product costing in service and manufacturing entities chapter 11

Product Costing in Service and Manufacturing Entities

Chapter 11

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada11-2

Introduction

Financial Accounting

Product costs are used to value inventory and

to compute cost ofgoods sold.

Managerial Accounting

Product costs are used for planning, control,

directing, and management decision

making.


TheProduct

Manufacturing Overhead

DirectLabour

DirectMaterial

Manufacturing Cost Flow


Direct Material

Example:Steel used tomanufacture

the automobile.

Raw material that is used to make,and can be conveniently

traced, to the finished product.


Cost of salaries, wages, and fringebenefits for personnel who work

directly on manufactured products.

Direct Labour

Example:Wages paid to an

automobile assemblyworker.


All other manufacturing costs


Materials used to support the production process. Examples: lubricants and

cleaning supplies used in an automobile assembly plant.

IndirectLabour

IndirectMaterial

OtherCosts




Cost of personnel who do not work directly on

the product. Examples: maintenance workers, janitors and security

guards.

IndirectLabour

IndirectMaterial

OtherCosts




Examples: depreciation on plant and equipment,

property taxes, insurance, utilities,

overtime premium, and unavoidable idle time.

IndirectLabour

IndirectMaterial

OtherCosts



Materials waiting to be processed.

Partially complete products – material to

which some labour and/or overhead has

been added.

Completed products awaiting sale.

Raw Materials

Finished Goods

Work-in-Process



Cost of Purchases

• Materials Used• Labour• Overhead

Cost of GoodsSold

Balance SheetIncome

StatementRaw

Materials

Total Mfg.Costs

Incurred

EndingInventory

EndingInventory

Cost of Goods Mfd.

EndingInventory

Work-in-Process

FinishedGoods


Cost Flow in Service Companies

Hotels

Attorneys

Banks

Hospitals ServiceCompanies

PublicAccountants

InsuranceFirmsAirlines

PlumbingCompanies


Service companies do not havework-in-process and finished

goods inventory accountswherein costs are stored before

being transferred to a cost ofgoods sold account.

Cost Flow in Service Companies


Let’s examine the cost flows in a manufacturing

company. We will use T-accounts and start with

materials.



Work in ProcessRaw Materials

Mfg. Overhead

•MaterialPurchases


•Direct Material

•Direct Material

•Indirect Material



Next let’s add labour costs and

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

with me?



•Direct Labour


•OverheadApplied to

Work inProcess

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.

•IndirectLabour

•Direct Labour

•Overhead Applied

•IndirectLabour

Wages Payable Work in Process

Mfg. Overhead


•Direct Material


Now let’s complete the

goods and sell them. Still with

me?



•Cost ofGoodsMfd.

Finished Goods

•Cost ofGoodsSold

•Cost ofGoodsMfd.

Cost of Goods Sold

•Cost ofGoodsSold

Work in Process•Direct

Material•Direct Labour

•Overhead Applied



Let’s look atthe January

transactions of Ventra

Manufacturing company.




Ventra pays $26,500 cash to purchase raw materials.

Raw Materials26,500

CashBal. 64,500

26,500Bal. 500



Ventra places $1,100 of raw materials into production in the process of making jewelry boxes.

Raw Materials

1,100

Work-in-ProcessBal. 0

26,500Bal. 500 1,100



Ventra pays $2,000 cash to purchase production supplies.

Production Supplies

26,500Cash

Bal. 64,500 2,000 2,000



Ventra pays production workers $1,400 cash.

26,500Cash

Bal. 64,500 2,000 1,100

Work-in-ProcessBal. 0

1,400 1,400



Ventra applies $1,680 of estimated manufacturing overhead costs at the end of the month of January.

Applied


Actual 1,100

Work-in-Process

1,400 1,680

1,680

Bal. 0

Applied overhead = 500 boxes × $3.36 per box


Estimated total manufacturingoverhead cost for the yearEstimated total units in theallocation base for the year

POHR =

A predetermined overhead rate (POHR) used to apply overhead to jobs is determined

before the period begins.

The Flow of Overhead Costs

$40,32012,000 jewelry boxes

POHR = = $3.36per box


Overhead applied = POHR × Actual activity

Actual amount of theallocation base such as

units produced, direct labour hours, or machine hours.

Based on estimates, and determined before the

period begins.



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.

$$




Ventra transfers the total cost of 500 jewelery boxes from work-in-process to finished goods.

Finished Goods

1,100

Work-in-Process

1,400 1,680

Bal. 0 4,180Bal. 836

4,180

100 boxes @ $8.36

Unit cost = $4,180 ÷ 500 boxes = $8.36 per box



Ventra recognizes cost of goods sold expense for 400 jewelry boxes sold to customers.

Finished Goods

4,180Bal. 836

Cost of Goods Sold 3,344 3,344

400 boxes @ $8.36 per box = $3,344



Ventura recognizes $5,600 of sales revenue for 400 boxes sold.

Revenue 5,600

400 boxes @ $14.00 per box = $5,600

26,500Cash

Bal. 64,500 2,000 1,400

5,600



Ventura pays $1,200 cash for actual manufacturing overhead costs including indirect labour, utilities, rent, etc.

26,500Cash

Bal. 64,500 2,000 1,400

5,600Applied


Actual 1,680 1,200

1,200



Ventura pays $1,200 cash for actual manufacturing overhead costs including indirect labour, utilities, rent, etc.

