The Clash Company Uses Job Order Costing 489455

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The Clash Company uses job-order costing. Costs are charged to jobs using normal costing, with overhead based on direct labor cost. Estimated direct labor cost for 2014 is $60,000, and the estimated overhead cost is $72,000. The beginning balance in Materials Control was $4,500, which only includes direct materials. During 2014, direct materials purchased totaled $40,000. The beginning Work in Process included costs from Jobs 111 and 222, with specific costs assigned. The beginning balance in Finished Goods included 50 units from Job 104, costing $80 per unit, with $20 per unit allocated to overhead. Direct costs charged during 2014 are given for Jobs 111, 222, 333, 444, and 555, including direct materials, direct labor, and units on each job. The company allocates under- or overallocated overhead at year-end using the most theoretically correct method. Actual overhead for 2014 was $70,000. All jobs except Job 555 were completed during the year, and at year-end, 375 units from Job 444 remained in Finished Goods. All other units in Finished Goods had been sold.

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This analysis examines the application of job-order costing in The Clash Company, focusing on the calculation of underallocated or overallocated overhead, the reconciliation of actual overhead rates with normal costing procedures, and the implications of these calculations on inventory valuation. It also explores the rationale behind overhead allocation methods and their impact on cost accounting accuracy and decision-making.

**1. Calculating Underallocated or Overallocated Overhead and Prorating It Appropriately

The first step involves determining the total applied overhead based on normal costing. Since overhead is allocated on the basis of direct labor costs, the predetermined overhead rate (POHR) must be established:

• POHR = Estimated Overhead / Estimated Direct Labor Cost = $72,000 / $60,000 = 1.2 or 120%

Using this rate, the applied overhead for 2014 is:

• Total Direct Labor Cost = Sum of direct labor costs from all jobs (including beginning balances and during the year). The direct labor charges for the jobs during 2014 are given: Job 111 ($10,000), Job 222 ($11,250), Job 333 ($15,000), Job 444 ($20,000), and Job 555 ($6,250). The beginning balances also include direct labor, totaling $1,000 for Job 111 and $2,000 for Job 222, which are already incorporated into the respective beginning balances.
• Total Direct Labor Cost During 2014 = $10,000 + $11,250 + $15,000 + $20,000 + $6,250 = $62,500

Thus, applied overhead is:

• Applied Overhead = Actual Direct Labor Cost x POHR = $62,500 x 1.2 = $75,000

The difference between applied overhead and actual overhead determines whether overhead is over- or underapplied:

• Overapplied Overhead = Applied Overhead - Actual Overhead = $75,000 - $70,000 = $5,000

Since overhead is overapplied by $5,000, this amount needs to be allocated to accounts based on the most technically correct method, i.e., proportionally to the overhead balances in Work in Process, Finished Goods, and Cost of Goods Sold.

2. Prorating the Overapplied Overhead Correctly

To allocate the overapplied overhead proportionally, determine the overhead balance in each account at year-end. The overhead costs assigned to each job and inventory are:

• Beginning work in process: Job 111 (allocated overhead $1,000), Job 222 ($2,000)
• Direct costs for jobs during 2014: Job 111 (overhead portion), Job 222, etc., based on the predetermined rate.
• Given the specific overhead allocations per job: For Job 111, total starting overhead was $1,000; for Job 222, $2,000. The current overhead allocation from direct costs during 2014 reflects applied overhead based on labor costs and the predetermined rate, while actual overhead expenditure was $70,000. Calculations indicate consistent application of overhead to jobs across the year; the comprehensive calculation involves summing overhead applied to all jobs, including ending inventory and completed jobs.

The total overhead allocated to Work in Process at year-end, summing starting balances and applied overhead during the year, is approximately aligned with the calculation of applied overhead, assuming that the overhead applied matches the predetermined rate times the actual labor costs incurred.

The under- or overapplied amount of $5,000 should be prorated across the relevant inventory accounts (Work in Process, Finished Goods, Cost of Goods Sold) based on their relative overhead balances. The most theoretically correct method involves prorating based on overhead costs or manufacturing overhead balances, ensuring a fair allocation reflecting each account’s share of total overhead.

3. Actual Overhead Rate and Balances Using Actual Costing

If The Clash Company had employed actual costing throughout the year, the actual overhead rate would be derived by dividing total actual overhead by total actual direct labor cost:

• Actual Overhead Rate = Actual Overhead / Actual Direct Labor Cost = $70,000 / $62,500 = 1.12 or 112%

Using this actual overhead rate to apply overhead to the jobs during 2014, the applied overhead would be:

• Applied Overhead (Actual Costing) = Total Direct Labor Cost x 1.12 = $62,500 x 1.12 = $70,000

This matches the actual overhead, resulting in zero over- or underapplied overhead. Consequently, the ending balance of Work in Process would reflect the sum of direct materials, direct labor, and applied overhead (using actual overhead rate), which should be consistent with actual costs incurred during the year.

4. Comparing Work in Process Balances Under Normal and Actual Costing

When reconciling the Work in Process balances calculated via normal costing with those computed using actual costing, differences mainly arise due to the treatments of overhead. Normal costing applies an estimated or predetermined rate, which can lead to over- or underapplied overhead, affecting Work in Process valuation. Actual costing, on the other hand, records overhead based on actual incurred costs, providing a more accurate depiction of inventory.

In this case, because we have determined that the overapplied overhead ($5,000) was prorated to adjust the normal costing balances, the corrected Work in Process amount after these adjustments should closely align with the actual costing balance, but minor differences may still exist due to timing or rounding. They should not be exactly the same, as normal costing relies on estimates and allocation bases, whereas actual costing reflects actual expenses incurred.

Conclusion

Accurate overhead application and consistent accounting methodologies are vital for reliable product costing. Prorating over- or underapplied overhead enhances inventory valuation accuracy and supports better managerial decision-making. While actual costing offers precise measurement of costs, normal costing remains prevalent due to its simplicity and practicality, provided that adjustments like prorating are systematically applied to reflect true costs.

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