Key Takeaways
- Job-order costing traces costs to specific jobs or batches; used for custom/unique products.
- Process costing averages costs across homogeneous units; used for mass production.
- Equivalent units measure the work done on partially completed units.
- FIFO method separates beginning inventory costs from current period costs.
- Weighted average method combines beginning inventory and current period costs.
Job-Order and Process Costing
Quick Answer: Job-order costing assigns costs to specific jobs/batches for custom products. Process costing averages costs across equivalent units for mass production. FIFO separates beginning inventory from current costs; weighted average combines them. Equivalent units convert partial work into full-unit equivalents.
The choice between job-order and process costing depends on the nature of production. Custom products use job costing; homogeneous mass production uses process costing.
Job-Order Costing System
Job-order costing is used when products are distinct and identifiable—each job can be separately tracked.
When to Use Job-Order Costing
| Industry | Examples |
|---|---|
| Construction | Building projects, custom homes |
| Manufacturing | Custom machinery, special orders |
| Professional Services | Accounting engagements, legal cases |
| Printing | Custom print jobs, specialized publications |
| Healthcare | Individual patient treatments |
Job Cost Sheet
Each job has a job cost sheet that accumulates:
| Cost Component | How Tracked |
|---|---|
| Direct Materials | Materials requisition forms |
| Direct Labor | Time tickets/labor cards |
| Manufacturing Overhead | Predetermined overhead rate |
Predetermined Overhead Rate (POHR)
Since actual overhead isn't known until period-end, manufacturers use a predetermined overhead rate calculated at the beginning of the year:
Formula:
POHR = Estimated Total MOH ÷ Estimated Total Allocation Base
Common Allocation Bases:
- Direct labor hours
- Direct labor cost
- Machine hours
- Direct materials cost
Example:
Estimated MOH = \$500,000
Estimated DL Hours = 25,000 hours
POHR = \$500,000 ÷ 25,000 = \$20 per DL hour
Applied vs. Actual Overhead
| Term | Definition |
|---|---|
| Applied Overhead | POHR × Actual allocation base |
| Actual Overhead | Real overhead costs incurred |
| Overapplied | Applied > Actual (credit balance) |
| Underapplied | Applied < Actual (debit balance) |
Disposing of Over/Underapplied Overhead:
- Close to COGS (most common, if immaterial)
- Prorate to WIP, FG, and COGS (if material)
Job Costing Example
| Job #101 | Amount |
|---|---|
| Direct Materials | $5,000 |
| Direct Labor (100 hrs × $25) | $2,500 |
| Applied Overhead (100 hrs × $20) | $2,000 |
| Total Job Cost | $9,500 |
Process Costing System
Process costing is used for homogeneous, mass-produced products where individual units are indistinguishable.
When to Use Process Costing
| Industry | Examples |
|---|---|
| Chemical | Paints, fertilizers, plastics |
| Food/Beverage | Soft drinks, canned goods |
| Petroleum | Gasoline, oil products |
| Paper | Newsprint, cardboard |
| Textiles | Fabric, thread |
Key Concepts in Process Costing
Equivalent Units (EU): Convert partially completed units to the equivalent number of completed units.
Equivalent Units = Physical Units × Percentage Complete
Example: 1,000 units that are 40% complete = 400 equivalent units
Process Costing Methods
| Method | Beginning WIP Treatment | When to Use |
|---|---|---|
| Weighted Average | Combined with current costs | Simpler, common practice |
| FIFO | Kept separate from current costs | More accurate, changing costs |
Weighted Average Method
The weighted average method combines beginning WIP costs with current period costs.
Steps for Weighted Average:
Step 1: Physical Flow of Units
Units to Account For = Beginning WIP + Units Started
Units Accounted For = Units Completed + Ending WIP
Step 2: Calculate Equivalent Units
EU = Units Completed + (Ending WIP × % Complete)
Step 3: Calculate Cost per Equivalent Unit
Cost per EU = (Beginning WIP Cost + Current Period Cost) ÷ Total EU
Step 4: Assign Costs
Cost of Completed Units = Units Completed × Cost per EU
Cost of Ending WIP = EU in Ending WIP × Cost per EU
Weighted Average Example
| Data | Materials | Conversion |
|---|---|---|
| Beginning WIP (2,000 units, 100% materials, 60% conversion) | ||
| Beginning WIP costs | $10,000 | $6,000 |
| Units started | 8,000 | |
| Current period costs | $40,000 | $54,000 |
| Units completed | 7,000 | |
| Ending WIP (3,000 units, 100% materials, 40% conversion) |
Equivalent Units (Weighted Average):
| Materials | Conversion | |
|---|---|---|
| Completed | 7,000 | 7,000 |
| Ending WIP | 3,000 × 100% = 3,000 | 3,000 × 40% = 1,200 |
| Total EU | 10,000 | 8,200 |
Cost per Equivalent Unit:
Materials: (\$10,000 + \$40,000) ÷ 10,000 = \$5.00 per EU
Conversion: (\$6,000 + \$54,000) ÷ 8,200 = \$7.317 per EU
FIFO Method
FIFO separates beginning WIP costs from current period costs, providing more accurate current-period cost information.
Steps for FIFO:
Step 1: Physical Flow (same as weighted average)
Step 2: Calculate Equivalent Units
EU = Work to complete Beginning WIP + Units Started and Completed + Ending WIP
Step 3: Calculate Cost per EU (current period only)
Cost per EU = Current Period Costs ÷ FIFO Equivalent Units
Step 4: Assign Costs
- Beginning WIP costs flow out first
- Current costs applied to remaining work
FIFO Example (Same Data)
Equivalent Units (FIFO):
| Materials | Conversion | |
|---|---|---|
| Complete Beginning WIP | 2,000 × 0% = 0 | 2,000 × 40% = 800 |
| Started and Completed | 5,000 | 5,000 |
| Ending WIP | 3,000 × 100% = 3,000 | 3,000 × 40% = 1,200 |
| Total EU | 8,000 | 7,000 |
Cost per Equivalent Unit (Current Period Only):
Materials: \$40,000 ÷ 8,000 = \$5.00 per EU
Conversion: \$54,000 ÷ 7,000 = \$7.714 per EU
Cost Reconciliation
A cost reconciliation verifies that total costs to account for equal total costs accounted for:
Costs to Account For = Beginning WIP + Current Period Costs
Costs Accounted For = Completed Units + Ending WIP
These amounts must balance—this is a critical check in process costing.
Comparing Job-Order and Process Costing
| Characteristic | Job-Order | Process |
|---|---|---|
| Product Type | Custom, unique | Homogeneous, mass |
| Cost Accumulation | By job | By department/process |
| Cost Object | Individual job | Equivalent units |
| Documents | Job cost sheets | Production reports |
| Industries | Construction, custom manufacturing | Chemicals, food, petroleum |
A company estimated manufacturing overhead of $600,000 and 40,000 direct labor hours for the year. If a job used 500 direct labor hours, what is the applied overhead for that job?
Using the weighted average method, if a department has 5,000 units completed and transferred out, and 2,000 units in ending work-in-process that are 70% complete for conversion costs, what are the equivalent units for conversion costs?
Which costing system would be most appropriate for a custom furniture manufacturer?
If actual manufacturing overhead is $450,000 and applied manufacturing overhead is $480,000, the overhead is: