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2010 The McGraw-Hill Companies, Inc.
Systems Design: Job-Order Costing
Chapter 3
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McGraw-Hill/Irwin Slide 2
Learning Objective 1
Distinguish betweenprocess costing and job-order costing and identifycompanies that would use
each costing method.
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McGraw-Hill/Irwin Slide 3
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
A company produces many units of a singleproduct.
One unit of product is indistinguishable fromother units of product.
The identical nature of each unit of product enablesassigning the same average cost per unit.
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McGraw-Hill/Irwin Slide 4
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
A company produces many units of a singleproduct.
One unit of product is indistinguishable fromother units of product.
The identical nature of each unit of product enablesassigning the same average cost per unit.
Example companies:
1. Weyerhaeuser (paper manufacturing)2. Reynolds Aluminum (refining aluminum ingots)3. Coca-Cola (mixing and bottling beverages)
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McGraw-Hill/Irwin Slide 5
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
Many different products are produced each period.
Products are manufactured to order.
The unique nature of each order requires tracing orallocating costs to each job, and maintaining costrecords for each job.
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McGraw-Hill/Irwin Slide 6
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
Many different products are produced each period.
Products are manufactured to order.
The unique nature of each order requires tracing orallocating costs to each job, and maintaining costrecords for each job.
Example companies:1. Boeing (aircraft manufacturing)
2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)
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Comparing Process and Job-Order Costing
Job-Order Process
Number of jobs worked Many Single Product
Cost accumulated by
Job Department
Average cost computed by Job Department
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Quick Check
Which of the following companies would belikely to use job-order costing rather thanprocess costing?
a. Scott Paper Company for Kleenex.b. Architects.
c. Heinz for ketchup.
d. Caterer for a wedding reception.e. Builder of commercial fishing vessels.
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Quick Check
Which of the following companies would belikely to use job-order costing rather thanprocess costing?
a. Scott Paper Company for Kleenex.b. Architects.
c. Heinz for ketchup.
d. Caterer for a wedding reception.e. Builder of commercial fishing vessels.
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Learning Objective 2
Identify the documents
used in a job-order costingsystem.
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ManufacturingOverhead
Job No. 1
Job No. 2
Job No. 3
Chargedirect
material anddirect labor
costs to
each job aswork is
performed.
Job-Order CostingAn Overview
Direct Materials
Direct Labor
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ManufacturingOverhead,includingindirect
materialsandindirect labor,are allocated
to all jobsrather thandirectly tracedto each job.
Indirect Manufacturing Costs
Direct Materials
Direct Labor
Job No. 1
Job No. 2
Job No. 3ManufacturingOverhead
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PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-09
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing OverheadReq. No. Amount Ticket Hours Amount Hours Rate Amount
Cost Summary Units Shipped
Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
The Job Cost Sheet
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Measuring Direct Materials Cost
Will E. Delite
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Measuring Direct Materials Cost
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Measuring Direct Labor Costs
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Job-Order Cost Accounting
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Learning Objective 3
Compute predeterminedoverhead rates and explainwhy estimated overhead
costs (rather than actualoverhead costs) are used inthe costing process.
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Why Use an Allocation Base?
Manufacturing overhead is applied to jobs that arein process. An allocation base, such as directlabor hours, direct labor dollars, or machine hours,
is used to assign manufacturing overhead to
individual jobs.
We use an allocation base because:
1.It is impossible or difficult to trace overhead costs to particular jobs.
2.Manufacturing overhead consists of many different items rangingfrom the grease used in machines to production managers salary.
3.Many types of manufacturing overhead costs are fixed even thoughoutput fluctuates during the period.
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The predetermined overhead rate (POHR)used toapply overhead to jobs is determined before theperiod begins.
Manufacturing Overhead Application
Estimated total manufacturingoverhead cost for the coming period
Estimated total units in theallocation base for the coming period
POHR =
Ideally, the allocation baseis a cost driver that causes
overhead.
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Using a predetermined rate makes itpossible to estimate total job costs sooner.
Actual overhead for the period is notknown until the end of the period.
The Need for a POHR
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Determining Predetermined Overhead Rates
Predetermined overhead rates are calculatedusing a three-step process.
Estimate the level of
production for theperiod.
Estimate total amountof the allocation base
for the period.
Estimate totalmanufacturing
overhead costs.
POHR =
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McGraw-Hill/Irwin Slide 23
Actual amount of allocation isbased upon the actual level of
activity (normal costing system).
