ACT503 Chap.4 Job Costing and Overhead Application
Job Costing and Overhead Application
Two systems at opposite ends of one question
A process costing system has masses of identical or similar units as its cost object, so the unit cost is total cost divided by units. A job costing system has a job as its cost object, and because each job consumes different amounts of resource an average would mislead, so a separate record is kept for every job.
Five terms are named as the building blocks of costing system design, and two of them carry the design choices: a cost pool is a bucket holding several separate indirect costs, and a cost allocation base is the systematic link between an indirect cost and the cost objects.
How many pools to open, and what base to attach to each, is the decision that separates this chapter from the activity based system later in the course.
Actual and normal costing differ in exactly one place
Both allocate direct costs identically, at actual rates multiplied by actual consumption.
The difference is the indirect rate: actual costing uses an actual indirect cost rate, while normal costing uses a budgeted rate multiplied by actual consumption. An actual rate can only be computed once the period closes, and managers need a job cost before then for six reasons the course lists, from pricing the job to preparing interim financial statements.
The seven step approach then runs from identifying the job to computing its total cost, and the two multiplications inside it take their inputs from different places: the rate is budgeted over budgeted, and the allocation is that budgeted rate multiplied by actual base activity.
Two overhead accounts, and three ways to clear the difference
Manufacturing overhead control is debited with the actual indirect costs incurred; manufacturing overhead allocated is credited with the amounts applied at the budgeted rate.
If actual exceeds allocated, overhead is underallocated and the year end adjustment increases cost of goods sold; if actual is less, it is overallocated and the adjustment decreases it.
Three disposal methods exist and they produce different closing balances on identical facts: recomputing every allocation at the actual rate, prorating the difference across work in process, finished goods and cost of goods sold, or writing the whole amount off. The choice is made on what the adjustment is for, how big the difference is, and whether the accuracy is worth the work.
What this chapter covers
- 01
Job costing against process costing, decided by the output
- 02
Cost pool and cost allocation base as design choices
- 03
Actual costing against normal costing
- 04
Six reasons a manager cannot wait for an actual rate
- 05
The seven step approach under normal costing
- 06
Budgeted rate and allocated overhead, two different multiplications
- 07
Overhead control against overhead allocated
- 08
Underallocated and overallocated, and what each does to cost of goods sold
- 09
Three disposal methods and the criteria for choosing
One rate, one job, and the year end position
- 2The budgeted overhead rate, from budgeted over budgeted.
- 3Overhead allocated to the job, and the job's total cost.
- 3Total overhead applied for the year against actual, with the direction named.
Key terms
- Cost Pool
- A bucket into which several separate indirect costs are put together so that one apportionment serves for all of them. The number of pools a system opens is the first design decision, and it is what separates a simple costing system from a refined one.
- Cost Allocation Base
- A systematic way of linking an indirect cost, or a group of them, to cost objects. Labour hours, machine hours and labour cost are common choices, and the base should be the driver that causes the pool to grow.
- Normal Costing
- A method that allocates indirect costs at a budgeted rate multiplied by the actual quantity of the allocation base consumed. Direct costs are allocated exactly as under actual costing, so the indirect rate is the only difference between the two methods.
- Underallocated Overhead
- The amount by which actual manufacturing overhead exceeds the overhead applied to production during the period. Costs were understated during the year, so the year end adjustment increases cost of goods sold.
- Proration
- A disposal method that spreads the year end overhead difference across work in process, finished goods and cost of goods sold in proportion to their relative size, either on their ending balances or on the overhead allocated inside those balances.
- Predetermined Overhead Rate
- Another name for the budgeted indirect cost rate, computed before the period from budgeted overhead divided by the budgeted quantity of the allocation base. It exists so that a job cost is available before the period closes.
Job Costing and Overhead Application FAQ
Why use a rate that is known in advance to be wrong?
Because an actual indirect cost rate cannot be computed until actual overhead and actual activity are both known, which is after the period ends. Managers need a job cost before then to price the job, monitor and manage its costs, evaluate whether it succeeded, learn from it, bid on new work and prepare interim statements. A budgeted rate buys all six at the price of one year end adjustment.
Which quantity goes into the rate and which into the allocation?
The rate divides budgeted overhead by the budgeted quantity of the base, so both inputs are budgeted. The allocation multiplies that budgeted rate by the actual quantity of the base a job consumed, so one input is budgeted and the other actual. Using the budgeted quantity in the second step recreates budgeted overhead and produces a variance of zero every time.
Do the three disposal methods give the same answer?
No, and that is why a question asks for more than one. On identical facts they leave different closing balances in work in process, finished goods and cost of goods sold. Prorating on ending balances weights by totals that also contain materials and labour, while prorating on allocated overhead weights only by the component that actually carried the wrong rate.
What does the argued part of an overhead disposal question want?
A preference with a reason drawn from accuracy and from purpose. Prorating on the overhead allocated inside each balance charges every account in proportion to the overhead actually put there, which is the strongest accuracy argument. Writing the whole amount off is defensible when the difference is immaterial, and the published criteria are what the adjustment is for, how big it is, and whether the accuracy is worth the work.
Exam move
Take one job through the seven steps on paper without looking at the list, then check which step you skipped. Almost everybody skips the fourth, deciding what actually goes into the pool, because it looks like bookkeeping rather than a decision.
Then reconcile the sum of overhead allocated across several jobs against the budgeted rate times total actual hours; if the two disagree, one job carries the wrong rate or the wrong base quantity.
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