Cost Accounting — Job Costing: Job Cost Sheets and Predetermined Overhead Rates

When every product has different specifications — custom furniture, ships, consulting projects — costs must be accumulated by job. That is job costing. Direct materials and direct labor are traced straight to the job, but manufacturing overhead must be allocated. The key question in this chapter is when, and on what basis, indirect costs are allocated. Process costing for homogeneous products is covered in chapter 4.

1. The job cost sheet

A job cost sheet is kept for each job, recording the direct materials and direct labor used on it and the manufacturing overhead applied to it. The total of the cost sheets for unfinished jobs is work in process; completed but unsold jobs are finished goods; and delivered jobs become cost of sales.

2. Why use a predetermined rate

Allocating manufacturing overhead at actual amounts causes two problems.

Timeliness: actual overhead is only known at the end of the period. Until then, the cost of jobs already finished, and the prices to quote, cannot be known.
Volatility: overhead varies with the season, such as winter heating, and in low-output months fixed costs fall on fewer jobs, making unit costs jump.

So a predetermined overhead rate is set at the start of the year and multiplied by the actual activity.

Predetermined rate and applied overhead

\begin{aligned}\text{Predetermined rate} &= \frac{\text{Budgeted annual manufacturing overhead}}{\text{Budgeted annual activity}} \\ \text{Applied overhead} &= \text{Actual activity of the job} \times \text{Predetermined rate}\end{aligned}

Choose an activity base with a causal link to the costs (direct labor hours, machine hours and so on).

3. Worked example

Company PP applies overhead on direct labor hours. Budgeted annual manufacturing overhead is ₩100 million and budgeted direct labor hours are 5,000, so the predetermined rate is ₩20,000 per hour.

Cost by job (unit: ₩10,000)
Job	Direct materials	Direct labor	Direct labor hours	Overhead applied	Total	Status
#101	1,200	900	1,500	3,000	5,100	Sold
#102	800	1,000	2,000	4,000	5,800	Sold
#103	600	500	800	1,600	2,700	Completed, unsold
#104	300	400	500	1,000	1,700	Unfinished
Total	2,900	2,800	4,800	9,600	15,300

Actual direct labor hours were 4,800, so applied overhead is ₩96 million. If actual manufacturing overhead is ₩100 million, overhead is underapplied by ₩4 million — costs were higher, or activity lower, than planned.

4. Disposing of the variance

Disposing of ₩4 million of underapplied overhead (unit: ₩10,000)
Method	Work in process (#104)	Finished goods (#103)	Cost of sales (#101, #102)
Write-off to cost of sales	0	0	+400
Proration on total cost	400 × 1,700/15,300 ≈ 44	400 × 2,700/15,300 ≈ 71	400 × 10,900/15,300 ≈ 285
Proration on overhead applied	400 × 1,000/9,600 ≈ 42	400 × 1,600/9,600 ≈ 67	400 × 7,000/9,600 ≈ 292

Write-off to cost of sales: add the whole variance to cost of sales. Simple, and used when the variance is small.
Proration: split it in proportion to the balances of work in process, finished goods and cost of sales, or to the overhead applied within them. This gives inventory amounts closer to actual cost. If the variance is material, proration is appropriate for financial reporting.
Non-operating treatment: a variance from abnormal causes (strikes, disasters) is not included in cost but recognized as a loss.

Overapplied overhead is deducted in the same ways.

Check your understanding

Company QQ uses a predetermined rate based on machine hours. Budgeted annual manufacturing overhead is ₩36 million and budgeted machine hours 12,000. Actual machine hours were 11,000 and actual manufacturing overhead ₩34.5 million. What is the overhead variance, and is it under- or overapplied? If overhead applied in closing work in process, finished goods and cost of sales is ₩3.3 million, ₩6.6 million and ₩23.1 million respectively, by how much is cost of sales adjusted under proration on overhead applied?

The predetermined rate is ₩3,000 per hour and applied overhead is $11{,}000 \times 3{,}000$ won, i.e. ₩33 million. That is ₩1.5 million less than the actual ₩34.5 million, so overhead is underapplied. Cost of sales accounts for 70% of the ₩33 million applied, so cost of sales increases by $150 \times 70\% = 105$ , i.e. ₩1.05 million. Work in process increases by ₩150,000 and finished goods by ₩300,000.

References

Charles Horngren, Srikant Datar and Madhav Rajan, Cost Accounting: A Managerial Emphasis, ch. 4
Ray Garrison, Eric Noreen and Peter Brewer, Managerial Accounting, ch. 2–3
Korea Accounting Standards Board, K-IFRS 1002 Inventories (allocation of fixed production overheads)