Difficulty: Introductory | Prerequisites: Chapter 1 cost classification (direct materials, direct labour, manufacturing overhead, product vs period costs).
Big Picture
Chapter 1 told you what the cost categories are. Chapter 2 tells you how to attach those costs to individual jobs (batches, orders, projects) so you can price them, bill customers and value inventory. Job-order costing is the system used whenever products or services are distinct enough that each job needs its own cost record: construction projects, custom furniture, legal engagements, film production. The central problem is manufacturing overhead, because it cannot be traced to a single job the way materials and labour can. The solution is a predetermined overhead rate.
TL;DR
In job-order costing, direct materials and direct labour are traced to each job. Manufacturing overhead is applied using a predetermined rate (estimated overhead divided by estimated activity). The total cost of a job is the sum of its direct materials, direct labour and applied overhead. The predetermined rate is calculated at the start of the period, not after.
Job-order costing
A costing system that assigns manufacturing costs to individual jobs, batches or orders, each tracked on its own job cost sheet. In simple terms, every order gets its own running tab of costs.
Job cost sheet (job cost record)
The document or record that accumulates the direct materials, direct labour and applied manufacturing overhead for a single job. Think of it as the receipt for everything spent on one order.
Predetermined overhead rate (POHR)
An overhead application rate computed at the beginning of the period: estimated total manufacturing overhead divided by the estimated total amount of the allocation base. In simple terms, it is the "per-unit" price of overhead, calculated in advance so you do not have to wait until year-end to cost a job.
Allocation base (cost driver)
The activity measure used to assign overhead to jobs. Common bases include direct labour hours, direct labour cost, and machine hours. Think of it as the yardstick you use to spread shared factory costs across jobs.
Applied overhead
The amount of manufacturing overhead charged to a specific job, calculated as the predetermined overhead rate multiplied by the actual amount of the allocation base used by the job. In simple terms, it is the overhead you write onto the job cost sheet.
Actual overhead
The manufacturing overhead costs that were really incurred during the period. This figure is only known after the period ends.
Overapplied overhead
The situation where applied overhead exceeds actual overhead. Too much overhead was charged to jobs.
Underapplied overhead
The situation where actual overhead exceeds applied overhead. Not enough overhead was charged to jobs.
Cost of goods manufactured (COGM)
The total manufacturing cost of goods completed during the period. It includes direct materials used, direct labour and applied manufacturing overhead, adjusted for changes in work-in-progress inventory.
At the start of the period, estimate two things:
Total manufacturing overhead for the year (all indirect factory costs).
Total allocation base activity for the year (e.g. direct labour hours).
POHR = Estimated total MOH / Estimated total allocation base
Worked example (E2-1): Estimated MOH = $94,000 + (20,000 DLH x $2 per DLH indirect component) = $134,000. Estimated DLH = 20,000. POHR = $134,000 / 20,000 = $6.70 per direct labour hour.
Worked example (E2-6): Estimated MOH = $680,000 + (0.5 x 80,000 DLH) = $720,000. Estimated DLH = 80,000. POHR = $720,000 / 80,000 = $9.00 per direct labour hour.
As jobs consume the allocation base (e.g. direct labour hours), overhead is applied:
Applied overhead for a job = POHR x Actual allocation base used by the job
Worked example (E2-2): POHR = $23.40 per machine hour. Job uses 10,800 machine hours. Applied overhead = $23.40 x 10,800 = $252,720.
Worked example (E2-6, part 2): Job uses 280 DLH. Applied overhead = 280 x $9 = $2,520. Total job cost = $2,520 + $38,000 (materials) + $21,000 (labour) = $61,520.
The total cost assigned to a job is: Direct materials + Direct labour + Applied MOH.
Worked example (E2-3):
POHR = $153 / 17 DLH = $9 per DLH.
Job A: Applied MOH = $9 x 14 DLH = $126.
Total cost of both jobs: $231 + $153 = $384, plus additional overhead for a second job, totalling $510.
Unit cost if 40 units produced: $510 / 40 = $12.75 per unit.
Worked example (E2-4):
POHR for overhead category 1 = $180 / 20 = $9 per base unit.
POHR for overhead category 2 = $40 / 20 = $2 per base unit.
Applied overhead: $9 x 16 = $144 and $2 x 12 = $24.
Total job cost: $340 + $180 + $144 + $25 + $40 + $24 = $753.
Unit cost if 10 units: $753 / 10 = $75.30 per unit.
