Module 2 - Lists Job Order Costing — Cost Flows

The most common way to eliminate overapplied and underapplied manufacturing overhead is to record the amount to cost of goods sold. What is an alternative way to eliminate these overapplications or underapplications of manufacturing overhead?

Allocate overapplied or underapplied manufacturing overhead to work-in-process inventory, finished goods inventory, and cost of goods sold on the basis of ending balances in these accounts Correct! Because the rate applied was too high or too low and the products being manufactured are at different stages (some are still being worked on, some are finished but not sold, and some are sold), if the cost of goods sold approach (which is an approximation) is not used, the misapplication would have to be correctly allocated to work-in-process inventory, finished goods inventory, and cost of goods sold based on ending balances for the period.

There are two methods of treating overapplied and underapplied manufacturing overhead in the accounting system:

Close overapplied or underapplied manufacturing overhead directly to cost of goods sold. Allocate overapplied or underapplied manufacturing overhead to work-in-process inventory, finished goods inventory, and costs of goods sold on the basis of the ending balances in these three accounts.

The work-in-process inventory account symbolically represents

the factory itself

As furniture is completed and moved off of the factory floor and into the finished goods warehouse, the materials, labor, and overhead costs of that product are moved out of work-in-process inventory and into

the finished goods inventory account.

Applied manufacturing overhead is directly recorded as a credit to which account?

?

When manufacturing overhead is underapplied, which entry is included in closing the manufacturing overhead account?

A debit to cost of goods sold Correct! Debit cost of goods sold; credit manufacturing overhead.

What is the manufacturing overhead rate that is applied to work-in-process during the manufacturing of products?

An estimate of what the total overhead will be for the product being made based on some allocation method such as machine hours or direct labor hours Correct! Applied overhead is an estimate of the overhead that will be incurred for each unit. Differences between actual and applied overhead will be dealt with later.

How are actual manufacturing overhead costs incurred throughout the year journalized?

As debits into the manufacturing overhead account Correct! As actual manufacturing overhead costs are incurred, they are entered as debits into the manufacturing overhead account.

Because manufacturing overhead costs generally do not coincide with the flow of production, a few extra steps are required to handle the accounting. These steps are:

Before the year begins, budget the estimated manufacturing overhead, estimate the allocation activity, and establish the predetermined overhead rate. During the year, as costs are incurred, record actual manufacturing overhead as debits to the manufacturing overhead account. During the year, as activity takes place, record applied manufacturing overhead as credits to the manufacturing overhead account and debits to the work-in-process account. At the end of the year, compare actual and applied overhead balances and close out the difference (i.e., the overapplied or underapplied overhead) in the manufacturing overhead account.

Lesson 6: Applied versus Actual Manufacturing Overhead

Compare applied manufacturing overhead to actual manufacturing overhead, and properly dispose of any difference to COGS.

It is important to understand that the debit side of the manufacturing overhead account is used to record actual overhead expenses.

Conversely, the credit side of this account is used to record applied manufacturing overhead that is simultaneously debited to the work-in-process inventory account

Which journal entry is used to record payment of factory rent in cash

Correct! Debit manufacturing overhead; credit cash. This is the case because factory rent is a manufacturing overhead expense.

What is the order of the steps followed in accounting for manufacturing overhead costs?

Correct! The correct sequence is the following: Before the year begins, budget the estimated manufacturing overhead, estimate the allocation activity, and establish the predetermined overhead rate. During the year, as costs are incurred, record actual manufacturing overhead as debits to the manufacturing overhead account. During the year, as activity takes place, record applied manufacturing overhead as credits to the manufacturing overhead account and debits to the work-in-process account. At the end of the period, compare actual and applied overhead balances and close out of the difference.

The same is true for other costs, such as depreciation and rent. If these costs relate to manufacturing, they are debited to manufacturing overhead.

Costs not related to manufacturing are debited to depreciation expense, rent expense, and so forth. The manufacturing costs will eventually become expenses when the products are sold (cost of goods sold).

The Flow of Product Costs

Credit: Manufacturing overhead, Salaries & Wages payable, and raw materials inventory. Debit: Work-in-process inventory (Cost of goods manufactured) Credit: Finished Goods Inventory Debit: Finished Goods Inventory (cost of goods sold) Credit: Cost of Goods Sold

Closing JE for UNDER-applied manufacturing overhead account

Debit - COGS Credit - Manufacturing Overhead

Closing JE for OVER -applied manufacturing overhead account

Debit - Manufacturing Overhead Credit - COGS

The purchase of raw materials on open account is recorded by which journal entry?

Debit raw materials inventory; credit accounts payable.

An overapplication of manufacturing overhead would be corrected by which entry?

Debiting manufacturing overhead and crediting cost of goods sold Correct! Overapplications of manufacturing overhead are corrected by debiting manufacturing overhead and crediting cost of goods sold.

Job Costs are

Direct Materials Direct Labor Manufacturing Overhead

Credits are used to record the flow of costs out of inventory.

For example, a credit to raw materials records the introduction of raw materials into the production process; a credit to work-in-process inventory records the outshipment of completed goods from the production facility to finished goods; and a credit to finished goods inventory represents the delivery of goods to a customer.

Debits record the flow of costs into a particular inventory.

For example, a debit to raw materials records the purchase of raw materials; a debit to work-in-process inventory records the inflow of materials, labor, and overhead costs; and a debit to finished goods inventory records the transfer of completed goods.

Lesson 5: Predetermined Overhead Rate

Learning Objective - Calculate predetermined overhead rate to apply to jobs.

At the end of an accounting period, the manufacturing overhead account has debits totaling $25,000 and credits totaling $28,000. In this case, which statement is true?

Manufacturing overhead is overapplied by $3,000. Correct! Because the manufacturing overhead account is credited when overhead is applied and because credits are $3,000 more than debits (which represent actual manufacturing overhead costs incurred), manufacturing overhead has been overapplied by $3,000.

What would least likely be assigned to manufacturing overhead?

Materials that are a key component to making manufactured goods Correct! Materials that are a key component would always be assigned to products as direct materials.

Most accounting systems that track product costs are based on a few key procedures: (Job Order Costing)

Step 1. Identify the product or project that needs cost measurement and track this project through the production process Step 2. Specifically trace the direct costs (costs of direct materials and direct labor) to each product or project. Step 3. Allocate an appropriate amount of overhead costs to each product or project.

The account for Manufacturing Overhead is a

Temporary Holding Tank(Debit)

In using a job order costing system, the cost accountant for Paradigm Toys made an entry debiting work-in-process inventory and crediting salaries and wages payable. What was the purpose of this entry?

To assign direct labor costs to the products being manufactured Correct! Work-in-process inventory is debited and salaries and wages payable is credited when direct labor costs are assigned to the products being manufactured.

1 / 1 The cost accountant for Bullzai, Inc., made a journal entry debiting manufacturing overhead and crediting salaries and wages payable. What was the purpose of the entry?

To record indirect labor costs to manufacturing overhead Correct! Debiting manufacturing overhead, credit salaries, and wages payable would be made when recording indirect labor costs; for example, factory supervisors, custodians, and maintenance people; to manufacturing overhead.

Smartistry Company uses a job order costing system and closes all underapplied and overapplied manufacturing overhead to cost of goods sold. The company accountant made the following entry at the end of the accounting period: debit to cost of goods sold and credit to manufacturing overhead

To record underapplied manufacturing overhead Correct! When cost of goods sold is debited and manufacturing overhead is credited, the purpose of the entry is to record the underapplication of overhead.

By definition, most manufacturing overhead costs benefit all products made in

a department or a company during a period.

Hence, manufacturing overhead is a very important account to help deal with the fact that actual costs, including actual manufacturing overhead costs, are needed for

accurate reporting of annual income and for computing a company's income tax liability at the end of the year.

Generally speaking, debits are used to record the flow of costs into a particular inventory,

and credits are used to record the flow of costs out of inventory

Generally speaking, debits are used to record the flow of costs into a particular inventory

and credits are used to record the flow of costs out of inventory.

Because the application process is based on the predetermined overhead rate, computed using budgeted data, it is highly unlikely that actual overhead costs will equal

applied overhead costs.

Accounting for the flow of direct materials and direct labor costs is pretty straightforward. Accounting for manufacturing overhead costs is complicated, however, by the fact that overhead costs must

be applied to products starting on the first day of the period

Nevertheless, the manufacturing overhead account is a temporary account that must be

closed out at the end of the year.

Applied (or assigned) overhead costs are removed from the overhead account with a

credit (and added into the production costs accumulated in work-in-process inventory).

Actual manufacturing overhead costs are recorded as

debits to the manufacturing overhead account.

Different Job Costs

direct materials, direct labor, and manufacturing overhead costs

Then, for manufacturing personnel, it must be determined whether the individuals worked

directly on the product (work-in-process inventory) or indirectly on the product (manufacturing overhead).

