Accumulating and Assigning Costs to Products Chapter 4.

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


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):



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).



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

Practice ExcercisesPractice Excercises

Handout Q1: Job order vs Process costing

E4-27

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


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

PracticePractice

Group Case 4-51

Accumulating and Assigning Costs to Products Chapter 4.

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