chapter 6 - fundamentals of product and service costing

©The McGraw-Hill Companies, Inc., 2008 Solutions Manual, Chapter 6 165

6 Fundamentals of Product and Service Costing

Solutions to Review Questions

6-1.

Cost allocation is the assignment of costs in cost pools to cost objects. The cost objects may be products, services, customers, processes, or anything for which we want to know the cost. Product costing uses cost allocation to calculate product costs. Product costing is an application of cost allocation where products are the cost objects.

6-2. Cost management systems should satisfy the following criteria:

• Cost systems should have a decision focus. • Different cost information is used for different purposes. • Cost information for managerial purposes must meet the cost-benefit test.

6-3. Cost flow diagrams serve two purposes. First, they help describe how a cost management system works, just like a flow chart helps you understand how a process works. Second, cost flow diagrams help managers identify and understand quickly the effect of changes in the system design on reported costs.

6-4. A job costing accounting system traces costs to individual units or to specific jobs (typically custom products). A process costing accounting system is used when identical units are produced through a series of uniform production steps. Operation costing is used when goods have some common characteristics (process costing) and some individual characteristics (job costing).

6-5. The predetermined overhead rate is the value at which overhead is applied to one unit of the cost allocation base. It is used in product costing to apply the overhead to the units produced.

©The McGraw-Hill Companies, Inc., 2008 166 Fundamentals of Cost Accounting

6-6. Continuous flow processing is used when a single product is mass produced in a continuing process. Examples would include products such as paint, gasoline, paper, or any others that are mass produced in a continuing process.

6-7. The basic cost flow model appears as follows:

Beginning balance + Transfers in – Transfers out = Ending balance Beginning balance is the balance of inventory at the beginning of the period. Transfers in represent inventory purchased or transferred in from another department (for example, raw materials would be goods transferred in to work in process) for the period. Transfers out are goods transferred from one department to another (for example, work in process would be transferred out to finished goods). Ending balance represents the amount of inventory in a department at the end of the accounting period.


Solutions to Critical Analysis and Discussion Questions

6-8. Although there may be no one correct way to allocate cost, cost allocation can provide managers with information about the costs of the resources they use. Ignoring costs that cannot be directly assigned leads to the possibility that managers forget that it is a real resource that is being used.

6-9. There are three important points to consider: 1. The cost system should meet the needs of the users (the decision makers). 2. The cost system must provide the appropriate data for its intended purpose.

Different cost information is used for different purposes. 3. Cost information for managerial purposes must meet the cost-benefit test. The costs

of implementing the system should be less than the benefits derived from the system (i.e. better decisions).

6-10. The basic cost flow model is as follows:

Beginning balance + Transfers in – Transfers out = Ending balance This model is used for finding one unknown or for comparing perpetual inventory system output to a physical inventory count. An example of finding one unknown is if the beginning balance is known (from the previous period ending balance), transfers in are known, and ending inventory is counted physically—and we are asked to find the cost of goods sold for the period (transfers out).

6-11. It is sometimes difficult (and frustrating) for managers when the cost accountant says that the cost depends on the decision being made. Many people feel that there is one cost that is “correct.” However, as we saw in Chapter 2, costs behave in different ways and this behavior is affected by the decision being made.


6-12. Reasons to agree with approach: If the products are not contributing to company profits, then the customers should be eliminated. This will increase overall company profits. Reasons not to agree with approach: The reported product costs and the associated product profits depend on the allocation of indirect costs. Under a different allocation process, the results could be very different. In addition, many of the indirect costs are unavoidable. If the products are eliminated, the costs will be allocated to the remaining products.

6-13. The way the “products” are defined will depend, at least in part, on the decision the dean is interested in making. They may be defined as degree programs vs. non-degree programs. They may be the different degree programs. They might be the credit hour (although it is unlikely you would be able to get much information at this level). You might ask about the time frame of the analysis (to determine fixed and variable costs), the source of the data, and how to treat costs that the school does not directly pay for but where the school consumes the resources (e.g., university buildings). This is a very difficult analysis in a university setting because of the high proportion of common costs and the difficulty in defining products.

6-14. The two most important criteria in determining an allocation base are (1) causality and (2) measurability. We would like an allocation base that “causes” costs. This is rarely possible, but it is a good criterion to use. Second, we need to be able to measure the allocation base at reasonable cost.

6-15. The allocation base determines the costs assigned to the cost objects. If these costs are used to make decisions and if they are based on inappropriate or improper allocation bases, they could lead the manager to make bad decisions.

6-16. There are many reasons why two companies may have different cost systems. First, they may be in different industries. We saw in the chapter that firms in continuous process industries have different cost systems than those in discrete manufacturing industries. Firms may be pursuing different strategies (cost containment versus product differentiation) and want different information from the cost system. A third reason is that some firms may be subject to regulations (for example, utilities) and the regulations dictate the information needed from the cost system.


6-17. A firm can have a two-stage system and use the same allocation base to allocate costs in the second stage. There will be different costs reported if the allocation base (direct labor, say) is used differently by the products in the second stage cost pools.


Solutions to Exercises

6-18. (20 min.) Basic Cost Flow Model: Office Mart. a. $300,000 (see item 5) b. $1,240,000 = $1,200,000 + $40,000 (see items 2 & 3) c. $200,000 (see item 5) d. $1,340,000. BB + TI – TO = EB $300,000 + $1,240,000 – X = $200,000 X = $300,000 + $1,240,000 – $200,000 X = $1,340,000

6-19. (20 min.) Basic Cost Flow Model: General Electric a. $67 million = $16 million + $27 million + (.8 x $30 million) b. $50.25 million = .75 x $67 million c. BB + TI – TO = EB 0 + $67 million – $50.25 million = EB EB = $16.75 million

6-20. (20 min.) Basic Cost Flow Model. Based on the basic formula: BB + TI – TO = EB a. $51,000 + $48,000 – $57,000 = X X = $42,000 b. $28,400 + X – $88,000 = $24,800 X = $24,800 – $28,400 + $88,000 X = $84,400 c. $67,000 + $170,000 – X = $56,000 X = $67,000 + $170,000 – $56,000 X = $181,000


6-21. (20 min.) Basic Cost Flow Model. Based on the basic formula: BB + TI – TO = EB A. $250,000 + $260,000 – $270,000 = X X = $240,000 B. $7,100 + X – $22,000 = $6,200 X = $6,200 – $7,100 + $22,000 X = $21,100 C. $156,000 + $280,000 – X = $128,000 X = $156,000 + $280,000 – $128,000 X = $308,000

6-22. (20 min.) Basic Cost Flow Model. Based on the basic formula: BB + TI – TO = EB A. $14,000 + $12,000 – $18,000 = X X = $8,000 B. $90,000 + X – $330,000 = $93,000 X = $93,000 – $90,000 + $330,000 X = $333,000 C. $65,000 + $230,000 – X = $30,000 X = $65,000 + $230,000 – $30,000 X = $265,000


6-23. (10 min.) Basic Product Costing: Enviro Corporation.

Materials............................................ $595,000 Labor................................................. 51,000 Manufacturing overhead.................... 204,000 Total cost...................................... $850,000 ÷ Gallons produced ........................... ÷ 1,700,000 = Cost per gallon............................... $0.50

6-24. (10 min.) Basic Product Costing: Big City Bank.

Labor.................................................. $ 17,000 Manufacturing overhead..................... 67,000 Total .............................................. $ 84,000 ÷ Checks processed........................... ÷ 1,400,000 = Cost per check ................................ $0.06


6-25. (20 min.) Basic Cost Flow Model: Kim and Smith Refiners

Total

a.

Sold

b. Work-in-Process, March 31

Production: Gallons ......................................... 180,000 160,000 20,000 Percentage complete................... 100% 80% Equivalent gallons ....................... 176,000 160,000 16,000 Costs: Materials...................................... $ 94,000 Labor .......................................... 24,200 Manufacturing overhead.............. 49,000 Total cost incurred ....................... $167,200 Cost per equivalent barrel............... $0.95a Cost assigned to product ................ $167,200 $152,000b $15,200c a $0.95 = $167,200 ÷ 176,000 equivalent units. b $152,000 = 160,000 equivalent units x $0.95. c $15,200 = 16,000 equivalent units x $0.95.


6-26. (20 min.) Basic Cost Flow Model—Ethical Issues: Old Tyme Soda a. and b.

Total

a.

Sold

b. Work-in-Process,

November 30 Production: Barrels.............................................. 10,000 8,800 1,200 Percentage complete ...................... 100% 30% Equivalent barrels............................ 9,160 8,800 360 Costs: Materials.......................................... $18,072 Manufacturing overhead.................. 20,400 Total cost incurred........................... $38,472 Cost per equivalent barrel .................. $4.20a Cost assigned to product.................... $38,472 $36,960b $1,512c a $4.20 = $38,472 ÷ 9,160 equivalent units. b $36,960 = 8,800 equivalent units x $4.20. c $1,512 = 360 equivalent units x $4.20.

c. (1) The change in the estimate will cause more cost to be assigned to work-in-process inventory and less to finished goods. As the finished goods are sold, cost of goods will be lower and income higher.

(2) Unless the production supervisor’s estimates are incorrect, the controller should not change the estimates. He or she has an ethical (and legal) obligation to ensure that the estimates reflect fairly the results of operations.


6-27. (15 min.) Process Costing: Van Goe. a. and b.

Total

a. Transferred to Finished

Goods

b. Work-in- Process,

January 31 Production: Gallons ......................................... 100,000 80,000 20,000 Percentage complete................... 100% 80% Equivalent gallons ....................... 96,000 80,000 16,000 Costs: Materials...................................... $219,200 Conversion costs ......................... 280,000 Total cost incurred ....................... $499,200 Cost per equivalent barrel............... $5.20a Cost assigned to product ................ $499,200 $416,000b $83,200c a $5.20 = $499,200 ÷ 96,000 equivalent units. b $416,000 = 80,000 equivalent units x $5.20. c $83,200 = 16,000 equivalent units x $5.20.


6-28. (15 min.) Process Costing: Opech, Inc. a. and b.

Total

a.

Shipped

b. Work-in-Process, May 31

Production: Barrels (millions).......................... 200 180 20 Percentage complete................... 100% 70% Equivalent barrels (millions)......... 194 180 14 Costs: Materials (millions)....................... $2,500 Conversion costs (millions).......... 3,320 Total cost incurred (millions)........ $5,820 Cost per equivalent barrel............... $30a Cost assigned to product ................ $5,820 $5,400b $420c a $30 = $5,820 ÷ 194 equivalent units. b $5,400 = 180 equivalent units x $30. c $420 = 14 equivalent units x $30.


6-29. (15 min.) Process Costing: Oholics, Ltd. a. and b.

Total

a.

Sold

b. Work-in-Process, April 30

Production: Pounds ........................................ 40,000 38,000 2,000 Percentage complete................... 100% 60% Equivalent pounds ....................... 39,200 38,000 1,200 Costs: Materials...................................... $44,000 Conversion costs ......................... 54,000 Total cost incurred ....................... $98,000 Cost per equivalent pound.............. $2.50a Cost assigned to product ................ $98,000 $95,000b $3,000c a $2.50 = $98,000 ÷ 39,200 equivalent units. b $95,000 = 38,000 equivalent units x $2.50. c $3,000 = 1,200 equivalent units x $2.50.


6-30. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings Predetermined overhead rate = $34.82 per direct labor hour.

Basic Dominator Total Units produced ...................... 1,000 250 1,250 Machine-hours....................... 4,000 2,000 6,000 Direct labor-hours.................. 3,000 2,000 5,000 Direct materials ..................... $10,000 $3,750 $13,750 Direct labor............................ 64,500 35,500 100,000 Manufacturing overhead........ 174,100 Total Costs ............................ $287,850

Burden Rate: ......................... Total overhead .................. $174,100 ÷ Direct labor-hours............ ÷ 5,000 = $34.82

6-31. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings

Predetermined overhead rate = 174.1% of direct labor cost.

Basic Dominator Total Units produced ...................... 1,000 250 1,250 Machine-hours....................... 4,000 2,000 6,000 Direct labor-hours.................. 3,000 2,000 5,000 Direct materials ..................... $10,000 $3,750 $13,750 Direct labor............................ 64,500 35,500 100,000 Manufacturing overhead........ 174,100 Total Costs ............................ $287,850 Burden Rate: ......................... Total overhead .................. $174,100 ÷ Direct labor cost .............. ÷ $100,000 =174.1%


6-32. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings Predetermined overhead rate = $29.0167 per machine-hour (rounded).

Basic Dominator Total Units produced .................. 1,000 250 1,250 Machine-hours................... 4,000 2,000 6,000 Direct labor-hours.............. 3,000 2,000 5,000 Direct materials ................. $10,000 $3,750 $13,750 Direct labor........................ 64,500 35,500 100,000 Manufacturing Overhead... 174,100 Total Costs ........................ $287,850

Burden Rate: ..................... Total overhead .............. $174,100 ÷ Machine-hours............. ÷ 6,000 =$29.0167

6-33. (20 Minutes) Cost Flow Diagram: Tiger Furnishings


6-34. (30 Minutes) Operation Costing: Howrey-David, Inc. The unit costs are:

Fatboy:............ $3,700 Screamer: ....... $4,700

Fatboy Screamer Total Number of units......................... 1,000 2,000 3,000 Materials cost per unit ............... $2,000 $3,000 Costs ......................................... $2,000,000 $6,000,000 $ 8,000,000 Operation costs: Direct Labor.......................... $ 3,000,000 Indirect materials.................. 800,000 Other overhead .................... 1,300,000 Total operation cost......... $ 5,100,000

Cost per unit in plant ................. ($5,100,000 ÷ 3,000 units) = $1,700 per unit. Operation cost (@ $1,700 per unit) ................... $1,700,000a $3,400,000b $5,100,000 Material cost.............................. 2,000,000 6,000,000 Total cost................................... $3,700,000 $9,400,000 Number of units......................... 1,000 2,000 Unit cost .................................... $3,700 $4,700

a $1,700,000 = 1,000 units x $1,700 per unit. b $3,400,000 = 2,000 units x $1,700 per unit.


6-35. (30 Minutes) Operation Costing: Organic Grounds. The unit costs are:

Star: ................ $8.96 Bucks: ............. $10.96

Star Bucks Total Number of units......................... 10,000 40,000 50,000 Materials cost per unit ............... $5.00 $7.00 Costs ......................................... $50,000 $280,000 $ 330,000 Operation costs: Direct Labor.......................... $ 60,000 Indirect materials.................. 17,000 Other overhead .................... 121,000 Total operation cost......... $198,000

Cost per unit in plant ................. ($198,000 ÷ 50,000 units) = $3.96 per pound. Operation cost (@ $3.96 per unit) ..................... $39,600a $158,400b $198,000 Material cost.............................. 50,000 280,000 Total cost................................... $89,600 $438,400 Number of units......................... 10,000 40,000 Unit cost .................................... $8.96 $10.96

a $39,600 = 10,000 units x $3.96 per unit. b $158,400 = 40,000 units x $3.96 per unit.


Solutions to Problems

6-36. (30 Minutes) Product Costing: Tiger Furnishings The unit costs are: Basic: $186.79 and Dominator: $404.22 Basic Dominator Total Direct materials ............................................................ $10,000 $3,750 $13,750 Direct labor................................................................... 64,500 35,500 100,000 Manufacturing overhead (@174.1% of Direct labor cost)a .................................. 112,295 61,806 174,100b Total costs.................................................................... $186,795 $101,056 $287,850b Units produced ............................................................. 1,000 250 Unit cost ....................................................................... $186.795 $404.22 a 174.1% = $174,100 ÷ $100,000. b Adjusted for rounding error.