Based on est imates, anddetermined before the
period begins.
Application of Manufacturing Overhead
Overhead applied = POHR Actual activity
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McGraw-Hill/Irwin Slide 24
For each direct labor hour worked on a particular job,$4.00 of factory overhead will be applied to that job.
Overhead Application Rate
POHR = $4.00 per DLH
$640,000
160,000 direct labor hours (DLH)POHR =
Estimated total manufacturingoverhead cost for the coming period
Estimated total units in theallocation base for the coming period
POHR =
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McGraw-Hill/Irwin Slide 25
Job-Order Cost Accounting
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McGraw-Hill/Irwin Slide 26
Job-Order Cost Accounting
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McGraw-Hill/Irwin Slide 27
Interpreting the Average Unit Cost
The average unit cost should not be interpretedas the costs that would actually be incurred if an
additional unit was produced.
Fixed overhead would not change if another unitwas produced, so the incremental cost of
another unit is something less than $118.
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McGraw-Hill/Irwin Slide 28
Quick Check
Job WR53 at NW Fab, Inc. required $200 of directmaterials and 10 direct labor hours at $15 per hour.Estimated total overhead for the year was $760,000and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.d. $730.
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McGraw-Hill/Irwin Slide 29
Job WR53 at NW Fab, Inc. required $200 of directmaterials and 10 direct labor hours at $15 per hour.Estimated total overhead for the year was $760,000and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.d. $730.
Quick Check
POHR = $760,000/20,000 hours $38
Direct materials $200Direct labor $15 x 10 hours $150
Manufacturing overhead $38 x 10 hours $380
Total cost $730
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McGraw-Hill/Irwin Slide 30
Learning Objective 4
Understand the flow of costsin a job-order costing system
and prepare appropriate
journal entries to recordcosts.
J b O d C ti
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McGraw-Hill/Irwin Slide 31
Job-Order CostingDocument Flow Summary
A sales order is thebasis of issuing a
production order.
A productionorder initiates
work on a job.
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McGraw-Hill/Irwin Slide 32
Job-Order CostingDocument Flow Summary
Job CostSheets
MaterialsRequisition
ManufacturingOverheadAccount
Directmaterials
Indirectmaterials
Materialsused may be
either direct or
indirect.
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McGraw-Hill/Irwin Slide 33
Job-Order CostingDocument Flow Summary
Job CostSheets
Employee TimeTicket
ManufacturingOverheadAccount
Anemployeestime may be either
direct or
indirect.
DirectLabor
IndirectLabor
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McGraw-Hill/Irwin Slide 34
Job-Order CostingDocument Flow Summary
ManufacturingOverheadAccount
OtherActual OHCharges
Job CostSheets
POHR
rate used
to apply
overhead
MaterialsRequisition
EmployeeTime Ticket
Indirect
Labor
Indirect
Material
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McGraw-Hill/Irwin Slide 35
Learning Objectives 4 and 7
Understand the flow of costs in a job-order costing system and prepareappropriate journal entries to record
costs.
Use T-accounts to show the flow ofcosts in a job-order costing system.
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McGraw-Hill/Irwin Slide 36
Job-Order Costing: The Flow of Costs
The transactions (in T-account and journal
entry form) that capturethe flow of costs in a
job-order costingsystem are illustrated on
the following slides.
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McGraw-Hill/Irwin Slide 37
Raw MaterialsMaterial
Purchases
Mfg. Overhead
Work in Process(Job Cost Sheet)
Actual Appl ied
DirectMaterials Direct
Materials
IndirectMaterials
Indirect
Materials
The Purchase and Issue of Raw Materials
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McGraw-Hill/Irwin Slide 38
Cost FlowsMaterial Purchases
Raw material purchases are recorded in aninventory account.
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McGraw-Hill/Irwin Slide 39
Cost FlowsMaterial Usage
Direct materials issued to a job increase Work inProcess and decrease Raw Materials. Indirectmaterials used are charged to ManufacturingOverhead and also decrease Raw Materials.
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McGraw-Hill/Irwin Slide 40
Mfg. Overhead
Salaries andWages Payable Work in Process(Job Cost Sheet)
DirectMaterials
DirectLabor
DirectLabor
IndirectMaterials
Actual Appl ied
IndirectLabor
IndirectLabor
The Recording of Labor Costs
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McGraw-Hill/Irwin Slide 41
The Recording of Labor Costs
The cost of direct labor incurred increases Workin Process and the cost of indirect labor
increases Manufacturing Overhead.
