Visit UMT online at ACCT125© 2006 UMT ACCOUNTING FUNDAMENTALS FOR MANAGERS University of Management and Technology 1901 North Fort Myer Drive Arlington, VA Voice: (703) Fax: (703) Website:

Visit UMT online at ACCT125© 2006 UMT Carl S. Warren Survey of Accounting (2 nd ed.) © 2004 South-Western

10-3 Visit UMT online at ACCT125© 2006 UMT Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

Visit UMT online at ACCT125© 2006 UMT Chapter 10 Accounting Systems for Manufacturing Businesses

10-5 Visit UMT online at ACCT125© 2006 UMT ContinuedContinued Learning Objectives 1.Distinguish the activities of a manufacturing business from those of a merchandise or service business. 2.Define and illustrate materials, factory labor, and factory overhead costs. 3.Describe accounting systems used by manufacturing businesses. 4.Describe and illustrate a job order cost accounting system. After studying this chapter, you should be able to:

10-6 Visit UMT online at ACCT125© 2006 UMT Learning Objectives 5.Use job order cost information for decision making. 6.Diagram the flow of costs for a service business that uses a job order cost accounting system. 7.Describe just-in-time manufacturing. 8.Describe and illustrate the use of activity-based costing in a service business.

10-7 Visit UMT online at ACCT125© 2006 UMT 1 Distinguish the activities of a manufacturing business from those of a merchandise or service business. Learning Objective

10-8 Visit UMT online at ACCT125© 2006 UMT MerchandisingMerchandising ManufacturingManufacturing Reports: Cost of merchandise sold Merchandise inventory Reports: Cost of goods sold Materials inventory Work in process inventory Finished goods inventory

10-9 Visit UMT online at ACCT125© 2006 UMT 2 Define and illustrate materials, factory labor, and factory overhead costs. Learning Objective

10-10 Visit UMT online at ACCT125© 2006 UMT Cost Classifications PeriodCostsPeriodCosts Selling Expenses Selling Expenses Administrative Expenses Administrative Expenses Direct Materials Direct Materials Factory Overhead Factory Overhead Direct Labor Direct Labor ProductCostsProductCosts

10-11 Visit UMT online at ACCT125© 2006 UMT Manufacturing Costs 1. Enters directly into the product. 2.Is significant amount of total product cost. 1.Enters directly into manufacturing the product. 2.Is significant amount of total product cost. Cost other than direct materials cost and direct labor cost incurred in the manufacturing of product. Direct Materials: Direct Materials: Direct Labor: Direct Labor: Factory Overhead: Factory Overhead:

10-12 Visit UMT online at ACCT125© 2006 UMT Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs Balance Sheet Income Statement

10-13 Visit UMT online at ACCT125© 2006 UMT Balance Sheet Materials Inventory Materials Inventory Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Income Statement Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs

10-14 Visit UMT online at ACCT125© 2006 UMT Work in Process Inventory Work in Process Inventory Balance Sheet Materials Inventory Materials Inventory Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Income Statement Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs

10-15 Visit UMT online at ACCT125© 2006 UMT Finished Goods Inventory Finished Goods Inventory Work in Process Inventory Work in Process Inventory Balance Sheet Materials Inventory Materials Inventory Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Income Statement Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs Cost of Goods Manufactured

10-16 Visit UMT online at ACCT125© 2006 UMT Cost of Goods Sold Cost of Goods Sold Finished Goods Inventory Finished Goods Inventory Work in Process Inventory Work in Process Inventory Balance Sheet Materials Inventory Materials Inventory Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Income Statement Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs Product costs flow through the balance sheet to the income statement

10-17 Visit UMT online at ACCT125© 2006 UMT Selling and Administrative Selling and Administrative Cost of Goods Sold Cost of Goods Sold Finished Goods Inventory Finished Goods Inventory Work in Process Inventory Work in Process Inventory Balance Sheet Materials Inventory Materials Inventory Manufacturing Cost Flows and Classifications Manufacturing Cost Flows and Classifications Product Costs Materials Purchases Materials Purchases Period Costs Income Statement Direct Labor Direct Labor Factory Overhead Selling and Administrative Selling and Administrative Costs Period costs flow directly to the income statement

10-18 Visit UMT online at ACCT125© 2006 UMT 3 Describe accounting systems used by manufacturing businesses. Learning Objective