6-37. (30 Minutes) Product Costing: Tiger Furnishings The unit costs are: Basic: $190.57 and Dominator: $389.13 Basic Dominator Total Direct materials ...................................................... $ 10,000 $3,750 $13,750 Direct labor............................................................. 64,500 35,500 100,000 Manufacturing overhead (@29.0167 per machine-hour) a............................ 116,067b 58,033c 174,100 Total costs.............................................................. $ 190,567 $97,283 $287,850 Units produced ....................................................... 1,000 250 Unit cost ................................................................. $ 190.57 $389.13 a $29.0167 per machine-hour = $174,100 ÷ 6,000 machine-hours. b $116,067 = 4,000 machine-hours x $29.0167 per machine-hour. c $58,033 = 2,000 machine-hours x $29.0167 per machine-hour.


6-38. (30 Minutes) Product Costing—Ethical Issues: Tiger Furnishings a. The unit costs are different because the two products use the machine hours and

direct labor costs in different proportions. The Basic model is more machine intensive (it uses relatively more machine hours than labor compared to the Dominator model). This means that when the company moves to machine hours to allocate costs, the Basic model will be assigned more overhead costs resulting in higher reported product costs.

b. Without knowing more about the production process at Tiger Furnishings, it is not possible to say which of these is better. Because you get different results, it may pay to use a two stage system to split overhead between that which is driven more by machine hours and that driven more by direct labor.

c. The allocation base should be chosen on the basis of how overhead is related to cost. Income is the result of this decision and not the basis for the decision.


6-39. (30 Minutes) Two-Stage Allocation and Product Costing: Mets Products a. The overhead rates are $9 per machine hour and 30% of direct-materials cost.

Account

Machine-Hour Related

Materials Related

Utilities …………………………. ................. $ 4,000 Supplies .................................................... $2,800 Machine depreciation and maintenance ... 8,800 Purchasing and storing materials ............. 3,200 Miscellaneous............................................ 3,400 _____________________________________ Total overhead ........................................ $ 16,200 $ 6,000 ÷ Total machine hours ............................... ÷ 1,800 hours ÷ Total materials cost ................................ ÷ $20,000 Overhead rate ........................................... $9 / hour 30%

b.

Baseball

Caps T-shirts Total Machine hours used........................................... 1,000 800 1,800 Direct materials costs …………………. $12,000 $8,000 $20,000 Direct labor costs ……………………… 4,000 2,400 6,400 Manufacturing overhead costs ………. Machine-hour related overheada...................... 9,000 7,200 16,200 Materials-related overheadb............................. 3,600 2,400 6,000 Total cost ........................................................... $28,600 $20,000 $48,600 Units produced ……………………….. 10,000 5,000 15,000 Cost per unit....................................................... $2.86 $4.00

a $9,000 = 1,000 machine hours x $9 per machine hour; $7,200 = 800 machine hours x $9 per machine hour. b $3,600 = $12,000 materials cost x 30%; $2,400 = $8,000 materials cost x 30%.


6-40. (30 Minutes) Two-Stage Allocation and Product Costing: Owl-eye Radiologists

a. The overhead rates are $46 per equipment hour and $50 per direct labor hour.

Account

Equipment- Hour Related

Direct-Labor Hour Related

Utilities …………………………. .................... $ 4,800 Supplies ....................................................... $12,600 Indirect labor and supervision ...................... 20,400 Equipment depreciation and maintenance ... 8,400 Miscellaneous............................................... 3,360 _____________________________________ Total overhead ........................................... $ 16,560 $ 33,000 ÷ Total equipment hours ............................... ÷ 360 hours ÷ Total labor hours........................................ ÷ 660 hours Overhead rate .............................................. $46 per hour $50 per hour

b.

