Under absorption costing, product costs include all manufacturing costs. Some manufacturing costs, such as direct materials, can be directly traced to particular products. For example, the cost of the airbags installed in a Toyota Camry can be easily traced to that particular auto. But what about manufacturing costs like factory rent? Such costs do not change from month to month, whereas the number and variety of products made in the factory may vary dramatically from one month to the next. Because these costs remain unchanged from month to month regardless of what products are made, they are clearly not caused by—and cannot be directly traced to—any particular product. Therefore, these types of costs are assigned to products and services by averaging across time and across products. The type of production process influences how this averaging is done.
Job-order costing is used in situations where many different products, each with individual and unique features, are produced each period. For example, a Levi Strauss clothing factory would typically make many different types of jeans for both men and women during a month.
This is a custom product that is being made for the first time, but if this were one of the company’s standard products, it would have an established bill of materials. A bill of materials is a document that lists the type and quantity of each type of direct material needed to complete a unit of product.
The materials requisition form is a document that specifies the type and quantity of materials to be drawn from the storeroom and identifies the job that will be charged for the cost of the materials. The form is used to control the flow of materials into production and also for making entries in the accounting records.
A job cost sheet records the materials, labor, and manufacturing overhead costs charged to that job.
Measuring Direct Labor Cost
Direct labor consists of labor charges that can be easily traced to a particular job. Labor charges that cannot be easily traced directly to any job are treated as part of manufacturing overhead. As discussed in a previous chapter, this latter category of labor costs is called indirect labor and includes tasks such as maintenance, supervision, and cleanup.
Today many companies rely on computerized systems (rather than paper and pencil) to maintain employee time tickets. A completed time ticket is an hour-by-hour summary of the employee’s activities throughout the day. One computerized approach to creating time tickets uses bar codes to capture data.
Computing Predetermined Overhead Rates.
There are three reasons for this:
Manufacturing overhead is an indirect cost. This means that it is either impossible or difficult to trace these costs to a particular product or job.
Manufacturing overhead consists of many different types of cost ranging from the grease used in machines to the annual salary of the production manager. Some of these costs are variable overhead costs because they vary in direct proportion to changes in the level of production (e.g., indirect materials, supplies, and power) and some are fixed overhead costs because they remain constant as the level of production fluctuates (e.g., heat and light, property taxes, and insurance).Page 123
Because of the fixed costs in manufacturing overhead, total manufacturing overhead costs tend to remain relatively constant from one period to the next even though the number of units produced can fluctuate widely. Consequently, the average cost per unit will vary from one period to the next.
An allocation base is a measure such as direct labor-hours (DLH) or machine-hours (MH) that is used to assign overhead costs to products and services. The most widely used allocation bases in manufacturing are direct labor-hours, direct labor cost, machine-hours and (where a company has only a single product) units of product.
Job order costing, Direct cost, indirect cost, common cost, manufacturing overhead cost, indirect material, job cost sheet, job number, subsidiary ledger, material requisition form, bill of materials, time ticket, allocation base
predetermined overhead rate, cost driver, fixed overhead, variable overhead
Raw materials, work in process, finished goods, cost of goods manufactured, manufactured overhead cost
Cost of goods manufactured