Fundamentals of Product & Service Costing Chapter 5

Learning Objectives Explain the fundamental themes underlying the design of cost systems. Explain how cost allocation is used in a cost management system. Explain how a basic product costing system works. Understand how overhead cost is allocated to products. Explain the operation of a two-stage allocation system for product costing. Describe the three basic types of product costing systems: job order, process and operations.

Cost System Keys to a good cost system Oriented to the needs of the decision makers Designed so that benefits exceed costs

Cost System Objective L.O. 1 Explain the fundamental themes underlying the design of cost systems. Provide information about costs relevant for decision making. The cost system accumulates and reports costs about processes, products, and services.

Why Calculate the Cost of a Product? For Decision Making What should we sell? At what sales price? What is the cost of goods sold? What is the cost of inventory?

Designing a Cost System Decision making Focus Different information for different purposes Financial the past Managerial the future Test Cost-benefit

Cost Allocation $ Direct materials $ Direct labor $ Overhead DM DL OH L.O. 2 Explain how cost allocation is used in a cost management system. $ Direct materials $ Direct labor $ Overhead DM DL OH Traced Directly Allocated using Direct labor $ Product A Product B

The Inventory Accounts Balance Sheet Raw Materials Work-In-Process Finished Goods Beg. Inventory Beg. Inventory Beg. Inventory Cost of Goods Completed and Transferred from WIP + + Purchases Direct Materials Transferred from Raw Materials + Raw Materials Available for Production = Direct Labor + Goods Available for Sale = Manufacturing Overhead + Raw Materials Transferred to WIP - Raw Materials Transferred to WIP - Cost of Goods Sold - Total Manufacturing Costs = Ending Inventory = Ending Inventory = Cost of Goods Completed and Transferred to Finished Goods - Cost of Goods Completed and Transferred to Finished Goods - To the income statement Ending Inventory =

A Product Costing System at Work L.O. 3 Explain how a basic product costing system works. How costs and units move through inventories. Beginning Balance Transfers In Transfers Out Ending Balance BB TI TO EB BB TI TO EB BB TI TO EB True for Raw Materials RM Work-In-Process WIP Finished Goods FG

Product Costing System Continued How costs and units move through inventories. RM DM to WIP BB Purchases EB IM to OH WIP DM Transfers to FG BB DL EB OH FG Transfers from WIP EB BB Cost of goods sold To income statement

Product Costing System Continued Baxter Paint April WIP Inventory Units – gallons of paint BB TO EB TI 100,000 gallons 100,000 gallons FG

A Product Costing System at Work Baxter Paint April WIP Inventory Costs BB TI TO EB DM $400,000 $0 $1,000,000 $0 DL $100,000 OH $500,000 $1,000,000 FG Cost per gallon $1,000,000 $10 per gallon 100,000

Work-In-Process Costs Let’s rewrite the basic cost flow model BB TI TO EB What are the costs? Where are the costs at the end of the period? DM DL OH $400,000 $100,000 $500,000 $1,000,000 $0 $1,000,000 $0 FG

Costing with Ending WIP Inventory Baxter Paint May WIP Units BB TI TO EB 110,000 gallons 90,000 gallons 20,000 gallons These gallons are half finished. FG

Equivalent Units Ending WIP Inventory How do we cost Baxter’s 20,000 gallons of paint that are only half finished? 20,000 gallons ½ finished Equivalent to 10,000 gallons finished 20,000 .5 90,000 To FG 10,000 Ending WIP Total equivalent units 100,000

Costing a Product Continued Baxter Paint May WIP Costs BB TI TO EB DM $390,000 ? ? $0 DL $100,000 OH $500,000 $990,000 FG Where is the $990,000? What is the cost of the 90,000 gallons transferred to FG and the 20,000 gallons still in WIP?

Costing a Product Continued Cost Flow Diagram Product Costing at Baxter Paints DM DL OH $390,000 $100,000 $500,000 Total $990,000 90,000 gallons 10,000 gallons Equivalent Gallons (90%) (10%) 100,000 FG WIP $891,000 $99,000

Costing Multiple Products Sammy’s Skis and Boards Units Skis Snowboards Total 500 150 650 Units produced 4,000 900 4,900 Direct labor hours 2,000 450 2,450 Machine hours Costs 75,000 15,000 90,000 Direct Material 100,000 22,500 122,500 Direct Labor

Costing Multiple Products Direct Materials Direct Labor $90,000 $122,500 Cost Pools Direct Direct Cost Objects Skis Snowboards $75,000 $15,000 $100,000 $22,500

Predetermined Overhead Rates L.O. 4 Understand how overhead cost is allocated to products. OH is indirect. Where do indirect costs belong? With the skis? Or with the boards? Indirect costs are allocated using a predetermined overhead rate. POHR POHR is the cost per unit of the allocation base used to charge overhead to products. $ POHR Base

Predetermined Overhead Rates Continued What are the estimated costs? Estimated overhead $ POHR Estimated allocation base What activity drives the overhead costs? Why use estimates? We need to cost products during the period. We don’t know the exact amount of indirect costs until the end of the period.

Sammy’s Skis and Boards Snowboards Total 4,000 900 4,900 Direct Labor hours Estimated Overhead Costs $98,000 $98,000 POHR $20 / DLH 4,900

Allocating OH to the Products Cost Pool OH $98,000 Cost Allocation Rule $20 / DLH Direct Labor Hours Cost Objects Skis Snowboards $80,000 $18,000 4,000DLH $20 900DLH $20

Sammy’s Skis and Boards Snowboards Total Units Units produced 500 150 650 Direct Labor hours 4,000 900 4,900 Costs Direct Material $75,000 $15,000 $90,000 Direct Labor 100,000 22,500 122,500 OH @ $20/DLH 80,000 18,000 98,000 Total $255,000 $55,500 $310,500 Cost per unit $510 $370

Two-Stage Allocation Systems L.O. 5 Explain the operation of a two-stage allocation system for product costing. Cost Pool Overhead $98,000 Intermediate Cost Pools Labor-related Machine-related $73,500 $24,500 Cost Allocation Rule Direct Labor Hours Machine Hours

Two-Stage Allocation Systems Continued Intermediate Cost Pools Labor-related Machine-related $73,500 $24,500 Cost Allocation Direct Labor Hours Machine Hours 4,900 2,450 $15/DLH $10/MH Cost Objects Skis Snowboards $60,000 $13,500 DL $20,000 $4,500 MH Allocated Overhead $18,000 $80,000

Sammy’s Skis and Boards Costs Skis Snowboards Total Direct Material $75,000 $15,000 $90,000 Direct Labor 100,000 22,500 122,500 OH @ $15/DLH 60,000 13,500 73,500 OH @ $10/MH 20,000 4,500 24,500 Total $255,000 $55,500 $310,500 Cost per unit $510 $370

Product Costing Systems L.O. 6 Describe the three basic types of product costing systems: job order, process, and operations. Job Costing Process Costing An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. An accounting system used when identical units are produced through a series of uniform production steps. Custom Homes Cornflakes Movies Facial Tissues Services Paint

Product Costing Systems Job Costing Operation Costing Process Costing An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. A hybrid costing system often used in manufacturing of goods that have some common characteristics plus some individual characteristics. An accounting system used when identical units are produced through a series of uniform production steps. Automobiles Computers Clothing

Chapter 5 The End