Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapters Three & Seven Overhead Allocation. Absorption costing vs Variable Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Product Costing Assigning costs to products-determine product cost Product Costs  Direct Materials  Direct Labor  Manufacturing Overhead Product Costing  Absorption Costing (Full Costing)  Job order costing  Process Costing  Variable Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Types of Product Costing Systems Process Costing Job-order Costing  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Types of Product Costing Systems Process Costing Job-order Costing  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit. Example companies: 1. Pınar Süt (dairy products) 2. DYO Paints (chemical) 3. Coca-Cola (mixing and bottling beverages) Example companies: 1. Pınar Süt (dairy products) 2. DYO Paints (chemical) 3. Coca-Cola (mixing and bottling beverages)

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Types of Product Costing Systems Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Types of Product Costing Systems Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job. Example companies: 1. TAI (aircraft manufacturing) 2. Mesa Insaat (large scale construction) 3. Walt Disney Studios (movie production) Example companies: 1. TAI (aircraft manufacturing) 2. Mesa Insaat (large scale construction) 3. Walt Disney Studios (movie production)

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Process and Job-Order Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Work in Proces s Direct Materials Direct Labor Manufacturing Overhead

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Jobs Costs are traced and applied to individual jobs in a job-order cost system. Direct Materials

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Comparing Job-Order and Process Costing Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead Processing Department Processing Department Costs are traced and applied to departments in a process cost system. Direct Materials

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Manufacturing Overhead Job No. 1 Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed. Direct Manufacturing Costs Direct Materials Direct Labor

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job. Direct Manufacturing Costs Direct Materials Direct Labor Job No. 1 Job No. 2 Job No. 3 Manufacturing Overhead

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Why Use an Allocation Base? Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct labor 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 ranging from the grease used in machines to production manager’s salary. 3.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Actual amount of the allocation based upon the actual level of activity. Based on estimates, and determined before the period begins. Application of Manufacturing Overhead Overhead applied = POHR × Actual activity

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin 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 direct labor hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR =

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Defining Under- and Overapplied Overhead The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is termed either underapplied or overapplied overhead. Underapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period. Overapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Multiple Predetermined Overhead Rates To this point we have assumed that there is a single predetermined overhead rate called a plantwide overhead rate. Large companies often use multiple predetermined overhead rates. May be more complex but... May be more accurate because it reflects differences across departments.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin The Predetermined Overhead Rate & Capacity Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because: 1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level. 2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use. Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because: 1.Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level. 2.Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Variable Costing: A Tool for Management

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Overview of Absorption and Variable Costing Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Variable Costing Absorption Costing Product Costs Period Costs Product Costs Period Costs

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Harvey Company produces a single product with the following information available: Unit Cost Computations

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Unit product cost is determined as follows: Selling and administrative expenses are always treated as period expenses and deducted from revenue as incurred. Unit Cost Computations

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Income Comparison of Absorption and Variable Costing Let’s assume the following additional information for Harvey Company.  20,000 units were sold during the year at a price of $30 each.  There were no units in beginning inventory. Now, let’s compute net operating income using both absorption and variable costing.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Absorption Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Variable manufacturing costs only. All fixed manufacturing overhead is expensed. Variable Costing

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Income Comparison of Absorption and Variable Costing Let’s compare the methods.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Reconciliation Fixed mfg. Overhead $150,000 Units produced 25,000 units = = $6.00 per unit We can reconcile the difference between absorption and variable income as follows:

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Extended Comparison of Income Data Harvey Company Year Two

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Unit Cost Computations Since there was no change in the variable costs per unit, total fixed costs, or the number of units produced, the unit costs remain unchanged.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Absorption Costing These are the 25,000 units produced in the current period.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Variable Costing All fixed manufacturing overhead is expensed. Variable manufacturing costs only.

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Reconciliation We can reconcile the difference between absorption and variable income as follows: Fixed mfg. Overhead $150,000 Units produced 25,000 units = = $6.00 per unit

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Income Comparison

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Summary

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin End of Chapters

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin