Fundamentals of Productand Service Costing

Cost Accounting-IIDr. Salah Hammad

Lecture 1

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Cost System

Keys to a good cost system:

• Oriented to the needs of the decision makers

• Designed so that benefits exceed costs

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Cost Management Systems

• The objective of the cost management systemis to provide information about costs relevantfor decision making.

• The cost system accumulates and reports costsabout processes, products, and services.

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Reasons to Calculate Productor Service Costs

• For decision making

• For deciding what to sell

• For setting prices

• For knowing the cost of goods sold

• For knowing the cost of inventory

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Cost Allocation and Product Costing

Basic Cost Flow Diagram

Directmaterials

Directlabor

Manufacturingoverhead

Alpha Beta

Costpools

Costobjects

Costallocation

rule

Indirect

(allocated by direct

labor cost)Direct

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Fundamental Themes Underlyingthe Design of Cost Systems

• Cost systems should have a decision focus.

• Different cost information is used fordifferent purposes.

• Cost information for managerial purposesmust meet the cost-benefit test.

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Basic Cost Flow Model

• How costs and units move through inventories:

Beginningbalance

Transfersin

Transfersout

Endingbalance

+ – =

BB TI TO EB+ – =

• This is true for the following accounts:– Raw Materials (RM)– Work-in-Process (WIP)– Finished Goods (FG)

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Costing with No Work-in-Process Inventories

• Baxter Paint begins production on April 1.

• It starts and completes production of 100,000gallons of paint in April and has no endingwork-in-process inventory.

Materials $ 400,000Labor 100,000

Manufacturing overhead 500,000Total $1,000,000

Cost of resources used in April:

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Costing with No Work-in-Process Inventories

BB TI TO EB+ – =

0100,000gallons

100,000gallons

0+ – =

FG

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Costing with No Work-in-Process Inventories

• What are the costs at the end of the period?

• $1,000,000 was added to work-in-processand then transferred out to finished goods.

• Since Baxter produced 100,000 gallons ofpaint, then the cost per gallon of paint is $10.

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Costing with Work-in-Process Inventories

Beginning inventory -0-Started in May 110,000

Total 110,000Ending WIP (50% complete) 20,000Transferred out 90,000

Production for Baxter Paint for May follows (gallons):

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Costing with Work-in-Process Inventories

BB TI TO EB+ – =

0110,000gallons

90,000gallons

20,000 gallons(50% complete)

+ – =

FG

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Costing with Work-in-Process Inventories

• How do we cost Baxter’s 20,000 gallons of paint thatare only half finished?

• 20,000 gallons half finished is equivalent to 10,000gallons finished.

• 90,000 gallons transferred out plus 10,000 equivalent gallonsof finished paint equals 100,000 equivalent gallons of paint.

Gallons of paint transferred out 90,000Equivalent gallons of finished paint 10,000Total equivalent gallons of paint 100,000

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Costing with Work-in-Process Inventories

Materials $390,000Labor 100,000

Manufacturing overhead 500,000Total $990,000

Costs incurred in May:

$990,000/100,000 gallons = $9.90 per gallon

90,000 gallons × $9.90/gallon = $891,000

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Costing with Work-in-Process Inventories

Direct material + Direct labor + Overhead($990,000)

Finished goodsinventory$891,000

Work-in-processinventory$99,000

Equivalent gallons90,000gallons(90%)

10,000gallons(10%)

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