

Direct material used $45,000 $70,000
Direct labor cost 14,000 15,000
Direct labor hours 1,000 hrs 1,500 hrs
Machine hours 2,000 hrs 1,000 hrs
I. Compute the total overhead cost for job-494
II. Compute the total cost of the job
B. At the end of the year the total actual manufacturing overhead cost was $2,100,000 in the Machining
department and $3,700,000 in the Assembly department. Assume that 55,000 actual machine hours
were used in the machining department and that direct labor cost of $2,200,000 was incurred in the
Assembly department: Is overhead under or over applied and by how much?
Example-10
Z Law firm uses job order costing with two direct cost categories ( professional partner labor and professional
associate labor) and two indirect cost categories ( general support and secretarial support). Budgeted data for
the company during a particular month is as follows:
Direct cost categories
Items Professional partner labor Professional associate labor
No. of professionals 5 20
Hours of billable time per professional per 1,600 1,600
year
Total compensation (average per professional $200,000 $80,000

Indirect cost categories

Items General support Secretarial support

Total cost $1,800,000 $400,000
Allocation base Professional associate labor Professional partner labor
Required
A. Compute the budgeted direct cost rates for professional partners and associate partners
B. Compute the budgeted indirect cost rates for professional partners and associate partners

16
 C. The has been offered to give professional services to Company X and Y that requires the following
resources:

Items X-Company X-Company

Professional partner labor 60 hrs 30 hrs
Professional associate labor 40 hrs 120 hrs
Compute the budgeted total cost of giving services to both companies
Example-11
A corporation uses a job order costing system. The following items relate the work in process account of the
company for the month of March.
Work in process March 1---------------------------$12,000
Direct material----------------------------------------40,000
Direct labor--------------------------------------------30,000
FOH applied-------------------------------------------27,000
Cost of goods manufactured------------------------100,000
The corporation applied overhead using direct labor cost.job-232, the only job in process at the end of March,
has been charged with FOH of $2,250.
Required: Compute AR=27,000/30,000=0.9
A. The cost of the job still in process
B. The direct material cost charged to job-232

