Accumulating and Accumulating and Assigning Costs to Assigning Costs to
Products Products
Accumulating and Accumulating and Assigning Costs to Assigning Costs to
Products Products
Chapter 4
Cost Flows in OrganizationsCost Flows in OrganizationsCost Flows in OrganizationsCost Flows in Organizations
In order to compute product costs, management accounting systems should reflect the actual cost flows in an organization
Manufacturing, retail, and service organizations have different patterns of cost flows resulting in different management accounting priorities
Exhibits 4-1 to 4-3
Review of Important Cost Review of Important Cost TermsTerms
Review of Important Cost Review of Important Cost TermsTerms
Cost Object Consumable resources vs
Capacity-related resources Direct vs Indirect costs
Handling Indirect Costs in a Manufacturing EnvironmentHandling Indirect Costs in a Manufacturing Environment
Direct costs: assign costs to the cost object directly;
Indirect costs: allocate a portion of the cost to the cost object
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
Allocation steps: Choose an allocation base:
e.g. direct labor hours, direct labor cost, or machine hours
Calculate allocation rate: Total Indirect Cost /Total Allocation base
Applied indirect costs = allocation rate * actual quantity of base used
Lollah Mfg Company expects annual mfg. overhead to be $800,000, 50,000 direct labor hours costing $1,600,000 and machine run time of 25,000 hours. Calculate overhead allocation rates based on direct labor hours, direct labor cost, and machine time.Product A: DL 10,000 hrs; DL cost $300,000; MH: 7,000 hrs
OH allocation (Direct labor hours):
OH allocation (Direct labor cost):
OH allocation (MH):
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
A lot of firms use a single overhead rate Which allocation base is better? Labor intensive? Highly mechanized?
Activity Based Costing (ABC) assigns overhead costs to products using a number of allocation bases (discussed in ch5; save pg130-134 for ch5).
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
Indirect Manufacturing Costs Indirect Manufacturing Costs (Overhead) Allocation(Overhead) Allocation
Predetermined Indirect Cost (OH) Rate Utilize estimates rather than actual costs and
quantities
Why not use actual amounts? Because total actual overhead cost and total actual level
of the allocation base are not known until the end of the accounting period, making it impossible to determine the actual overhead rate until that time.
Allows decisions to be made based on budgeted amounts. Thus, we can have an immediate cost figure to determine the price to charge for a job (customer).
Overapplied OverheadOverapplied OverheadOverapplied OverheadOverapplied Overhead
If applied OH is greater than actual, OH is overapplied
Overapplied OH eliminated at end of period as follows:
-If small amount, Dr. Mfg. OH and Cr. COGS
-If relatively large amount, apportion and close to Work in Process, Finished Goods and COGS
Actual overheadcosts incurred
Overhead costsapplied to jobs
Ending Balance
Manufacturing Overhead
Underapplied OverheadUnderapplied OverheadUnderapplied OverheadUnderapplied Overhead
If actual OH is greater than applied, OH is underapplied
Underapplied OH eliminated at end of period as follows:
-If small amount, Dr. COGS and Cr. Mfg. OH
-If relatively large amount, apportion and close to Work in Process, Finished Goods and COGS
Actual overheadcosts incurred
Overhead costsapplied to jobs
Ending Balance
Manufacturing Overhead
Actual overhead was $1,500,000. The predetermined overhead rate was $17 per direct labor hour, and there were 100,000 direct labor hours. Overhead was:
a.Underapplied by $200,000b.Overapplied by $200,000c.Underapplied by $20,000d.Overapplied by $20,000
Job-Order versus Process Job-Order versus Process Costing Costing
Job-Order versus Process Job-Order versus Process Costing Costing
Job Order Costing Product: custom
e.g. construction Document: job cost
sheet WIP-job Job costs
=DM+DL+OH allocated
Process Costing Product: identical
e.g. producers of paints and plastics
Document: production cost report
WIP-department Cost accumulated by
each operation. Unit cost =total costs of
production/ total number of units produced
Job-Order and Process Costing Job-Order and Process Costing ExamplesExamples
Job-Order and Process Costing Job-Order and Process Costing ExamplesExamples
Relating Product Costs to Relating Product Costs to JobsJobs
Relating Product Costs to Relating Product Costs to JobsJobs
Process Costing:Process Costing:Cost Flows through Departments & Cost Flows through Departments &
AccountsAccounts
Process Costing:Process Costing:Cost Flows through Departments & Cost Flows through Departments &
AccountsAccounts
Process Costing:Costs and Units Process Costing:Costs and Units
Process costing is essentially a system of averaging. Manufacturing costs are divided by
equivalent units to calculate an average unit cost. A company that uses process costing system needs
to keep records for both product costs and units. Costs: Beg WIP + Cost Incurred during the
period=Cost Transferred out +End WIP Units: Units in Beg WIP+ Units started=Units
Completed + Units in End WIP
Handout Q2
Calculating Unit CostCalculating Unit CostCalculating Unit CostCalculating Unit Cost
Cost Per Equivalent UnitThe average unit cost is referred to as cost per equivalent unit
Calculating Unit CostCalculating Unit CostCalculating Unit CostCalculating Unit Cost
Equivalent Units Partially completed units are converted to a
comparable number of completed units, called equivalent unitse.g. 100 units that are 50% complete are equivalent to
50 complete units (100 x 50%)
Equivalent units may be different for material and conversion costs (labor and OH) if they enter production at different times. Easy to identify when materials are added
Materials are often added at the beginning of the process. Sometimes they are added evenly or at the end of the process.
Harder to identify when labor and overhead are added Often grouped together as conversion costs Assumed to be added evenly
Process Costing:Process Costing:Kent Chemicals ExampleKent Chemicals Example
Process Costing:Process Costing:Kent Chemicals ExampleKent Chemicals Example
Mixing Department Beginning Work in Process: 10,000 gallon (% complete: 100% materials, 80% conversion costs)
-Direct material costs = $18,000-Direct labor =$7,800-Overhead = $23,400
70,000 gallons started-Direct material costs = $142,000 -Direct labor cost = $62,200 - Overhead cost = $186,600
60,000 gallons completed. Ending WIP 100% completed for materials and 50% completed for conversion costs.
Required: Finish the product cost report for the mixing department of Kent (Handout Q3)
Dealing with Transferred-In CostDealing with Transferred-In CostDealing with Transferred-In CostDealing with Transferred-In Cost
Process Costing Systems generally use multiple processes
Items completed in one processing department, costs are transferred to the next department
Transferred-in costs are treated as direct materials in the next processing departing.
When units are completed in the final process, the costs are transferred to finished goods.
Drop a Product LineDrop a Product Line
Analysis involves calculating the change in income that will result from dropping the product line:
If income increases, the product line should be dropped
If income decreases, the product line should not be dropped
Note: Allocated costs are not relevant
Dropping a Product Line – Mercer Hardware Example
Dropping a Product Line – Mercer Hardware Example
ToolsHardwareSupplies
GardenSupplies
Total3 products
Sales $120,000 $200,000 $80,000 $400,000Traceable costs:
Cost of goods sold (81,000) (90,000) (60,000) (231,000)Other variable costs (2,000) (4,000) (1,000) (7,000)Direct fixed costs (8,000) (5,000) (3,500) (16,500)
Non-traceable costsCompany fixed costs (24,000) (40,000) (16,000) (80,000)
Division net income $5,000 $61,000 ($500) $65,500
Mercer HardwareProduct Line Income Statement
For the Year Ended December 31, 2006
Profit calculation with three product lines
Dropping a Product Line – Mercer Dropping a Product Line – Mercer Hardware ExampleHardware Example
Dropping a Product Line – Mercer Dropping a Product Line – Mercer Hardware ExampleHardware Example
ToolsHardwareSupplies
Total2 products
Total3 products
Sales $400,000Traceable costs:
Cost of goods sold (231,000)Other variable costs (7,000)Direct fixed costs (16,500)
Non-traceable costsCompany fixed costs (80,000)
Division net income $65,500
Total company fixed costs are $80,000 whether 2 or 3 products are sold
Mercer HardwareProduct Line Income Statement
For the Year Ended December 31, 2006
Profit calculation with two product lines
Beware of the Cost Allocation Death Spiral
Beware of the Cost Allocation Death Spiral
When dropping a product line- Common fixed costs are not
incremental- Common fixed cost allocation is spread
among remaining product lines
Management must understand and remember this impact when making decisions