10-19 Visit UMT online at ACCT125© 2006 UMT Cost Accounting Systems 1. Many different jobs are worked on during each period and unit costs are computed by job. 2.Costs are accumulated using a job cost sheet. 1.A single product is produced on a continuous basis and unit costs are computed by department. 2.Costs are accumulated and reported using a departmental production report. Job Order Cost System Job Order Cost System Process Cost System Process Cost System

10-20 Visit UMT online at ACCT125© 2006 UMT 4 Describe and illustrate a job order cost accounting system. Learning Objective

10-21 Visit UMT online at ACCT125© 2006 UMT Materials Information and Cost Flows Job 71 1,000 units of American History Balance$ 3,000 Direct Materials Direct Labor Factory Overhead Job 72 4,000 units of Algebra Direct Materials Direct Labor Factory Overhead Materials Requisitions

10-22 Visit UMT online at ACCT125© 2006 UMT Materials Information and Cost Flows Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor Factory Overhead Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor Factory Overhead Materials Requisitions

10-23 Visit UMT online at ACCT125© 2006 UMT Labor Information and Cost Flows Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor Factory Overhead Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor Factory Overhead Time Tickets

10-24 Visit UMT online at ACCT125© 2006 UMT Labor Information and Cost Flows Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor3,500 Factory Overhead Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor7,500 Factory Overhead Time Tickets

10-25 Visit UMT online at ACCT125© 2006 UMT Predetermined Factory Overhead Rates Activity base examples Estimated total factory overhead costs Estimated activity base Predetermined factory overhead rate = 1. Direct labor hours 2. Direct labor dollars 3. Machine hours 4. Direct materials 5. Other

10-26 Visit UMT online at ACCT125© 2006 UMT Predetermined Factory Overhead Rates Estimated total factory overhead costs Estimated activity base Predetermined factory overhead rate = Why is the predetermined overhead rate calculated from estimated numbers at the beginning of the period? It is a tradeoff between accuracy and timeliness. If a company waited until the end of an accounting period, when all overhead costs are known, the allocated factory overhead would be accurate but not timely.

10-27 Visit UMT online at ACCT125© 2006 UMT Predetermined Factory Overhead Rates Estimated total factory overhead costs Estimated activity base Predetermined factory overhead rate = $50,000 estimated factory overhead costs 10,000 estimated direct labor hours =

10-28 Visit UMT online at ACCT125© 2006 UMT Predetermined Factory Overhead Rates Estimated total factory overhead costs Estimated activity base Predetermined factory overhead rate = $50,000 estimated factory overhead costs 10,000 estimated direct labor hours = $5 per direct labor hour

10-29 Visit UMT online at ACCT125© 2006 UMT Predetermined Factory Overhead Rates Estimated total factory overhead costs Estimated activity base Predetermined factory overhead rate = $50,000 estimated factory overhead costs 10,000 estimated direct labor hours = $5 per direct labor hour For each direct labor hour worked, factory overhead applied is $5. Job x $5 = $1,750 Job x $5 = $2,500 DirectFactory LaborOverhead HoursApplied

10-30 Visit UMT online at ACCT125© 2006 UMT Assigning Factory Overhead to Jobs Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor3,500 Factory Overhead Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor7,500 Factory Overhead Time Tickets Predetermined Overhead Rates

10-31 Visit UMT online at ACCT125© 2006 UMT Assigning Factory Overhead to Jobs Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor3,500 Factory Overhead1,750 Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor7,500 Factory Overhead2,500 Time Tickets Predetermined Overhead Rates

10-32 Visit UMT online at ACCT125© 2006 UMT Summary of Job Cost Sheets Job 71 1,000 units of American History Balance$ 3,000 Direct Materials2,000 Direct Labor3,500 Factory Overhead1,750 Total Job Cost$10,250 Job 72 4,000 units of Algebra Direct Materials$11,000 Direct Labor7,500 Factory Overhead2,500 $21,000 Total of debits to Work in Process

10-33 Visit UMT online at ACCT125© 2006 UMT Goodwell Printers Income Statement For the Month Ended December 31, 2004 Sales$28,000 Cost of goods sold20,150 Gross profit$ 7,850 Selling and admin. expenses: Sales salaries expense$2,000 Office salaries expense1,500 Total selling and admin. expenses3,500 Income from operations$ 4,350

10-34 Visit UMT online at ACCT125© 2006 UMT 5 Use job order cost information for decision making. Learning Objective