Accounting For Spoilage, Re-Work and Scrap

Generally, manufacturing operations cannot escape the occurrence of certain losses or output reduction due to
scrap, spoilage, or defective work. Although sometimes these are the cost of doing good units, management
and the entire personnel of an organization should cooperate to reduce such losses to a minimum. As long as
they occur, however, they must be reported and controlled.
Definition of terminologies
Scrap Materials: are raw materials left over from the production process that cannot be put back into the
production for the same purpose. However, they may be useful for different purpose or production process.
Waste Materials: are parts of raw materials left over after production that has no further use or resale value.
Sometimes cost may be incurred to dispose waste materials.
Spoiled Units: are units that do not meet production standards and are either sold for their salvage value or
discarded. Spoiled units have imperfections that cannot be economically corrected. They may be sold as items
of inferior quality or “seconds”.
Defective (rework) units: are units that do not meet production standards and must be further processed in
order to be salable as good units. Such units have imperfections considered correctable because the market
value of the corrected units will be greater than the total cost incurred for the units.
Note: scrap is the by-product of the production of the primary product whereas spoiled and defective goods
are not by-products but imperfections of the primary product.
Types of Spoilage
The key objectives in accounting for spoilage are determining the magnitude of the costs of spoilage and
distinguishing between the costs of normal and abnormal spoilage.
Normal Spoilage
Normal Spoilage is spoilage that is an inherent result of the particular production process and arises even
under efficient operating conditions. For a given production process, management must decide the rate of
spoilage it is willing to accept as normal. Costs of normal spoilage are typically treated as component of the
costs of good unit manufactured because good units cannot be made without the simultaneous appearance of
17
spoiled units. Normal spoilage rates should be computed using total units completed as the base, not total
actual units started in production. Because total units started also include any abnormal spoilage in addition to
normal spoilage. Moreover, the normal spoilage is the amount of expected spoilage associated or related to
the good units produced.
Abnormal Spoilage
Abnormal Spoilage is spoilage that should not arise under efficient operating conditions. It is not an inherent
result of the particular production process. Abnormal spoilage is regarded as avoidable and controllable. Line
operators and other plant personnel can generally decrease abnormal spoilage by minimizing machine break
downs, accidents and the like. Abnormal spoilage costs are written off as losses of the accounting period in
which detection of the spoiled units occurs.
Job Costing and Spoilage
The concepts of normal and abnormal spoilage also apply to job-costing systems. Abnormal spoilage is
usually regarded as controllable by the manager. Costs of abnormal spoilage are not considered as inventor
able costs and are written off as costs of the period in which detection occurs. Normal Spoilage costs in job-
costing systems just as in process costing systems are inventor able costs, although managements are
tolerating only small amounts of spoilage as normal.
Spoilage is an important consideration in any production and cost related to planning and control decision.
Since in most cases spoilage is unavoidable, management must determine the most efficient production
process that will keep spoilage to a minimum possible. When assigning costs, job-costing systems generally
distinguish between normal spoilage attributable to a specific job and normal spoilage common to all jobs.
Generally, as it is mentioned above in this chapter, spoilage is classified into two: normal and abnormal.
1. Normal spoilage:
Is spoilage that results despite efficient production method. The costs of normal spoilage are considered to
be unavoidable cost of producing good units and are therefore treated as a product cost. Normal spoilage
costs are accounted for in two ways:
 Applied to a specific job
 Applied to all jobs
Normal spoilages are recorded in an asset account like “Spoiled Goods Inventory” account.
2. Abnormal spoilage:
Is spoilage in excess of what is considered normal for a particular production process. The total cost
of abnormal spoilage should be charged to an expense account like “Loss from Abnormal Spoilage”
account.
Example-1
Assume that in ABC Company 10,000 units were put into production for job 09. The total cost of production
was $ 300,000. Normal spoilage for the job is estimated to be 50 units. At the completion of production only
9,910 units were good. All spoiled units are estimated to have a salvage value of $5 each.
Required:
1. Present the required journal entry assuming normal spoilage is-
A. Applied to a specific job
B. Applied to all jobs
2. Compute the unit cost of the remaining finished good units.
Solution
To record normal spoilage:
a) To specific job
Spoiled Goods Inventory…………250
WIP-job 09…….…………………….250
b) To all jobs:
Spoiled Goods Inventory…………250
18
 FOH- Control…………………….1, 250
WIP- job 09……..……………….1, 500
To record abnormal spoilage:
Spoiled goods inventory...……….200
Loss from Abnormal Spoilage……1,000
WIP-job 09…................................... 1,200
Example-2
In a Machine Shop 5 aircraft parts out of a job lot of 50 aircrafts parts are spoiled. Costs assigned prior to
inspection point are $2,000 per part. The current disposal price of the spoiled parts is estimated to be $600 per
part. When the spoilage is detected, the spoiled goods are inventoried at $600 per part.
Normal Spoilage attributable to a specific job:
Materials Control (5*$600) 30001
Work-in Process Control (specific job) (5*$600) 3000
Note that the Work-in Process Control (specific job) has already been debited $10,000 for the spoiled parts (5
spoiled parts * $2,000 per part). The effect of the $3,000 entry is that the net cost of the normal spoilage,
$7,000 ($10,000-$3,000) becomes an additional cost of the 45(50-5) good units produced. The total cost of
the 45 good units is $97,000. $90,000 (45units*$2,000 per unit) incurred to produce the good units plus the
$7,000 net cost of normal spoilage.
Normal Spoilage common to all jobs
Materials Control (spoiled goods at disposal value 5*$600) 3000
MOH Control (normal spoilage $10,000-$3,000) 7000
Work-in Process Control (specific job 5*$2,000) 10000
Abnormal Spoilage:
Materials Control (spoiled goods at current disposal value: 3000
Loss from Abnormal Spoilage 7000
Work-in Process Control (specific job) 10000
Accounting for defective (rework) units
As with spoiled units, defective units are classified as either normal or abnormal.
Normal defective units: The numbers of defective units in any particular production process that can be
expected despite efficient operations are known as normal defective units. Normal defective rework costs may
be:
A) Applied to a specific job.
B) Applied to all jobs.
Abnormal defective units: The number of defective units in excess of what is considered to be normal for an
efficient productive operation is called abnormal defective units. The total cost of reworking abnormal
defective units should be charged to “Loss from Abnormal Defective” Account.
Example-1
Assume that 40,000 units are placed into production for job 10. Normal defective units for this job are
estimated to be 400 whereas actual defective units were 1000.The total cost to rework the 1000 defective units
was as follows:
Per unit
Direct materials…………..$500……$0.50
Direct labor………………..1000……1.00
FOH-applied……………… 500…….0.50
$2000 $2.00
Required: Present the required entry assuming that normal rework costs are applied to
1

