Lecture Managerial accounting: Creating value in a dynamic business environment (10th edition): Chapter 3 - Ronald W. Hilton, David E. Platt

Chapter 3 - Product costing and cost accumulation in a batch production environment. After completing this chapter, you should be able to: Discuss the role of product and service costing in manufacturing and nonmanufacturing firms, diagram and explain the flow of costs through the manufacturing accounts used in product costing, distinguish between job-order costing and process costing,...

Product Costing and Cost Accumulation in a Batch Production Environment

Chapter 3

Product and Service Costing

Financial Accounting

Product costs are used

to value inventory and

to compute cost of

goods sold

Managerial Accounting and Cost Management

Product costs are used for planning, control,

directing, and management decision

making.

Direct material cost Product cost transferred

Direct labor cost

Manufacturing overhead when product is finished

Expense closed into

Income Summary at end

of accounting period

Work-in-Process Inventory Finished Goods Inventory

Cost of Goods Sold Income Summary

Flow of Costs in Manufacturing Firm

Used for production of large, unique, high-cost items

Built to order rather than mass produced.

Many costs can be directly traced to each job.

Job-Order Costing

Types of Product-Costing Systems

Typical job-order cost applications:

Special-order printing Building construction Also used in the service industry

Hospitals Law firms

Process Costing

Job-Order Costing

Types of Product-Costing Systems

Process Costing

Job-Order Costing

Used for production of small, identical, low cost items.

Mass produced in automated continuous production process.

Costs cannot be directly traced to each unit of product.

Typical process cost applications:

Petrochemical refinery Paint manufacturer Paper mill

Types of Product-Costing Systems

Overhead is applied to jobs using a predetermined overhead

rate (POHR) based on estimates made at the beginning of

the accounting period.

POHR = Budgeted manufacturing overhead cost

Budgeted amount of cost driver (or activity base) Overhead applied = POHR × Actual activity

Based on estimates , and

determined before the

period begins

Actual amount of the allocation base, such as direct labor hours,

incurred during the period

Manufacturing Overhead Costs

    Overhead is applied to jobs using a predetermined  overhead rate (POHR) based on estimates made at the 

beginning of the accounting period.

POHR = Budgeted manufacturing overhead cost

Budgeted amount of cost driver (or activity base)

Overhead applied = POHR × Actual activity

Recall the Aluminum Boat example where:

Overhead applied = $30 per DLH × 600 DLH = $18,000

Manufacturing Overhead Costs

Let’s examine the cost flows in a job-order costing system We will use T-accounts and start with materials

Job-Order System Cost Flows

Work in Process (Job-Cost Record)

Job-Order System Cost Flows

Next let’s add labor costs and

applied manufacturing overhead to the job-order cost flows Are you

with me?

Job-Order System Cost Flows

•Direct Labor

•Indirect

Labor

Wages Payable (Job-Cost Record) Work in Process

Job-Order System Cost Flows

•Direct Labor

If actual and applied manufacturing overhead are

not equal, a year-end adjustment is required We will look at the procedure to accomplish this later.

•Indirect

Labor

•Direct Labor

•Overhead

Applied

•Indirect

Labor

Wages Payable (Job-Cost Record) Work in Process

Job-Order System Cost Flows

Now let’s complete the goods and sell them Still with

me?

Job-Order System Cost Flows

•Cost of

Goods Mfd.

Finished Goods

•Cost of

Goods Sold

•Cost of

Goods Mfd

Cost of Goods Sold

•Cost of

Goods Sold

Let’s return to AFB Company and see what we will do if actual and applied overhead are not

equal

Job-Order System Cost Flows

Actual Overhead costs for the year: $5,050,000

Actual direct labor hours worked for the year: 170,000

Applied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $30.00 per DLH × 170,000 DLH = $5,100,000

Applied overhead exceeds actual overhead by

$50,000

This difference is called overapplied overhead

Overhead Application Example

Work in

Process

Finished Goods

Cost of Goods Sold

$50,000 may be allocated

to these accounts.

$50,000 may be closed directly to cost of goods sold.

Cost of Goods Sold

AFB Company’s

Method OR

Overapplied and Underapplied

Manufacturing Overhead

Actual overhead costs

$5,050,000

$50,000 overapplied

to jobs

$5,100,000

AFB’s Mfg Overhead for the year

AFB’s Cost

of Goods Sold

for the year

Overapplied and Underapplied

Manufacturing Overhead

Alternative 1 Alternative 2

Overhead is Allocation of Goods Sold

UNDERAPPLIED INCREASE INCREASE

Work in Process Cost of Goods Sold (Applied OH is less Finished Goods

than actual OH) Cost of Goods Sold

Work in Process Cost of Goods Sold (Applied OH is greater Finished Goods

than actual OH) Cost of Goods Sold

Overapplied and Underapplied

Manufacturing Overhead -

Summary

Schedule of Cost of Goods Manufactured

Direct material:

Raw material inventory, beginning $xxx Add: Raw material purchases xxx Raw material available for use $xxx Deduct: Raw material, ending xxx Raw material used $xxx

Manufacturing overhead

Indirect material $xxx Indirect labor xxx Other actual overhead charges xxx Total actual manufacturing overhead $xxx Add: Overapplied overhead

or Deduct: Underapplied overhead xxx Overhead applied to work-in-process xxx

Total manufacturing costs $xxx Add: Work-in-process inventory, beginning xxx

Deduct: Work-in-process inventory, ending xxx

Schedule of Cost of Goods Manufactured

Schedule of Cost of Goods Sold

Finished goods inventory, beginning $xxx Add: Cost of goods manufactured* xxx Cost of goods available for sale $xxx Deduct: Finished goods inventory, ending xxx Cost of goods sold $xxx Add: Underapplied overhead

or Deduct: Overapplied overhead xxx Cost of goods sold (adjusted) $xxx

* From Cost of Goods Manufactured Schedule

Schedule of Cost of Goods Sold

Actual direct material

and direct labor

combined with

actual overhead.

Actual direct material

and direct labor combined with

predetermined overhead.

Using a predetermined rate makes it

possible to

possible to estimate estimate total job costs sooner.

Actual overhead for the period is not

known until the end of the period.

Actual and Normal Costing

Indirect Materials

Other Overhead

Departmental Overhead Rates

Machine Hours

Raw Materials Cost

Other Overhead Indirect

Labor

Missions Programs

Cases

THE JOB

Job-Order Costing in Nonmanufacturing Organizations

Changing Technology in Manufacturing

Operations

has eliminated much of the

paperwork associated with

job-order

cost systems.

simplified data entry to record

material and labor use