General Approach to Job Costing Using Normal Costing

Learning Objective 4 Outline the seven-step approach to normal costing

• the seven-step approach is used to compute direct and indirect costs of a job

We illustrate normal costing for the Robinson Company example using the following seven steps to assign costs to an individual job. This approach is commonly used by companies in the manufacturing, merchandising, and service sectors.

1. Step 1: IDENTIFY THE JOB THAT IS THE CHOSEN COST OBJECT. The cost object in the Robinson Company example is Job WPP 298, manufacturing a paper-making machine for Western Pulp and Paper (WPP) in 2020. Robinson’s managers and management accountants gather information to cost jobs through source documents. A source document is an original record (such as a labor time card on which an employee’s work hours are recorded) that supports journal entries in an accounting system. The main source document for Job WPP 298 is a job-cost record. A job-cost record, also called a job-cost sheet, is used to record and accumulate all the costs assigned to a specific job, starting when work begins. Exhibit 4-2 shows the job-cost record for the paper-making machine ordered by WPP. Follow the various steps in costing Job WPP 298 on the job-cost record in Exhibit 4-2.

1.  Step 2: IDENTIFY THE DIRECT COSTS OF THE JOB. Robinson identifies two direct-manufacturing cost categories: direct materials and direct manufacturing labor. 
   1. • Direct materials: On the basis of the engineering specifications and drawings provided by WPP, a manufacturing engineer orders materials from the storeroom using a basic source document called a materials-requisition record, which contains information about the cost of direct materials used on a specific job and in a specific department. Exhibit 4-3, Panel A, shows a materials-requisition record for the Robinson Company. See how the record specifies the job for which the material is requested (WPP 298) and describes the material (Part Number MB 468-A, metal brackets), the actual quantity (8), the actual unit cost ($14), and the actual total cost ($112). The $112 actual total cost also appears on the job-cost record in Exhibit 4-2. If we add the cost of all materials requisitions, the total actual direct materials cost is $4,606, which is shown in the Direct Materials panel of the job-cost record in Exhibit 4-2.

1. • Direct manufacturing labor: Accounting for direct manufacturing labor is similar to accounting for direct materials. The source document for direct manufacturing labor is a labor-time sheet, which contains information about the amount of labor time used for a specific job in a specific department. Exhibit 4-3, Panel B, shows a typical weekly labor-time sheet for a particular employee (G. L. Cook). Each day Cook records the time spent on individual jobs (in this case WPP 298 and JL 256), as well as the time spent on other tasks, such as the maintenance of machines and cleaning, that are not related to a specific job.
2.  The 25 hours that Cook spent on Job WPP 298 appears on the job-cost record in Exhibit 4-2 at a cost of  $\$450\hspace{0.17em}(25\hspace{0.17em}\text{hours} \times \$18\hspace{0.17em}\text{per hour})$. Similarly, the job-cost record for Job JL 256 will show a cost of  $\$216\hspace{0.17em}(12\hspace{0.17em}\text{hours} \times \$18\hspace{0.17em}\text{per hour})$. The 3 hours of time spent on maintenance and cleaning at $18 per hour equals $54. This cost is part of indirect manufacturing costs because it is not traceable to any particular job. This indirect cost is included as part of the manufacturing-overhead cost pool allocated to jobs. The total direct manufacturing labor costs of $1,579 for the paper-making machine that appears in the Direct Manufacturing Labor panel of the job-cost record in Exhibit 4-2 is the sum of all the direct manufacturing labor costs charged by different employees for producing and installing Job WPP 298. 
3.  All costs other than direct materials and direct manufacturing labor are classified as indirect costs. 
4. Step 3: SELECT THE COST-ALLOCATION BASES TO USE FOR ALLOCATING INDIRECT COSTS TO THE JOB. Recall that indirect manufacturing costs are those costs that are necessary to do a job, but that cannot easily and unambiguously be traced to a specific job. It would be impossible to complete a job without incurring indirect costs such as supervision, manufacturing engineering, utilities, and machine depreciation and repairs. Moreover, different jobs require different quantities of indirect resources. Because these costs cannot be traced to a specific job, managers must allocate them to jobs in a systematic way.
5. Companies often use multiple cost-allocation bases to allocate indirect costs because different indirect costs have different cost drivers. For example, some indirect costs such as depreciation and repairs of machines are more closely related to machine-hours. Other indirect costs such as supervision and production support are more closely related to direct manufacturing labor-hours. Robinson, however, chooses direct manufacturing labor-hours as the sole allocation base for assigning all indirect manufacturing costs to jobs. The managers do so because, in Robinson’s labor-intensive environment, they believe the number of direct manufacturing labor-hours largely drives the manufacturing overhead resources required by individual jobs. (We will see in Chapter 5 that managers in many manufacturing environments often need to broaden the set of cost-allocation bases.) In 2020, Robinson budgets 28,000 direct manufacturing labor-hours.
6. Step 4: IDENTIFY THE INDIRECT COSTS ASSOCIATED WITH EACH COST-ALLOCATION BASE. Because Robinson believes that a single cost-allocation base—direct manufacturing labor-hours—can be used to allocate indirect manufacturing costs to jobs, Robinson creates a single cost pool called manufacturing overhead costs. This pool represents all indirect costs of the Manufacturing Department that are difficult to trace directly to individual jobs. In 2020, budgeted manufacturing overhead costs total $1,120,000.
7. As we can see in this step and Step 3 above, managers first identify cost-allocation bases and then identify the costs related to each cost-allocation base, not the other way around. They choose this order because the creation of cost pools (the number of cost pools, and the grouping of specific indirect cost items into certain cost pools) must be guided by an understanding of the companies’ cost drivers (the reasons why indirect costs are being incurred). Of course, Steps 3 and 4 are often done almost simultaneously.
8. Step 5: COMPUTE THE INDIRECT-COST RATE FOR EACH COST-ALLOCATION BASE. For each cost pool, the budgeted indirect-cost rate is calculated by dividing the budgeted total indirect costs in the pool (determined in Step 4) by the budgeted total quantity of the cost-allocation base (determined in Step 3). Robinson calculates the rate for its single cost-allocation base and manufacturing overhead cost pool as follows:

1. Step 6: COMPUTE THE INDIRECT COSTS ALLOCATED TO THE JOB. The indirect costs of a job are calculated by multiplying the actual quantity of each allocation base (one allocation base for each cost pool) associated with the job by the budgeted indirect cost rate of each allocation base (computed in Step 5). Recall that Robinson’s managers selected direct manufacturing labor-hours as the only cost-allocation base. Robinson uses 88 direct manufacturing labor-hours on the WPP 298 job. Consequently, the manufacturing overhead costs allocated to WPP 298 equal $\mathrm{\$}\text{3,520}\hspace{0.17em}(\mathrm{\$}40 \text{per\hspace{0.17em}direct\hspace{0.17em}manufacturing\hspace{0.17em}labor}‐\text{hour}\times 88\hspace{0.17em}\text{hours})$ and appear in the Manufacturing Overhead panel of the WPP 298 job-cost record in Exhibit 4-2.
2. Step 7: COMPUTE THE TOTAL COST OF THE JOB BY ADDING ALL DIRECT AND INDIRECT COSTS ASSIGNED TO THE JOB. Exhibit 4-2 shows that the total manufacturing costs of the WPP job are $9,705.

Recall that Robinson bid a price of $15,000 for the job. At that revenue, the normal-costing system shows that the job’s gross margin is $\text{\$}5\text{,}295\hspace{0.17em}(\text{\$}15\text{,}000-\text{\$}9\text{,}705)$ and its gross-margin percentage is $35.3\text{\%\hspace{0.05em}}(\text{\$}5\text{,}295÷\text{\$}15\text{,}000=0.353)$.

Robinson’s manufacturing and sales managers can use the gross margin and gross-margin percentage calculations to compare the profitability of different jobs. A job-cost analysis provides the information managers need to gauge the manufacturing and sales performance of their firms and to answer questions about why some jobs are not as profitable as others. Were direct materials wasted? Was the direct manufacturing labor cost of the job too high? Was the job simply underpriced? With the explosion in the availability of data and analytic tools, the ability of companies to use job costing to improve profitability has grown significantly (see Concepts in Action: Better Job Costing Through Big Data and Data Analytics).

Exhibit 4-4 is an overview of Robinson Company’s job-costing system. The exhibit illustrates the five building blocks of job-costing systems introduced at the beginning of this chapter: (1) cost objects, (2) direct costs of a cost object, (3) indirect (overhead) costs of a cost object, (4) indirect-cost pools, and (5) cost-allocation bases. (The symbols in the exhibit are used consistently in the costing-system overviews presented in this text. A triangle always identifies a direct cost, a rectangle represents an indirect-cost pool, and an octagon describes a cost-allocation base.) Costing-system overviews such as Exhibit 4-4 are important learning tools. We urge you to sketch one when you need to understand a costing system.

Note the similarities between Exhibit 4-4 and the cost of the WPP 298 job described in Step 7. Exhibit 4-4 shows two direct-cost categories (direct materials and direct manufacturing labor) and one indirect-cost category (manufacturing overhead). Step 7 also describes two direct-cost categories and one indirect-cost category.