19
 a. A specific job
b. All jobs
Solution
Abnormal defective = total defective –normal defective.
=1000 units –400 units = 600 units
To record normal defective
A) To specific job
WIP-job 10 (400x Br 2)……………….800
Materials (400x0.5)………....................200
Payroll (400x0.1)………………….…...400
FOH-Applied……….…………...…….200
B) To all jobs
FOH-control………………………..800
Materials…………….……………...200
Payroll……………………………..400
FOH-Applied………….……………200
To record abnormal Defectives:
Loss from Abnormal Defects (600x$2)………..1,200
Material (600x0.5)………………………………..300
Payroll (600x1)……………………………………600
FOH-Applied (600x0.5)…………………………..300
A compound entry can also be made
a) WIP-Job 10………………………………..800
Loss from Abnormal Defectives…………1,200
Materials………………………………… 500
Payroll………………………….…….…. 1,000
FOH-Applied…….…………………………500
b) FOH- control……………….……….. 800
Loss from defects……….………….. 1,200
Materials ………………….……………. 500
Payroll …………………………………….1, 000
FOH-Applied……………………………....500
Example-2
Consider Hull Machine Shop; assume that the 5 spoiled parts used in the illustration are reworked. The
journal entry for the $10,000 of total cost assigned to the 5 spoiled units before considering rework costs are
as follows:
Work-in Process Control (Specific Job) 10000
Materials Control 4000
Wage payable Control 4000
MOH Allocated 2000
Normal Rework common to all jobs:
MOH Control (rework costs) 3800
Materials Control 800
Wage payable control 2000
MOH Allocated 1000
Abnormal rework:
20
 Loss from Abnormal Rework 3800
Materials Control 800
Wage Payable Control 2000
MOH Allocated 1000
Accounting for Scrap Materials
As for spoilage and defective units, the cost accounting system should provide a method of costing and
control for scrap. When the amount of scrap produced exceeds the norm it could be an indicator of
inefficiency. When the scarp value is small no entry is made until the scarp is sold. At the time the scarp is
sold the following entry will be made:
Cash (A/R)…… …….xxx
Scrap Revenue/WIP/FOH-con……………..xxx
The income from scrap sales is usually reported as “Other Income” in the income statement. When the value
of the scarp is relatively high an inventory card will be prepared and if both the quantity and the market value
of the scrap are known, the following journal entries are made.
To record the inventory:
Scrap Materials………………………..xxx
Scrap Revenue /WIP / FOH-ctrl…………..xxx
When the scrap is sold:
Cash (A/R)…………………xxx
Scrap Materials………………….xxx
Note:
1. Sometimes scrap may be sold for more or less than the value at which it is recorded.
Any difference between the sales price and the recorded value is treated as an adjustment to the account
that was originally credited. (i.e., WIP, FOH- control, Scrap Revenue, Miscellaneous income, etc)
2. If the market value of the scrap is not known, no journal entry is made until the scrap is sold. At the time of
sale, the following entry is made:
Cash…………….……………………..xxx
Scrap Revenue (WIP or FOH-ctrl)…………..xxx
Example
Bisrat Teshome Company maintains a Scrap Inventory account for metal scrap recovered from operations in
the cutting department. On September 8, 2005 5,300 pounds of scrap with an estimated market value of
$2,385 are transferred from the Factory to the storeroom.
Instruction: make journal entries to record
1. The storage of the metal scrap. (Credit WIP account)
2. The cash sale of 1,900 pounds of scrap at recorded value.
3. The sale of 2,100 pounds of scrap at $0.52 per pound on credit.
4. The sale of 1,300 pounds of scrap at $ 0.39 per pound on credit.
Solution
1. Scrap Material……………..2,385
WIP…………………………….2, 385
2. Cash……………………….855
Scrap Materials……………855
3. A/R……………………..1,092
Scrap Material………………945
WIP…………………………147
4. A/R……………………507
WIP…………………....78
Scrap Material……………585

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 Chapter 4: Process Costing
Process costing is one of the two widely used cost accumulation procedures that are used when products are
manufactured under conditions of continuous processing or under mass production methods. Process costing
is a method for assigning product costs to units of product when all units of product are virtually the same.
Products are completed in a short time, and costs for a single period can be averaged over the number of units
produced. These conditions exist in industries that produce such products as plastics, textiles, petroleum, steel,
sugar, drugs, etc. With process costing, costs are not traced to units of product. Instead, all production costs
(unit-level and otherwise) are assigned or allocated based on total production costs and total units produced.
Job costing and process costing differ in the way costs are assigned, and they differ because of differences in
product characteristics. With job costing, many costs are traceable to jobs or can be assigned to specific jobs
using cost-driver rates. For products in a process costing environment, all costs must be assigned using a cost-
driver approach. The key difference is that the only cost-driver is the actual number of units produced.
 In general, process costing is used:
 In homogeneous products
 In continuous processing
 In mass production techniques
Process costing is most commonly used in industries that produce essentially homogeneous (i.e. uniform)
products on a continuous basis.
 Firms producing distinct and unique products use job order costing where as firms producing similar
or identical units use process-costing system.
 Process costing system accumulate costs by department for a period of time, just as a job order costing
system accumulate costs by job, and the total cost then will be assigned to the units produced during
that period.
Similarities between job-Order and Process Costing
1. The same basic purposes exist in both systems, which are to assign material, labor, and overhead cost
to products and to provide a mechanism for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts, including MO, Raw Materials,
Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both systems.
Differences between Job-Order and Process Costing
Job-Order Costing Process Costing

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1. Many different jobs are worked on 1. A single product is produced either on a
during each period, with each job having continuous basis for long periods of time.
different production requirements. All units of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the
controlling the accumulation of costs by a key document showing the accumulation
job. and disposition of costs by a department.
4. Unit costs are computed by job on the 4. Unit costs are computed by department
job cost sheet. on the department production report.

 In manufacturing process costing setting, each unit is assumed to receive the same amount of direct
materials cost, direct manufacturing labor costs, and indirect manufacturing costs. Units are computed
by dividing total costs by the number of units.
 The principal difference between process costing and job costing is the extent of averaging used to
compute unit costs of products or services. In job-costing system, individual jobs use different
quantities of production resources. Thus, it would be incorrect to cost each job at the same average
production cost.
 In contrast, when identical or similar units of products or services are mass produced, and not
processed as individual jobs, process costing averages production costs over all units produced.
The difference between job order and process costing system is, thus, the extent of the averaging used to
compute unit cost. In job order costing each job differs in terms of material used, labor incurred, and
manufacturing overhead. Hence, it is impossible to assign the same cost for different jobs. On the contrary,
identical units produced in mass took equal amount of direct material, direct labor, and manufacturing
overhead. Thus, the unit cost can be found by dividing total cost by the number of units produced.
There are three cases in process costing that will be considered in section.
Case 1: Process costing with zero beginning and zero ending work in process inventory that is all units
are started and fully completed by the end of the accounting period.
Illustrating Process Costing
Haron Chemical Company makes different chemicals and uses process costing system to account for its
operation. One of its products, namely Product A, is produced in two processing departments: the Mixing
Department and the Bottling Department. Product A is marketed in one-liter bottles.
Part I: Mixing Department
In the Mixing Department, various ingredients are added at the start of the process and costs are accumulated
in two pools, one for direct material and another for all conversion costs. Direct material is added at the
23
beginning of the process and conversion costs are applied evenly through out the process. Data for the first
month of operation (September) of the Mixing Department is given below:
Physical Units, Costs and Stages of Completion

Beginning work in process 0 units

Started during the month 1,000 units
Completed during the month 1,000 units
Direct material costs Br. 80,000
Conversion costs Br. 40,000
Ending work in process 0 units

Total cost of production for the month is computed as follows:

Direct material costs-------------------------------80,000
Conversion costs-------------------------------------40,000
Total cost--------------------------------------------120,000