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McGraw-Hill/Irwin Slide 42
Mfg. Overhead
Salaries and
Wages Payable
Work in Process
(Job Cost Sheet)Direct
Materials
Direct
Labor
DirectLabor
Indirect
Materials
Actual Appl ied
IndirectLabor
Indirect
Labor
Recording Actual Manufacturing Overhead
OtherOverhead
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McGraw-Hill/Irwin Slide 43
Recording Actual Manufacturing Overhead
In addition to indirect materials and indirect labor,other manufacturing overhead costs are chargedto the Manufacturing Overhead account as they
are incurred.
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McGraw-Hill/Irwin Slide 44
Learning Objective 5
Apply overhead cost toWork in Process using apredetermined overhead
rate.
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McGraw-Hill/Irwin Slide 45
Mfg. Overhead
Salaries and
Wages Payable
Work in Process
(Job Cost Sheet)Direct
Materials
Direct
Labor
DirectLabor
Indirect
Materials
Actual Appl ied
IndirectLabor
Indirect
Labor
Applying Manufacturing Overhead
OtherOverhead
OverheadApplied
OverheadApplied to
Work inProcess
If actual and appliedmanufacturing overheadare not equal, a year-endadjustment is required.
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McGraw-Hill/Irwin Slide 46
Applying Manufacturing Overhead
Work in Process is increased when ManufacturingOverhead is applied to jobs.
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McGraw-Hill/Irwin Slide 47
Accounting for Nonmanufacturing Cost
Nonmanufacturing costs are not assigned toindividual jobs, rather they are expensed in the
period incurred.
Examples:1. Salary expense of employees
who work in a marketing, selling,
or administrative capacity.2. Advertising expenses are expensedin the period incurred.
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McGraw-Hill/Irwin Slide 48
Accounting for Nonmanufacturing Cost
Nonmanufacturing costs (period expenses) arecharged to expense as they are incurred.
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McGraw-Hill/Irwin Slide 50
Finished GoodsWork in Process(Job Cost Sheet )
DirectMaterials
DirectLabor
OverheadApplied
Cost ofGoods
Mfd.
Cost ofGoods
Mfd.
Transferring Completed Units
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McGraw-Hill/Irwin Slide 51
Transferring Completed Units
As jobs are completed, the Cost of GoodsManufactured is transferred to Finished Goods from
Work in Process.
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McGraw-Hill/Irwin Slide 52
Finished Goods
Cost of Goods Sold
Work in Process(Job Cost Sheet)
DirectMaterials
DirectLabor
OverheadApplied
Cost ofGoods
Mfd.
Cost ofGoods
Mfd.
Cost ofGoodsSold
Cost ofGoods
Sold
Transferring Units Sold
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McGraw-Hill/Irwin Slide 53
Transferring Units Sold
When finished goods are sold, two entries arerequired: (1) to record the sale, and (2) to record
the Cost of Goods Sold.
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McGraw-Hill/Irwin Slide 54
Learning Objective 8
Compute underapplied oroverapplied overhead cost andprepare the journal entry to
close the balance in
Manufacturing Overhead to theappropriate accounts.
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McGraw-Hill/Irwin Slide 55
Problems of Overhead Application
The difference between the overhead cost applied toWork in Process and the actual overhead costs of aperiod is referred to as either underapplied or
overapplied overhead.
Underapplied overheadexists when the amount ofoverhead applied to jobs
during the period using the
predetermined overheadrate is less thanthe total
amount of overhead actuallyincurred during the period.
Overapplied overheadexists when the amount ofoverhead applied to jobs
during the period using the
predetermined overheadrate is greater thanthe totalamount of overhead actuallyincurred during the period.
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McGraw-Hill/Irwin Slide 56
PearCos actual overheadfor the year was $650,000with a total of 170,000direct labor hours worked on
jobs.
How much total overhead was applied to PearCos jobs
during the year? Use PearCos predeterminedoverhead rate of $4.00 per direct labor hour.
Overhead Application Example
Overhead Applied During the Period
Applied Overhead = POHR Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
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McGraw-Hill/Irwin Slide 57
PearCos actual overheadfor the year was $650,000with a total of 170,000direct labor hours worked on
jobs.
How much total overhead was applied to PearCos jobs
during the year? Use PearCos predeterminedoverhead rate of $4.00 per direct labor hour.
Overhead Applied During the Period
Applied Overhead = POHR Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
Overhead Application Example
PearCo has overappliedoverhead for the yearby $30,000. What will
PearCo do?
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McGraw-Hill/Irwin Slide 59
Tiger, Inc. had actual manufacturing overheadcosts of $1,210,000 and a predetermined overheadrate of $4.00 per machine hour. Tiger, Inc. worked290,000 machine hours during the period. Tigers
manufacturing overhead is
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
Quick Check
Overhead Applied$4.00 per hour 290,000 hours= $1,160,000
Underapplied Overhead$1,210,000 - $1,160,000= $50,000
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Disposition of
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McGraw-Hill/Irwin Slide 61
Disposition ofUnder- or Overapplied Overhead
PearCosMfg. Overhead
Actual
overheadcosts
$650,000
$30,000overapplied
PearCos Costof Goods Sold
Unadjusted
Balance
AdjustedBalance $30,000
$30,000
Overhead
appliedto jobs
$680,000
Allocating Under- or Overapplied
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McGraw-Hill/Irwin Slide 62
g ppOverhead Between Accounts
Assume the overhead applied in ending Work inProcess Inventory, ending Finished GoodsInventory, and Cost of Goods Sold is shown below:
Amount
Percent of
Total
Allocation
of $30,000Work in process 68,000$ 10% 3,000$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000$ 100% 30,000$
Allocating Under- or Overapplied
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McGraw-Hill/Irwin Slide 63
g ppOverhead Between Accounts
Amount
Percent of
Total
Allocation
of $30,000Work in process 68,000$ 10% 3,000$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000$ 100% 30,000$
We would complete the following allocation of$30,000 overapplied overhead:
10% $30,000
Allocating Under- or Overapplied
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McGraw-Hill/Irwin Slide 64
g ppOverhead Between Accounts
Amount Percent ofTotal Allocation of$30,000
Work in process 68,000$ 10% 3,000$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000$ 100% 30,000$
Overapplied and Underapplied Manufacturing
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McGraw-Hill/Irwin Slide 65
Overapplied and Underapplied ManufacturingOverhead - Summary
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . of Goods Sold Allocation
UNDERAPPLIED INCREASE INCREASECost of Goods Sold Work in Process
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold
OVERAPPLIED DECREASE DECREASE
Cost of Goods Sold Work in Process(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold
PearCos
Method
More accurate but more complex to compute.
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McGraw-Hill/Irwin Slide 66
Quick Check
What effect will the overappliedoverhead haveon PearCosnet operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.c. Net operating income will decrease.
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McGraw-Hill/Irwin Slide 67
Quick Check
What effect will the overapplied overhead haveon PearCosnet operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.c. Net operating income will decrease.
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McGraw-Hill/Irwin Slide 68
May be more complexbut . . .
Multiple Predetermined Overhead Rates
To this point, we have assumed that there is a singlepredetermined overhead rate called a plantwideoverhead rate.
Large companiesoften use multiple
predeterminedoverhead rates.
May be more accurate becauseit reflects differences across
departments.
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McGraw-Hill/Irwin Slide 69
Job-Order Costing in Service Companies
Job-order costing is used in many differenttypes of service companies.
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McGraw-Hill/Irwin Slide 70
The Use of Information Technology
Technology plays an important part in manyjob-order cost systems. When combined with
Electronic Data Interchange (EDI) or a web-basedprogramming language called Extensible Markup
Language (XML), bar coding eliminates theinefficiencies and inaccuracies associated with
manual clerical processes.
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2010 The McGraw-Hill Companies, Inc.
The Predetermined Overhead Rateand Capacity
Appendix 3A
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McGraw-Hill/Irwin Slide 72
Learning Objective 9
(Appendix 3A)Understand the implications of
basing the predeterminedoverhead rate on activity at
capacity rather than onestimated activity for the period.
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McGraw-Hill/Irwin Slide 73
Predetermined Overhead Rate and Capacity
Calculating predetermined overhead rates using anestimated, or budgeted amount of the allocation basehas been criticized because:
1.Basing the predetermined overhead rate uponbudgeted activity results in product costs that fluctuatedepending upon the activity level.
2.Calculating predetermined rates based upon
budgeted activity charges products for costs that theydo not use.
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McGraw-Hill/Irwin Slide 74
Capacity-Based Overhead Rates
Criticisms can be overcome by usingestimated total units in the allocation base
at capacity in the denominator of the
predetermined overhead rate calculation.