Hospital Patients

Other Patients Total

Equipment hours used ....................................... 240 120 360 Direct labor-hours............................................... 480 180 660 Direct labor costs ……………………… $38,400 $10,800 $49,200 Overhead costs ………. Equipment-hour related overheada.................. 11,040 5,520 16,560 Direct labor-hours related overheadb............... 24,000 9,000 33,000 Total cost ........................................................... $73,440 $25,320 $98,760 Patients ………………………………….. 640 860 1,500 Cost per patient.................................................. $114.75 $29.44

a $11,040 = 240 equipment hours x $46 per equipment hour; $5,520 = 120 equipment hours x $46 per equipment hour. b $24,000 = 480 direct labor-hours x $50 per direct labor-hour; $9,000 = 180 direct labor-hours x $50 per direct labor-hour.


6-41. (40 Minutes) Operation Costing: Vermont Instruments The unit costs are:

Fin-X: ....... $23 Sci-X: ....... $28

Fin-X Sci-X Total Number of units......................... 10,000 40,000 50,000 Parts cost per unit ..................... $20 $25 Costs ......................................... $200,000 $1,000,000 $ 1,200,000 Operation costs: Direct Labor.......................... 62,000 Parts..................................... 17,500 Overhead ............................. 70,500 Total operation cost......... $ 150,000

Cost per unit in plant ................. ($150,000 ÷ 50,000 units) = $3 per unit. Operation cost (@ $3 per unit) .. $ 30,000a $ 120,000b $150,000 Material cost.............................. 200,000 1,000,000 Total cost................................... $ 230,000 $1,120,000 Number of units......................... 10,000 40,000 Unit cost .................................... $23 $28

a $30,000 = 10,000 units x $3 per unit. b $120,000 = 40,000 units x $3 per unit.


6-42. (45 Minutes) Accounts Analysis, Two-Stage Allocation, and Product Costing: Tiger Furnishings

a. Cost Flow Diagram

Overhead

Machine-Related

Overhead

Direct Labor Cost

Related

Overhead

Machine Hours Direct Labor Cost

First Stage

Second Stage

DominatorBasic


6-42 (continued) b. Basic $188.00 Dominator $400.00 Basic Dominator Total Units Produced........................................... 1,000 250 1,250 Machine hours............................................ 4,000 2,000 6,000 Direct labor hours....................................... 3,000 2,000 5,000 Direct materials .......................................... $10,000 $3,750 $ 13,750 Direct labor................................................. 64,500 35,500 100,000 Manufacturing Overhead

Machine-hour related

Direct labor cost related

Utilities................................................... $1,800 $0 $1,800 Supplies ................................................ 0 5,000 5,000 Training ................................................. 0 10,000 10,000 Supervision ........................................... 0 25,800 25,800 Machine depreciation ............................ 32,000 0 32,000 Plant depreciation.................................. 14,200 0 14,200 Miscellaneous ....................................... 0 85,300 85,300 Total ................................................. $48,000 $126,100 174,100 Total Costs ................................................. $287,850

Burden Rates Machine hour rate ................................. ($48,000 ÷ 6,000 hours =) $8.00 Direct labor cost rate ............................. ($126,100 ÷ $100,000) = 126.1%


6-42 (continued) Product Costing Direct material ......................................... $ 10,000 $ 3,750 $ 13,750 Direct labor.............................................. 64,500 35,500 100,000 Overhead Machine-related (@$8 per machine-hour)...... 32,000a 16,000b 48,000 Labor-related (@126.1% direct labor cost) 81,335c 44,766d 126,100 Total overhead ....................................... $113,335 $60,766 $174,100 Total cost.................................................... $187,835 $100,016 $287,850 ÷ Units produced ........................................ ÷ 1,000 ÷ 250 1,250 = Unit cost ................................................. = $188 = $400 a $32,000 = 4,000 machine-hours x $8 per machine-hour. b $16,000 = 2,000 machine-hours x $8 per machine-hour. c $81,335 = $64,500 x 126.1% direct labor cost. d $44,766 = $35,500 x 126.1% direct labor cost

chapter 6 - fundamentals of product and service costing

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