The predetermined overhead rate is created by

dividing estimated manufacturing overhead by the estimate of the expected level of activity (e.g., direct labor hours) to be used to allocate overhead during the year.

It is critical that you understand the differences among the three different classifications of manufacturing overhead costs outlined above:

estimated, actual, and applied.

Different budgeted activity measures

example: direct labor hours or machine hours

As goods are completed, the costs are then credited out of the work-in-process inventory account and debited into the

finished goods inventory account where they remain until the goods are sold.

Manufacturing overhead consists of numerous expenditures, such as

indirect labor, indirect materials, utilities, rent, and the like. The sum of these various expenditures provides the balance in the manufacturing overhead account.

In accounting terminology, manufacturing overhead costs are applied to (or absorbed by)

jobs or products.

Indirect labor costs include the wages of employees who perform functions not related to a specific job, such as

maintenance and custodial.

Do not make the mistake of debiting manufacturing overhead costs to an expense account. Although these costs eventually do become an expense, first they are debited to

manufacturing overhead, then allocated to work-in-process inventory, then transferred to finished goods inventory, and finally expensed in cost of goods sold

Do not make the mistake of debiting manufacturing overhead costs to an expense account. Although these costs eventually do become an expense, first they are debited to

manufacturing overhead, then allocated to work-in-process inventory, then transferred to finished goods inventory, and finally expensed in cost of goods sold.

In contrast to direct materials and direct labor, manufacturing overhead (the third type of product cost) involves

more complex accounting procedures and estimation problems

Consider the manufacturing overhead account to be simply a temporary holding tank for

overhead costs that you do not immediately know how to assign to production.

As a result, a predetermined overhead rate is used to systematically apply

overhead to the products in work-in-process inventory

Once completed, cost data for jobs are used in

pricing similar jobs, estimating costs for the next year, and measuring income.

Journal entries symbolically represent the flow of costs through a

production process

The same debits and credits used to generate the external financial statements are also used to carefully track the flow of costs from

raw materials inventory, to work-in-process inventory, to finished goods inventory, and finally to cost of goods sold.

You should also note that at the end of the period, the company will usually have three inventory balances:

raw materials inventory, work-in-process inventory, and finished goods inventory.

The same debits and credits used to generate the external financial statements are also used to carefully track the flow of costs from

raw materials inventory, to work-in-process inventory, to finished goods inventory, and finally to cost of goods sold.

Manufacturing overhead account is a

temporary account.

Finally, as furniture is sold to customers, the costs of those goods are moved out of the finished goods inventory account and into

the cost of goods sold account.

As employees work directly on Broyman's products, their labor costs are recognized in

the work-in-process inventory account.

As raw materials move onto the factory floor, costs move out of the raw materials inventory account and into

the work-in-process inventory account.

However, the management process of controlling and evaluating costs and prices cannot wait until the end of the year. Hence, while both actual and applied manufacturing overhead costs are accounted for constantly throughout the year, actual overhead costs are

too sporadic to be effectively used as prices, and costs are constantly evaluated throughout the year. This is why predetermined overhead rates are used to apply overhead evenly throughout the year.

For the manufacturing overhead account, debits are used to record actual overhead costs,

while credits represent the systematic allocation of overhead costs to products in work-in-process inventory.

The centerpiece of all the debits and credits in these journal entries is the

work-in-process inventory account

The "action" in a product costing system (whether job order costing or process costing is used) centers around the

work-in-process inventory account, which is a symbolic representation of the factory.

Actual manufacturing overhead costs, on the other hand, are entered first as debits to manufacturing overhead and then are allocated to

work-in-process inventory by crediting manufacturing overhead.

as you saw in tracking production costs for Broyman's mahogany table, when the wages are related to manufacturing, the debit is to

work-in-process inventory for direct labor and to manufacturing overhead for indirect labor. Thus, in management accounting, it is important to first determine whether salaries are for manufacturing or for nonmanufacturing personnel.

As the manufacturing process goes forward, the indirect costs related to manufacturing overhead are allocated to

work-in-process inventory.

Manufacturing overhead is effectively a temporary holding account that simultaneously records actualoverhead costs as they occur irregularly throughout the year while regularly transferring allocated overhead costs into the asset account called

work-in-process inventory.

Note that direct labor, when incurred, and direct materials, when used, are debited directly to

work-in-process inventory.