26,500Cash

Bal. 64,500 2,000 1,400

5,600Applied


Actual 1,680 1,200

1,200

Manufacturing overhead is $480 overapplied at the end of

January. If a difference between actual and applied overhead exists at year end, the amount will be closed to

cost of goods sold.



At the end of the year,Ventra has the following

account balances:



Supplies: $2,000 purchased, $1,700 used.

See Cost of GoodsManufactured and

Sold Schedule



Explanation of Manufacturing

Overhead balance follows.



Applied


Actual39,64843,400

3,752

Manufacturing overhead is $3,752 underapplied.

11,800 boxes manufactured × $3.36 POHR



Applied


Actual39,64843,400

3,752

Manufacturing overhead is $3,752 underapplied.

Cost of Goods Sold 83,600

10,000 boxes @ $8.36

3,752 3,752

Underapplied overhead is closed to Cost of Goods Sold leaving a zero balance in the

overhead account.

87,352


Analyzing the Underapplied Overhead

Spending variance$3,080 unfavorable

$43,400 $40,320 $39,648

Volume variance$672 unfavorable

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

Total variance is $3,752 unfavorable, theamount of underapplied overhead.



Let’s prepare aSchedule of Cost of Goods

Manufactured and Soldfor Ventra.


Preparing a Cost of Goods Manufactured and Sold Schedule

Direct Raw Material Used 25,960$ Direct Labour 33,040 Manufacturing Overhead Applied 39,648 Total Manufacturing Costs 98,648 Plus : Beginning Work-in-Process Inventory 0Total Work-in-Process Inventory 98,648 Less Ending Work-in-Process Inventory 8,360 Cost of goods manufactured 90,288 Plus Beginning Finished Goods Inventory 836 Cost of Goods Available for Sale 91,124 Less Ending Finished Goods Inventory 7,524 Cost of Goods Sold-Unadjusted 83,600 Plus : Under Applied Overhead 3,752 Cost of Goods Sold-Actual 87,352$


Ventra Manufacturing CompanySchedule of Cost of Goods Manufactured and Sold

Direct Raw Material Used 25,960$ Direct Labour 33,040 Manufacturing Overhead Applied 39,648 Total Manufacturing Costs 98,648 Plus Beginning Work-in-Process Inventory 0Total Work-in-Process Inventory 98,648 Less Ending Work-in-Process Inventory 8,360 Cost of goods manufactured 90,288 Plus Beginning Finished Goods Inventory 836 Cost of Goods Available for Sale 91,124 Less Ending Finished Goods Inventory 7,524 Cost of Goods Sold 83,600

Computation of Direct Raw Materials Used

Beginning Raw Materials Inventory 500$ Plus Purchases 26,500 Raw Materials Available for Use 27,000 Less Ending Raw Materials Inventory 1,040 Direct Raw Materials Used 25,960$



Direct Raw Material Used 25,960$ Direct Labour 33,040 Manufacturing Overhead Applied 39,648 Total Manufacturing Costs 98,648 Plus Beginning Work-in-Process Inventory 0Total Work-in-Process Inventory 98,648 Less Ending Work-in-Process Inventory 8,360 Cost of goods manufactured 90,288 Plus Beginning Finished Goods Inventory 836 Cost of Goods Available for Sale 91,124 Less Ending Finished Goods Inventory 7,524 Cost of Goods Sold-Unadjusted 83,600 Plus: Under Applied Overhead 3,752 Cost of Goods Sold-Unadjusted 87,352$


Reported in the current assets section of the balance sheet.


Let’s look at theIncome Statement

for Ventra.

Financial Statements



Ventra Manufacturing CompanyIncome Statement

For the Year Ended December 31, 20X2

Sales revenue (10,000 boxes @$14.00) 140,000$ Cost of Goods Sold 87,352 Gross margin 52,648 Selling and Administrative Expenses 31,400 Net income 21,248$


Let’s look at theBalance Sheet

for Ventra.




Assets Cash 79,860$ Raw Materials Inventory 1,040 Work-inProcess Inventory 8,360 Finished Goods Inventory 7,524 Production Supplies 300 Manufacturing Equipment 40,000$ Less Accumulated Amortization 20,000 Book Value Manufacturing Equipment 20,000 Total Assets 117,084

Shareholder's Equity Common Stock 76,000 Retained Earnings 41,084 Total Shareholders' Equity 117,084$

Ventra Manufacturing CompanyBalance Sheet

As of December 31, 20X2


Let’s look at theCash Flow Statement

for Ventra.




Cash Outflows for Production of Inventory: Raw Material Purchases 26,500$ Labour ($1,400 + $31,640) 33,040 Supplies 2,000 Other Manufacturing Overhead ($1,200 + $30,500) 31,700 Total 93,240


Let’s compare absorption and

variable costing.

The Motive to Overproduce – Absorption Costing



Reeve Manufacturing Company incurs the followingcosts to produce 2,000 units of inventory:

Let’s see what happens to costsif Reeve increases production.


Now let’s compute income at the three levelof production if Reeve sells 2,000 units.




Level of Production 2000 3000 4000Sales @ $20 per unit × 2,000 units 40,000$ 40,000$ 40,000$ Cost of Goods Sold $15 per unit × 2,000 units 30,000 $13 per unit × 2,000 units 26,000 $12 per unit × 2,000 units 24,000 Gross Margin 10,000$ 14,000$ 16,000$

Internally, many companies use variable costingto motivate managers to increase profitability

without motivating them to overproduce.


Variable Costing

Net income is not affected by production increases.


End of Chapter 11

product costing in service and manufacturing entities chapter 11

Documents