A&MIS 2121W. F. Bentz A&MIS 212 – Session 2 William F. Bentz January 10, 2002 Fisher College of Business

A&MIS 2122W. F. Bentz Thursday’ Agenda  Chapter 2, Exercise 3  Chapter 2, Problem 13  Introduce Job-Order Costing Systems

A&MIS 2123W. F. Bentz Key Issues in Product Costing  Terminology  Points of potential confusion  Accounts

A&MIS 2124W. F. Bentz Concept of “Cost”  Cost is a sacrifice; a measurable cost is the relinquishment of a measurable asset or the creation of a measurable liability.

A&MIS 2125W. F. Bentz GAAP Product Cost  For Work-in-Process and Finished Goods inventory purposes (GAAP), only manufacturing costs are included in “product” costs. Product costs remain in inventory until the associated product are sold or decline in value. When the associated products are sold, the “product cost” is added to Cost of Goods Sold.

A&MIS 2126W. F. Bentz Meanings of Product Cost R&DDesign Produc- tion Consumer Service Distri- bution Market- ing Inventoriable product costs Reimbursable government contract costs Decision-relevant costs

A&MIS 2127W. F. Bentz GAAP Expenses (Period Costs)  Costs are incurred for activities that do not directly create products, but support the creation of products. These costs are charged to expense accounts during the accounting period incurred and thus are called period expenses.

A&MIS 2128W. F. Bentz GAAP Expenses--Examples  Administrative Expenses ◈ Corporate officers ◈ Corporate buildings ◈ Corporate costs like the annual audit fees ◈ Corporate costs like  Selling (Marketing) Expenses  Distribution Expenses

A&MIS 2129W. F. Bentz Accounting-Speak Costs Incurred Period Expenses Product Costs (Inventory) Expensed During a Period Assets ( Prepaids) ( PP&E)

A&MIS 21210W. F. Bentz Concept—Service Potential  In accounting, service potential can be thought of as the present value of the cash flows from an activity, at some level of risk, or adjusted for risk.

A&MIS 21211W. F. Bentz Concept—Cost  Actions that decrease the present value of cash outflows, at a given level of risk, are actions that decrease cost. Actions that increase the present value of future cash outflows, at a given level of risk, are actions that increase cost.

A&MIS 21212W. F. Bentz Concept—Cost  Actions that increase the risk of future cash flows are actions that increase cost. Actions that decrease the risk of future cash flows are actions that decrease cost. and so on.

A&MIS 21213W. F. Bentz Terminology—Costing  Costing is the process of estimating the cost (sacrifice) of taking action. Costs are the result of undertaking and maintaining activities. Thus, costing is largely a matter of assigning costs (sacrifices) with the activities which caused those sacrifices.

A&MIS 21214W. F. Bentz Terminology—Cost Object  A cost object is any activity for which a separate measurement of cost is desired.  An activity involves doing something  Cost objects are derived from the purposes for which the cost information is to be used (different costs for different purposes).

A&MIS 21215W. F. Bentz Terminology—Costing Systems  Costing systems are the information systems used to accumulate cost data either regularly or intermittently. Usually cost systems are flexible enough to collect information for a variety of purposes.

A&MIS 21216W. F. Bentz Terminology—Costing Systems  A variety of costing systems may exist in any one organization (engineering, accounting, production, distribution).

A&MIS 21217W. F. Bentz Terminology—Cost Analysis  Cost analysis is the process of assessing the expected impact of managerial decisions on the financial performance of an entity. Decision analysis includes cost analysis.

A&MIS 21218W. F. Bentz Terminology—Cost Incurred  Cost incurred is the cost that an entity has experienced as a result of the execution of some activity for a specified period of time. Although it is in the past, cost incurred may have to be estimated. Accurate, valid measures of cost incurred require information about separable activities.

