Problem 17 - Accounting

Question

The consulting firm of Reznick and Fedder accumulates costs associated with individual cases, using a job order cost system. The following transactions occurred during May: May 7 Charged 440 hours of professional (lawyer) time to the Daley Co. breech of contract suit to prepare for the trial, at a rate of \(\$ 175\) per hour. 11 Reimbursed travel costs to employees for depositions related to the Daley case, \$24,000. 22 Charged 225 hours of professional time for the Daley trial at a rate of \(\$ 250\) per hour. 25 Received invoice from consultants Rucker and Putnam for \(\$ 47,000\) for expert testimony related to the Daley trial. 30 Applied office overhead at a rate of \(\$ 45\) per professional hour charged to the Daley case. 31 Paid secretarial and administrative salaries of \(\$ 20,000\) for the month. 31 Used office supplies for the month, \(\$ 6,000\). 31 Paid professional salaries of \(\$ 55,000\) for the month. 31 Billed Daley \(\$ 260,000\) for successful defense of the case. a. Provide the journal entries for each of the above transactions. b. How much office overhead is over- or underapplied? c. Determine the gross profit on the Daley case, assuming that over- or underapplied office overhead is closed annually to cost of services.

Step-by-Step Solution

Answer

a. Journal entries are provided for each transaction. b. Office overhead is neither over- nor underapplied if actual overhead is not provided. c. Gross profit on the Daley case is $25,825.

Step 1: Journal Entry for Professional Time on May 7

**Date:** May 7 Dr. Work in Process (Daley Case) 80 hours x $175/hour = $77,000 Cr. Salaries and Wages Payable 80 hours x $175/hour = $77,000 This entry records the professional lawyer time charged to the Daley breach of contract suit.

Step 2: Journal Entry for Reimbursed Travel Costs on May 11

**Date:** May 11 Dr. Work in Process (Daley Case) $24,000 Cr. Accounts Payable $24,000 This entry records the travel costs related to the Daley case.

Step 3: Journal Entry for Professional Time on May 22

**Date:** May 22 Dr. Work in Process (Daley Case) 225 hours x $250/hour = $56,250 Cr. Salaries and Wages Payable 225 hours x $250/hour = $56,250 This entry records the professional time charged to the Daley trial.

Step 4: Journal Entry for Consultant Invoice on May 25

**Date:** May 25 Dr. Work in Process (Daley Case) $47,000 Cr. Accounts Payable $47,000 This entry records the invoice received from consultants for expert testimony.

Step 5: Journal Entry for Applied Office Overhead on May 30

**Date:** May 30 Total Professional Hours = 440 hours + 225 hours = 665 hours Dr. Work in Process (Daley Case) 665 hours x $45/hour = $29,925 Cr. Manufacturing Overhead $29,925 This entry applies office overhead to the Daley case.

Step 6: Journal Entry for Secretarial and Administrative Salaries on May 31

**Date:** May 31 Dr. Salaries Expense $20,000 Cr. Cash $20,000 This entry records the payment of secretarial and administrative salaries for the month.

Step 7: Journal Entry for Office Supplies Used on May 31

**Date:** May 31 Dr. Office Supplies Expense $6,000 Cr. Office Supplies $6,000 This entry records the use of office supplies during the month.

Step 8: Journal Entry for Professional Salaries on May 31

**Date:** May 31 Dr. Salaries Expense $55,000 Cr. Cash $55,000 This entry records the payment of professional salaries for the month.

Step 9: Journal Entry for Billing Daley on May 31

**Date:** May 31 Dr. Accounts Receivable $260,000 Cr. Service Revenue $260,000 This entry records the billing of Daley for the successful defense of the case.

Step 10: Calculate Over- or Underapplied Office Overhead

**Calculation:** Total Applied Overhead = $29,925 If the applied overhead matches the actual overhead incurred, then overhead is neither over- nor underapplied. Based on the given data, we are to consider overhead applied in the job costing as the correct assumption unless actual overhead is provided.

Step 11: Calculate Gross Profit on Daley Case

**Total Costs for Daley Case:** - Total professional time (May 7 + May 22): $77,000 + $56,250 = $133,250 - Travel costs: $24,000 - Consultant fees: $47,000 - Applied overhead: $29,925 **Total Costs:** $234,175 **Revenue from Daley:** $260,000 **Gross Profit:** Revenue - Total Costs =$260,000 - $234,175 =$25,825 The gross profit from the Daley case is $25,825.

Key Concepts

Journal Entries

In job order costing, journal entries are vital to accurately record the costs associated with a specific job, such as a legal case in a consulting firm. Each financial transaction occurring during the job is documented in these entries. This includes expenses like professional time, travel costs, consultant fees, and overhead applications. For instance, charging professional time involves debiting the Work in Process account for the job, reflecting the incurred cost of labor, and crediting Salaries and Wages Payable to recognize the liability to employees. Similarly, when reimbursing travel costs or receiving consultant invoices, you debit the Work in Process account to incorporate these costs into the job, and credit Accounts Payable to account for future payments. Such meticulous documentation through journal entries ensures each job's cost remains tracked correctly, ultimately aiding in determining the job's profitability when compared against the generated revenue.

Overhead Application

Overhead application in job order costing refers to attributing indirect costs, such as office expenses, to a specific job based on a predetermined rate. Unlike direct expenses, overhead isn't separately tracked for each job but instead, is applied based on professional hours worked. For example, if the overhead application rate is $45 per professional hour and a total of 665 hours is worked on a case, the applied overhead amounts to $29,925. This overhead is added to the Work in Process account, ensuring all incurred costs reflect on the case financially. Balancing overhead requires comparing applied overhead to actual expenses incurred. If actual data isn't provided, it's assumed applied overhead accurately reflects real costs. Managing overhead application helps firms maintain comprehensive cost control, ensuring resources are allocated efficiently across different jobs.

Gross Profit Calculation

Gross profit calculation is a crucial aspect of job order costing, derived by subtracting total costs from the revenue billed to a client. It signifies the profitability of a job in monetary terms and helps firms assess the effectiveness of their operations.To compute gross profit, aggregate all job-related costs: professional hours (e.g., \(133,250), travel (\)24,000), consultants' fees (\(47,000), and applied overhead (\)29,925). Here, total costs for the Daley case equal \(234,175. With a revenue of \)260,000 from successfully defending the case, the formula for gross profit is as follows:\[ \text{Gross Profit} = \text{Revenue} - \text{Total Costs} \]\[ \text{Gross Profit} = 260,000 - 234,175 = 25,825 \]This $25,825 reflects the job's profit after covering all expenses, serving as a clear indication of the financial success of the case.

Professional Time Billing

Professional time billing is essential in service-oriented firms like consulting, where the main product is labor. It involves tracking and charging the time professionals spend on a client's case. For example, the Daley case required 665 hours of professional time from the consulting firm Reznick and Fedder. These hours are recorded at different rates based on the service provided: trial preparation at $175 per hour and trial attendance at $250 per hour result in professional charges of $133,250. This detailed tracking ensures transparency and accuracy in billing clients for work done, and it forms the basis for journal entries and subsequent financial analyses. Accurate professional time billing is essential not only for client satisfaction and trust but also for ensuring correct job costing and profitability evaluation.