Using actual overhead would mean you cannot cost any job until the period ends (because actual overhead is not known until then). A predetermined rate lets you cost jobs throughout the year. The trade-off is that applied overhead will rarely equal actual overhead exactly, creating over- or underapplied overhead that is adjusted at year-end.
Predetermined overhead rate (POHR) = Estimated total manufacturing overhead / Estimated total allocation base
Applied overhead for a job = POHR x Actual allocation base used by the job
Total job cost = Direct materials + Direct labour + Applied manufacturing overhead
Unit cost = Total job cost / Number of units in the job
Over- or underapplied overhead = Applied overhead - Actual overhead (positive = overapplied, negative = underapplied)
Job-order costing is the system behind every custom-work business that needs to quote prices or bill clients: law firms tracking billable hours per case, construction companies costing each building project, advertising agencies billing per campaign. The predetermined overhead rate is what lets a contractor give you an estimate before the project starts, rather than sending you a final bill months later.
Students often use actual overhead instead of applied overhead when computing a job's total cost. In job-order costing you apply overhead using the predetermined rate, not the actual amount.
Students forget that the POHR uses estimates for both the numerator (total MOH) and the denominator (total allocation base). Both figures are budgeted at the start of the period.
Students assume overapplied overhead is always bad. It simply means you charged more overhead to jobs than you actually incurred. The adjustment at year-end corrects this.
Students mix up the allocation base with the overhead itself. The allocation base (e.g. direct labour hours) is the measure used to spread overhead; it is not an overhead cost.
⚠️ Computing the POHR is nearly guaranteed on the exam. Be comfortable dividing estimated overhead by estimated activity, and watch for problems that include both fixed and variable overhead components in the estimate.
⚠️ Applying overhead to a job: multiply POHR by the actual base consumed by that job. Do not confuse estimated base hours (used to set the rate) with actual base hours (used to apply it).
⚠️ Computing total job cost and unit cost: add direct materials, direct labour and applied overhead, then divide by the number of units.
⚠️ Problems may use multiple overhead rates (one per department or cost pool). Apply each rate separately to the base the job consumed in that department.
True or false: The predetermined overhead rate uses actual overhead and actual activity.
False. It uses estimated overhead and estimated activity, both set at the start of the period.
Fill in the blank: Applied overhead for a job = POHR x ________.
Actual allocation base used by the job.
True or false: If applied overhead is greater than actual overhead, overhead is underapplied.
False. That is overapplied overhead.
Fill in the blank: Total job cost = Direct materials + Direct labour + ________.
Applied manufacturing overhead.
True or false: You can compute unit cost for a job before the job is finished.
Not reliably, because total direct materials and direct labour are not final until the job is complete.
Q: A company estimates $94,000 in fixed overhead and $2 per direct labour hour in variable overhead. It expects 20,000 direct labour hours. What is the predetermined overhead rate?
A: Total estimated MOH = $94,000 + ($2 x 20,000) = $134,000. POHR = $134,000 / 20,000 = $6.70 per direct labour hour.
Q: The POHR is $23.40 per machine hour. A job uses 10,800 machine hours. How much overhead is applied to the job?
A: $23.40 x 10,800 = $252,720.
Q: A job's cost sheet shows $38,000 in direct materials, $21,000 in direct labour and 280 direct labour hours at a POHR of $9 per DLH. What is the total cost of the job?
A: Applied overhead = 280 x $9 = $2,520. Total job cost = $38,000 + $21,000 + $2,520 = $61,520.
Q: Two jobs are completed. Their combined costs total $510 and 40 units were produced across both jobs. What is the average unit cost?
A: $510 / 40 = $12.75 per unit.
Q: A department has two overhead pools with rates of $9 per base unit and $2 per base unit. A job uses 16 units of the first base and 12 units of the second. Direct materials are $340, direct labour is $180, and other traceable costs are $25 + $40. What is the total job cost?
A: Applied overhead = ($9 x 16) + ($2 x 12) = $144 + $24 = $168. Total job cost = $340 + $180 + $144 + $25 + $40 + $24 = $753.
Job-order costing builds directly on Chapter 1's cost classification. The three manufacturing cost categories (direct materials, direct labour, MOH) are the inputs to every job cost sheet.
This connects forward to process costing, where costs are averaged across large batches of identical units rather than tracked per job. The choice between the two systems depends on whether products are distinct (job-order) or homogeneous (process).
The concept of over- and underapplied overhead connects to variance analysis later in the course, where you will break the overhead difference into spending and volume components.
Related Terms / Search Tags
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