Unit cost
Direct material------------------80(80,000/1000)
Conversion cost-----------------40(40,000/1000)
Total------------------------------120(120,000/1000)
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the second month of operation (October) of the Mixing Department is given below:
Physical Units, Costs and Stages of Completion
Beginning work in process 0 units
Started during the month 2,000 units
Completed during the month 800 units
Ending work in process (60% completed as to conversion costs.) 1,200 units

Direct material costs Br. 160,000

Conversion costs Br. 91,200

How should the co. calculate the cost of fully assembled units in and the cost of partially assembled
units still in process at the end of September?
Steps:
 Summarize the flow of physical units of output.
 Compute output in terms of equivalent units.
24
  Compute equivalent unit costs.
 Summarize total costs to account for.
 Assign total costs to unit’s completed and to units in ending work in process.
Step 1: Summarize the flow of physical units of output (Quantity schedule)
This schedule shows the physical flow of units into and out of departments. The total units to account for must
equal to the total units accounted for.
Step 2: Equivalent Units (EUs) Schedule:
Equivalent units are the number of units for which periodic manufacturing cost is incurred. Equivalent units
equal the total units completed plus incomplete unit restated in terms of completed units.
Step 3: Equivalent unit costs
This is computed by dividing costs incurred by the related equivalent units
Step 4: Cost to Account for Schedule:
This schedule shows which costs are charged to or accumulated by the department. Unit costs broken down
by the cost elements are also presented in this section.
Step5: Assign total costs to unit’s completed and to units in ending work in process
This schedule shows the distribution of accumulated costs to units completed & transferred and to units still in
process. The total cost to account for must equal to the total cost accounted for.
Usually process costing system is illustrated under three cases. These cases are: -
Physical units and Equivalent units (Step 1&2)
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 0 units
Started during the month 2,000 units
Total units to Account for 2,000 units
Completed during the month 800 800 800
Work in process ending 1,200 1,200 720
Total units accounted for 2,000
Work done current period 2,000 1,520

Production cost report Total production cost Direct material cost Conversion cost
Costs added this period 251,200 Br. 160,000 Br. 91,200
Equivalent units 2,000 1,520
Equivalent unit cost (Step-3) 80 60
Total cost to account for(st-4) 251,200
Assignment of cost (step-5)
Completed& transferred out 112,000 800*80 800*60
W/P ending: Direct material 96,000 1,200*80
Conversion cost 43,200 720*60
Total W/P ending 139,200
Total cost accounted for 251,200

Journal entries
 W/P mixing department------------160,000
25
 A/P------------------------------------------160,000
 W/P mixing department-----------------91,200
Various accounts-----------------------------------------91,200

Case 3: Process costing with some beginning and some ending work in process inventory.
Data for the third month of operation (November) of the Mixing Department is given below:
Beginning work in process 1,200 units
Started during the month 1,000 units
Completed during the month 1,600 units
Ending work in process (50% completed as to conversion costs.) 600 units*

Direct material costs Br. 69,000

Conversion costs Br. 70,800

Weighted-Average process costing method

This method calculates the equivalent unit cost of the work done to date (regardless of the period in which it
was done) and assigns this cost to equivalent units completed and transferred out of the process and to
equivalent units in ending work in process inventory.
The weighted average cost is the total of all costs entering in the work in process account (regardless of
whether it is from the beginning work in process or from work started during the period) divided by total
equivalent units of work done to date.
Using the weighted average method, the cost of partially and fully computed units can be computed
as follows:
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 1,200
Started during the month 1,000
Total units to Account for 2,200
Completed during the month 1,600 1,600 1,600
Work in process ending 600 600 300
Total units accounted for 2,200
Work done to date 2,200 1,900

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Cost incurred to date 165,000 114,000
Equivalent units 2,200 1,900

26
 Equivalent unit cost (Step-3) 75 60
Total cost to account for(st-4) 279,000
Assignment of cost (step-5)
Completed& transferred out 216,000 1,600*75 1,600*60
W/P ending: Direct material 45,000 600*75
Conversion cost 18,000 300*60
Total W/P ending 63000
Total cost accounted for 279,000