10-35 Visit UMT online at ACCT125© 2006 UMT Job 144 Item: 200 folding chairs Materials Quantity (board feet) Materials Price Materials Amount Direct materials: Wood Direct materials per chair 1,600 $3.50 $5,600 $28

10-36 Visit UMT online at ACCT125© 2006 UMT Job 163 Item: 200 folding chairs Materials Quantity (board feet) Materials Price Materials Amount Direct materials: Wood Direct materials per chair 2,000 $3.50 $7,000 $35

10-37 Visit UMT online at ACCT125© 2006 UMT 6 Diagram the flow of costs for a service business that uses a job order cost accounting system. Learning Objective

10-38 Visit UMT online at ACCT125© 2006 UMT Wages Payable Direct labor xxx Indirect labor xxx Factory Overhead Work in ProcessCost of Services Indirect labor xxx Supplies used xxx Applied overhead (xxx) Direct laborxxx Applied overhead xxx Completed jobs (xxx) Completed jobsxxx Supplies Used xxx Flow of Costs Through a Service Business

10-39 Visit UMT online at ACCT125© 2006 UMT 7 Describe just-in-time manufacturing. Learning Objective

10-40 Visit UMT online at ACCT125© 2006 UMT Issue Just-in-Time Manufacturing Traditional Manufacturing InventoryReduces inventory.Increases inventory to “buffer” or protect against process problems. Lead timeReduces lead time.Increases lead time as a buffer against uncertainty. Setup timeReduces setup time.Disregards setup time as an improvement priority. Production layoutEmphasizes product-oriented layout. Emphasizes process-oriented layout. ContinuedContinued

10-41 Visit UMT online at ACCT125© 2006 UMT Issue Just-in-Time Manufacturing Traditional Manufacturing Role of the EmployeeEmphasizes team-oriented employee involvement. Emphasizes work of individuals, following manager instructions. Production scheduling policyEmphasizes pull manufacturing. Emphasizes push manufacturing. QualityEmphasizes zero defects.Tolerates defects. SuppliersEmphasizes supplier partnering. Treats suppliers as “arm’s- length,” independent entities.

10-42 Visit UMT online at ACCT125© 2006 UMT 8 Describe and illustrate the use of activity- based costing in a service business. Learning Objective

10-43 Visit UMT online at ACCT125© 2006 UMT Activity-Based Costing This approach allocates overhead more accurately than a single, plant-wide overhead rate (as shown above) With activity-based costing, overhead costs are initially aggregated in activity cost pools. These cost pools are related to a specific activity, such as machine usage, inspections, moving, setups, engineering. Each cost pool is then associated with an expected utilization rate to calculate an activity rate. For example, a radiology department has costs of $960,000 and expects to produce 3,000 images, so the activity rate is $320 per image.

10-44 Visit UMT online at ACCT125© 2006 UMT Activity Activity- Base Usage  Activity Rate= Activity Cost Admitting1 admission  $180 per admission=$ 180 Radiological testing2 images  320 per image=640 Operating room4 hours  200 per hour=800 Pathological testing1 specimen  120 per specimen=120 Dietary and laundry7 days  150 per day=1,050 Total$2,790 Activity-Based Costing Mary Wilson was a patient in the hospital. The hospital overhead associated with her stay includes the following:

10-45 Visit UMT online at ACCT125© 2006 UMT Activity-Based Costing Note that only those activities that affected Mary are charged to her bill. Patient activity costs also may be combined with direct costs, such as drugs and supplies, for reporting with the revenues earned for each patient. The result is a customer-based profitability report. Such reports can be used by management to guide decisions on pricing or service delivery. These reports also may be useful in determining if services for a given patient were remarkable in some way. In the following illustration, Birini appears to have received a remarkable number of services relative to the revenue.

10-46 Visit UMT online at ACCT125© 2006 UMT HOPEWELL HOSPITAL Customer (Patient) Profitability Report For the Period Ending December 31, 2004 Adcock, Kim Birini, Brian Conway, Don Wilson, Mary Revenues$9,500$21,400$5,050$3,300 Less patient costs: Drugs and supplies$ 400$1,000 $ 300$ 200 Admitting180 Radiological testing1,2802,560 1, Operating room2,4006,4001, Pathological testing Dietary and laundry4,20014,7001,050 Total patient costs$8,700$25,440$4,530$2,990 Income from operations$ 800$(4,040)$ 520$ 310