A&MIS 21219W. F. Bentz “Product Costs (GAAP)  Product (inventoriable) costs include all manufacturing costs regardless of traceability or behavior. Direct materials Direct labor Indirect labor, materials, depreciation, services, etc. ConversionConversion Prime cost

A&MIS 21220W. F. Bentz The Flow of Costs Inventory System Work in Process Finished Goods Inventory Cost of Goods Sold Payroll System Indirect Costs Assigned

A&MIS 21221W. F. Bentz Costing Objects Next, let us consider how one associates the costs incurred to a set of cost objects in the costing process. Costs Incurred Object 1 Object 2 Object 3

A&MIS 21222W. F. Bentz Cost Assignment  Tracing – direct costs can be traced to cost objects 1.Ability to trace with acceptable accuracy, validity, and cost Technology is improving our ability to trace The more complex the production process, the more difficult and costly the tracing process

A&MIS 21223W. F. Bentz Cost Assignment  Tracing (continued) 2.Cost-effective to trace costs The greater the cost, the greater the value of tracing Technology is reducing the cost of tracing The value of tracing increases with competition More complex mfg. systems increase the need to trace

A&MIS 21224W. F. Bentz Cost Assignment  Cost allocation is the process of assigning costs to cost objects when those costs cannot be traced cost-effectively.  Cost allocation ranges from relatively unambiguous, with high face validity, to relatively arbitrary.  Most distortions in product and service costing are related to cost allocation, not cost tracing.

A&MIS 21225W. F. Bentz Job-Costing One costing system is called job- costing or job-order costing. Job- costing systems are designed to cost a single unit or project, or one or more batches of very similar units.

A&MIS 21226W. F. Bentz Job-Costing Applications Job-costing is suited to:  Ship building  Construction projects  Printing shops with diverse jobs  Medical procedures  Repair shops  Consulting projects

A&MIS 21227W. F. Bentz Costing Jobs--Materials  When materials and component parts are taken out of inventory and put into process, the cost of those materials are traced to the job for which they were used. The total cost of all materials used in a period is debited to Work-in-Process. That debit amount must equal the total of the material costs charged to individual jobs.

A&MIS 21228W. F. Bentz Costing Jobs--Labor  When the total cost of labor is determined each period, that cost is either traced to specific jobs or charged to indirect cost. Workers and their supervisors must have a system for keeping tract of who worked on what jobs.

A&MIS 21229W. F. Bentz Costing Jobs—Indirect Costs  Indirect costs are allocated to jobs based on predetermined (budgeted) overhead (indirect manufacturing cost rates (PORs). In the least complex systems, there will be one POR. In more complex processes, there may be a number of cost drivers involved, and a corresponding POR for each cost driver.

A&MIS 21230W. F. Bentz To cost a specific job  Trace the direct costs to each job  For each job record the amount of the driver activity for each BICR  Multiply the BICR times the amount of activity for each cost driver  Add the cost components to compute the total cost (inventory value) of each job

A&MIS 21231W. F. Bentz The Flow of Costs Adjustment Indirect Costs Allocated Indirect Costs Incurred Cost of Goods Sold Finished Goods Inventory Work in Process Payroll System Inventory System

A&MIS 21232W. F. Bentz Inventory values zThe cost of any job is the cumulative amount of the costs charged to that job in the current and previous periods. The cost accumulates until the job is completed. The costs incurred for long- term construction contracts, as discussed in A&MIS 521, would be accumulated using a job-cost system.

A&MIS 21233W. F. Bentz Updating the costs of jobs  Direct materials would likely be accounted for using a perpetual inventory system  Direct labor costs would be updated every time a payroll is computed and at the end of every accounting period.  Indirect costs are charged to jobs at the end of every accounting period prior to completion and when they are finished.

A&MIS 21234W. F. Bentz Refinements  One can keep track of categories of cost within a job. For example, a large construction company I once worked for kept track of the cost of; (1) concrete floors, (2) walls & piers, (3) electrical systems, (4) roofing, and (5) mechanical systems. The company used this information to price bids and to select subcontractors on the basis of costs.

A&MIS 21235W. F. Bentz Problem Areas  A major consideration in the quality of the direct cost information lies in the tracing of costs to jobs. A potential problem occurs when workers are involved in several jobs each morning or afternoon and do not keep accurate time records.

A&MIS 21236W. F. Bentz