Journal entries
 W/P mixing department------------69,000
A/P------------------------------------------69,000
 W/P mixing department-----------------70,800
Various accounts-----------------------------------------70,800
 W/P mixing department-----------------216,000
W/P Bottling department --------------------------------216,000
First-in, First-out Method
The FIFO process costing method assigns the cost of the previous period’s equivalent units in beginning
work-in process inventory to the first units completed and transferred out of the process, and assigns the cost
of equivalent units worked on during the current period first to complete beginning inventory, then to start and
complete new units in ending work in process inventory. This method assumes that the earliest equivalent
units in the work in process account are completed first. A distinct feature of the FIFO process-costing
method is that work done on beginning inventory before the current period is kept separate from work done in
the current period. Costs incurred in the current period and units produced in the current period are used to
calculate costs per equivalent unit of work done in the current period. In contrast equivalent unit and cost per
equivalent unit calculations in the weighted average method merge the units and costs in beginning inventory
with units and costs of work done in the current period.

Using the FIFO method, the cost of partially and fully computed units can be computed as follows:
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 1,200
Started during the month 1,000
Total units to Account for 2,200
Completed during the month
From beginning 1,200 480

27
 Started and completed 400 400 400
Work in process ending 600 600 300
Total units accounted for 2,200
Work done only current period 1,000 1,180

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Work done only current period 1,000 1,180
Equivalent unit cost (Step-3) 69 60
Total cost to account for(st-4) 279,000
Assignment of cost (step-5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 139,200

Cost to complete these units:

Direct Materials 0 0*69

Conversion costs 28,800 480*60

Total cost from beginning 168,000

Started and completed 51,600 400*69 400*60

Total Completed& transferred out 219,600
W/P ending: Direct material 41,400 600*69
Conversion cost 18,000 300*60
Total W/P ending 59,400
Total cost accounted for 279,000

Journal entries
 W/P mixing department------------69,000
A/P------------------------------------------69,000
 W/P mixing department-----------------70,800
Various accounts-----------------------------------------70,800
 W/P bottling department-----------------219,600
W/P mixing department --------------------------------219,600
Transferred-in Costs in Process Costing
Transferred-in costs also called previous department costs are the costs incurred in a previous department that
are carried forward as the product’s cost when it moves to a subsequent process in the production cycle. That

28
 is as the units move from one department to the next, their costs are transferred with them. Transferred in
costs are treated as if they are a separate type of direct material added at the beginning of the process. In other
words, when successive departments are involved, transferred units from one department become all or a part
of the direct materials of the next department; however they are called transferred-in costs, not direct material
costs.
Assume the following data for Haron Chemicals during the month of November in the Bottling
department
In the Bottling Department, where the product is bottled, labeled, and placed in cartons, costs are
accumulated in the two cost pools (materials and conversion) as that of the Mixing Department plus
a transferred-in cost pool. However, direct material is added at the end of the process and
conversion costs are incurred evenly through-out the process.
Physical units Transferred in costs Direct material costs Conversion costs
Beginning work in process 1,200 units 100% complete 0% complete 75% complete
Transferred-in during the month 1,600 units
Completed during the month 2,000 units
Ending work in process 800 units 100% complete 0% complete 50% complete

Costs incurred
Beginning work in process:
Transferred in costs (1,200 x Br. 170) Br. 204,000
Direct material costs 0
Conversion costs 90,000

Transferred in during the month:

Weighted average 216,000
First-in, first-out 219,600

Direct material costs incurred during the month 60,000

Conversion costs incurred during the month 150,000

Transferred-in Costs and Weighted average method

Step-1 Step-2 Equivalent units
Flow of production Physical units Transferred-in costs Direct Material Conversion costs
Beginning work in process 1,200
Transferred in during the month 1,600
Total units to Account for 2,800
Completed during the month 2,000 2,000 2,000 2,000
Work in process ending 800 800 0 400
Total units accounted for 2,800
Work done to date 2,800 2,000 2,400

Production cost report Total production cost Transferred-in costs Direct material cost Conversion cost
Beginning W/P Br294,000 204,000 0 Br. 90,000

29
 Current period cost 426,000 216,000 60,000 150,000
Cost incurred to date 420,000 60,000 240,000
Equivalent units 2,800 2,0 00 2,400
Equivalent unit cost (Step-3) 150 30 100
Total cost to account for(st-4) 720,000
Assignment of cost (step-5)
Completed& transferred out 560,000 2000*150 2,000*30 2,000*100
W/P ending: Transferred-in 120,00 800*150
Direct material 0 0*30
Conversion cost 40,000 400*100
Total W/P ending 160,000
Total cost accounted for 720,000

Journal entries
 W/P bottling department------------60,000
A/P------------------------------------------60,000
 W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
 Finished goods-----------------560,00
W/P Bottling department --------------------------------560,000
Transferred-in Costs and FIFO method
Step-1 Step-2 Equivalent units

Flow of production Physical units Transferred-in costs Direct Material Conversion costs
Beginning work in process 1,200
Transferred-in during the month 1,600
Total units to Account for 2,800
Completed during the month
From beginning 1,200 0 1,200 300
Transferred-in and completed 800 800 800 800
Work in process ending 800 800 0 400
Total units accounted for 2,200
Work done only current period 1,600 2,000 1,500

Production cost report Total production cost Transferred-in costs Direct material cost Conversion cost
Beginning W/P Br294,000 Br204,000 Br. 0 Br. 90,000
Current period cost 429,600 219,600 60,000 150,000
Work done only current period 1,600 2,000 1,500
Equivalent unit cost (Step-3) 137..25 30 100
Total cost to account for(st-4) 723,600
Assignment of cost (step-5)

30
 Completed:
From the beginning WIP:
Cost in the beginning WIP 294,000

Cost to complete these units:

Transferred-in costs 0 0*137.25

Direct Materials 36,000 1,200*30

Conversion costs 30,000 300*100

Total cost from beginning 360,000

Started and completed 213,800 800*137.25 800*30 800*100

Total Completed& transferred out 573,800
W/P ending: Transferred-in 109,800 800*137.25
Direct material 0 0*30
Conversion cost 40,000 400*100
Total W/P ending 149,800
Total cost accounted for 723,600

Journal entries
 W/P bottling department------------60,000
A/P------------------------------------------60,000
 W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
 Finished goods-----------------573,80
W/P Bottling department --------------------------------573,800

Process Costing and Spoilage

A key issue in accounting for spoilage in process-costing systems is how to count spoiled units. Units of
abnormal spoilage should be counted and recorded separately. But what units of abnormal spoilage should be
counted and recoded? Theses units can either be counted (Approach A) or not counted (Approach B).
Approach A leads to more accurate product costs because it makes visible the costs associated with normal
spoilage and spreads it over good units. Approach B is less accurate because it spreads the costs of normal
spoilage over all units.

Inspection Points and Allocating Costs of Normal Spoilage

Most illustrations in this material assume inspection upon completion. Spoilage might actually occur at
various stages of the production cycle, but it typically detected only at one or more specific inspection points.

31
An inspection point is the stage of the production cycle where products are checked to determine whether
they are acceptable or unacceptable units. The cost of spoiled units is assumed to be all costs incurred by
spoiled units prior to inspection. When spoiled units have a disposal value, the net cost spoilage is computed
by deducting disposal value from the costs of the spoiled goods accumulated to the inspection point

Illustration
A company manufactures a wooden recycling container in its formatting department. Direct material for this
product is added at the start of the process and conversion costs are added evenly through out the process.
Some units of the product are spoiled as a result of defects which are detectable only up on the inspection of
finished units. Normally, spoiled units are 10% of good units completed.
The following data relate to the company for July, 2008
Physical units:
W/P-Beginning (60% complete as conversion costs) -----------------------------1,500 units
Started during July----------------------------------------------------------------------8,500
Completed and transferred out--------------------------------------------------------7,000
W/P-Ending (50% complete as conversion costs) --------------------------------2,000
Total cost for July:
W/P Beginning
Direct material-----------------------------------$12,000
Conversion costs-----------------------------------9,000
Direct material costs added in July--------------------76,500
Conversion costs added in July------------------------89,100
Note: Total spoilage= Beginning W/P Started in July-(Completed Ending W/P)
=1,500+8,500-(7,000+2,000) =1,000
Normal spoilage=10%*7,000=700
Abnormal spoilage=1,000-700=300
The cost of fully and partially completed units can be computed using the usual 5 step procedure.
A. Weighted average method of process costing with spoilage
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 1,500
Started during the month 8,500
Total units to Account for 10,000
Good units completed 7,000 7,000 7,000
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
32
 Total units accounted for 10,000
Work done to date 10,000 9000

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br21,000 Br. 12,000 Br.9,000
Current period cost 165,600 76,000 89,100
Cost incurred to date 85,500 98,100
Equivalent units 10,000 9,000
Equivalent unit cost (Step-3) 8.85 10.9
Total cost to account for(st-4) 186,800
Assignment of cost (step-5)
Good units Completed& trans
Cost before Normal spoilage 138,250 7,000*8.85 7,000*10.9
Normal spoilage 13,825 700*8.85 800*10.9
Total cost of good units 152,075
Abnormal spoilage 5,925 300*8.85 300*10.9
W/P ending: Direct material 17,700 2,000*8.85
Conversion cost 10,900 1,0000*60
Total W/P ending 28,600
Total cost accounted for 186,800

Journal entries: To record normal and abnormal spoilage

 Finished goods--------------------------152,075
Work in process-----------------------------------------152,075
 Loss from abnormal spoilage-----------------5,925
Work in process----------------------------------------5,925

B. FIFO method of process costing with spoilage

Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 1,500
Started during the month 8,500
Total units to Account for 10,000
Completed during the month
From beginning 1,500 0 600
Started and completed 5,500 5,500 5,500
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Total units accounted for 10,000

33
 Work done only current period 8,500 8,180

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br21,000 Br. 12,000 Br. 9,000
Current period cost 165,600 76,500 89,100
Work done only current period 8,500 8,100
Equivalent unit cost (Step-3) 9 11
Total cost to account for(st-4) 186,800
Assignment of cost (step-5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 21,000

Cost to complete these units:

Direct Materials 0 0*9

Conversion costs 6,600 600*11

Total cost from beginning 27,700

Started and completed 110,000 5,500*9 5,500*11

Normal spoilage 14,000 700*9 700*11
Total cost of good units 151,600
Abnormal spoilage 6,000 300*9 300*11
W/P ending: Direct material 18,000 2000*9
Conversion cost 11,000 1,000*11
Total W/P ending 29,000
Total cost accounted for 186,600

Journal entries:
To record normal and abnormal spoilage
 Finished goods--------------------------151,600
Work in process-----------------------------------------151,600
 Loss from abnormal spoilage-----------------6,000
Work in process----------------------------------------6,000
Inspection and Spoilage at Intermediate Stage of Completion in process Costing
In some cases inspection may take place not on finished goods but at various stage of production. In this case,
spoilage is computed on only those units passing the inspection point.

Example: The following data relate to ZAK Company for a given month
W/P-Beginning-----------------11,000(25% complete as to conversion costs)
Started this period--------------74,000
Good units completed----------61,000
34
W/P-Ending----------------------16,000
Total spoilage---------------------8,000
Additional information
 Normal spoilage is 10% of good units passing inspection
 Direct material is added at the beginning of the process and conversion cost is added evenly through
out the process
 Inspection occurs at 20%, 50% and 100%
See the following:
Flow of production 20% 50& 100%
Beginning work in process 11,000 11,000 11,000
Started during the month 74,000 74,000 74,000
Total units to Account for 85,000 85,000 85,000
Good units completed 61,000 61,000 61,000
Normal spoilage 6,600 7,700 6,100
Abnormal spoilage 1,400 300 1,900
Work in process ending 16,000 16,000 16,000
Note: 6,600=10 %( 74,000-8,000); because W/P-beginning is already inspected
7,700=10 %( 85,000-8,000); because all units passed inspection this period
6,100=10 %( 61,000)
Physical units and equivalent units for the company can be computed as follows if inspection takes
place at 50% of completion
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 11,000
Started during the month 74,000
Total units to Account for 85,000
Good units Completed 61,000 61,000 61,000
Normal spoilage 7,700 7,700 3,850(.5*7,700)
Abnormal spoilage 300 300 150
Work in process ending 16,000 16,000 12,000
Total units accounted for 85,000
Work done to date 85,000 77,000

35