Lets look at the difference!
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McGraw-Hill/Irwin Slide 75
An Example
Equipment is leased for $100,000 peryear. Running at full capacity, 50,000units may be produced. The company
estimates that 40,000 units will beproduced and sold next year. What is
the predetermined overhead rate?
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McGraw-Hill/Irwin Slide 76
An Example
Equipment is leased for $100,000 per year.Running at full capacity, 50,000 units may beproduced. The company estimates that 40,000 units
will be produced and sold next year.
TraditionalMethod
= $2.50 per unit$100,000
40,000=
CapacityMethod
= $2.00 per unit$100,00050,000
=
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McGraw-Hill/Irwin Slide 77
Quick Check
Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. At fullcapacity, it can cork 50,000 cases of wine peryear. The company estimates 40,000 cases of
wine will be produced and sold next year. Whatis the predetermined overhead rate based on theestimatednumber of cases of wine?
a. $2.00 per case.
b. $2.50 per case.c. $4.00 per case.
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McGraw-Hill/Irwin Slide 78
Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. At fullcapacity, it can cork 50,000 cases of wine peryear. The company estimates 40,000 cases of
wine will be produced and sold next year. Whatis the predetermined overhead rate based on theestimatednumber of cases of wine?
a. $2.00 per case.
b. $2.50 per case.c. $4.00 per case.
Quick Check
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McGraw-Hill/Irwin Slide 79
Quick Check
Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. At fullcapacity, it can cork 50,000 cases of wine peryear. The company estimates 40,000 cases of
wine will be produced and sold next year. Whatis the predetermined overhead rate based on thenumber of cases of wineat capacity?
a. $2.00 per case.
b. $2.50 per case.c. $4.00 per case.
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McGraw-Hill/Irwin Slide 80
Crest Winery in Woodinville leases an automaticcorking machine for $100,000 per year. At fullcapacity, it can cork 50,000 cases of wine peryear. The company estimates 40,000 cases of
wine will be produced and sold next year. Whatis the predetermined overhead rate based on thenumber of cases of wineat capacity?
a. $2.00 per case.
b. $2.50 per case.c. $4.00 per case.
Quick Check
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McGraw-Hill/Irwin Slide 81
Quick Check
When capacityis used in the denominator of the
predetermined rate, what happens to thepredetermined overhead rate as estimated activitydecreases?
a. The predetermined overhead rate goes up when activity
goes down.
b. The predetermined overhead rate stays the same becauseit is not affected by changes in activity.
c. The predetermined overhead rate goes down when activity
goes down.
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McGraw-Hill/Irwin Slide 82
When capacityis used in the denominator of the
predetermined rate, what happens to thepredetermined overhead rate as estimated activitydecreases?
a. The predetermined overhead rate goes up when activity
goes down.
b. The predetermined overhead rate stays the same becauseit is not affected by changes in activity.
c. The predetermined overhead rate goes down when activity
goes down.
Quick Check
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McGraw-Hill/Irwin Slide 83
Quick Check
When estimated activityis used in the
denominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the samebecause it is not affected by changes in activity.
c. The predetermined overhead rate goes down when
activity goes down.
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McGraw-Hill/Irwin Slide 84
When estimated activityis used in the
denominator of the predetermined rate, whathappens to the predetermined overhead rate asestimated activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the samebecause it is not affected by changes in activity.
c. The predetermined overhead rate goes down when
activity goes down.
Quick Check
I S P i C i
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McGraw-Hill/Irwin Slide 85
Income Statement PreparationCapacity
Actual volume 40,000 cases
Selling price $40.00 per caseVariable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Capacity 50,000 cases
Predetermined overhead rate $2.00 per case
Fixed selling and admin. expense $500,000 per year
Revenue 1,600,000$
Cost of goods sold 1,040,000
Gross margin 560,000
Cost of idle capacity 20,000Selling and admin. expense 500,000
Net operating income 40,000$
I St t t P ti T diti l
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McGraw-Hill/Irwin Slide 86
Income Statement PreparationTraditional
Actual volume 40,000 cases
Selling price $40.00 per caseVariable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Capacity 40,000 cases
Predetermined overhead rate $2.50 per case
Fixed selling and admin. expense $500,000 per year
Revenue 1,600,000$
Cost of goods sold 1,060,000
Gross margin 540,000
Cost of idle capacity -Selling and admin. expense 500,000
Net operating income 40,000$
E d f Ch t 3
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End of Chapter 3