6-1 Product Costing and the Manufacturing Environment C hapter 6 Prepared by Douglas Cloud Pepperdine University

6-2 1.Understand the inventory requirements and the related inventory measurement issues of service, merchandising, and manufacturing organizations. 2.Explain the basic conceptual framework of inventory costing for financial reporting. 3.Describe the manufacturing environment as it relates to product costing systems. ObjectivesObjectives After studying this chapter, you should be able to: ContinuedContinued

6-3 4.Explain the operation of a basic job costing system. 5.Explain the operation of a basic process costing system. ObjectivesObjectives

6-4 Financial Accounting Financial reporting is the process of preparing a firm’s financial statements in accordance with GAAP. These financial reporting concepts include some fundamental techniques and prototype approaches that managers can apply to a variety of manufacturing settings and specific products.

6-5 INVENTORY COSTS IN VARIOUS ORGANIZATIONS Organization Asset Expense Service Supplies Inventory Supplies Expense Merchan- dising Merchandise Inventory Supplies Inventory Cost of Goods Sold Supplies Expense ContinuedContinued

6-6 INVENTORY COSTS IN VARIOUS ORGANIZATIONS Organization Asset Expense Manu- facturing Raw Materials Inventory Manufacturing Supplies Inventory Office Supplies Expense Office Supplies Inventory Work-in Process Inventory Finished Goods Inventory Cost of Goods Sold

6-7 Product Costs for Financial Reporting Raw materials used Manufacturing supplies used Production employees’ wages Depreciation on plant Expired insurance on plant Production supervisors’ salaries Plant maintenance Plant utilities Production equipment rent Plant office supplies used Raw materials used Manufacturing supplies used Production employees’ wages Depreciation on plant Expired insurance on plant Production supervisors’ salaries Plant maintenance Plant utilities Production equipment rent Plant office supplies used These costs are assigned to the asset inventory These costs are expensed when inventory is sold

6-8 Period Costs for Financial Reporting Nonfactory office supplies used General and administrative salaries Depreciation on showroom Expired insurance on showroom President’s salary Showroom maintenance Nonfactory office utilities Nonfactory office rent Nonfactory office supplies used General and administrative salaries Depreciation on showroom Expired insurance on showroom President’s salary Showroom maintenance Nonfactory office utilities Nonfactory office rent These items are expensed as incurred

6-9 THREE PRODUCT COSTS Work-in-Process Inventory Direct Labor Factory Overhead Cost of the primary raw materials used in production Wages earned by production employees for the actual time spent working on the product All other manufacturing costs Finished Goods Inventory Cost of Goods Sold

6-10 A Closer Look At Manufacturing Overhead Possibly the biggest challenge in measuring the cost of a product is determining the amount of overhead incurred to produce it.

6-11 Problems Resulting From Measuring Product Cost Using Actual Overhead Actual manufacturing overhead cost may not be known until days or weeks after the end of the period, delaying the calculation of unit product cost.

6-12 Also, some costs that are seasonal are not incurred each period, thus making the actual cost of product produced in one month greater than that of another, even though nonseasonal costs may have been identical for both months. Problems Resulting From Measuring Product Cost Using Actual Overhead

6-13 Another point… When there is a significant amount of fixed overhead, the costs assigned to products will vary from period to period, depending on the overall volume of activity. Problems Resulting From Measuring Product Cost Using Actual Overhead

6-14 Using Predetermined Overhead Rates To overcome these problems, most firms use a predetermined manufacturing overhead rate to assign manufacturing overhead costs to products.

6-15 Predetermined Predicted total manufacturing manufacturing overhead cost for the year overhead rate Predicted total direct labor per direct hours for the year labor hour = Using Predetermined Overhead Rates A predetermined overhead rate based on direct labor hours

6-16 Manufacturing Predetermined overhead Actual direct manufacturing assigned to labor hours overhead rate Work-In-Process per direct labor Inventory hour = x Using Predetermined Overhead Rates

6-17 Using a predetermined manufacturing overhead rate based on direct labor hours, we can compute the assignment of overhead to Work-in-Process Inventory. Using Predetermined Overhead Rates

6-18 Late in 2004, Harmon Manufacturing Company predicted a 2005 activity level of 25,000 direct labor hours with manufacturing overhead totaling $187,500. Predetermined Predicted total manufacturing manufacturing overhead cost for the year overhead rate Predicted total direct labor per direct hours for the year labor hour = Using Predetermined Overhead Rates

6-19 $187,500 25,000 direct-labor hours = Using Predetermined Overhead Rates Late in 2004, Harmon Manufacturing Company predicted a 2005 activity level of 25,000 direct labor hours with manufacturing overhead totaling $187,500. $7.50 per direct labor hour

6-20 If 2,000 direct labor hours were used in September, what would be the applied overhead? 2,000 x $7.50 = $15,000 Using Predetermined Overhead Rates

6-21 The Manufacturing Environment In process manufacturing, a single product (or a closely related set of products) is produced on a continuous basis

6-22 In job order production, products are manufactured in singles units or in batches of identical units. The Manufacturing Environment

6-23 The production order contains a job’s unique identification number and assigns a unique identification number to a job The Manufacturing Environment

6-24 A job-cost sheet is a document used to accumulate the cost for a specific job in a job-cost system The Manufacturing Environment

6-25 Production Files and Records A file is simply a collection of related records. A record is a related set of alphabetic and/or numeric data items.

6-26 Basic Production Records Raw Materials Inventory Record Part No________________ Description_________________ Purchased Issued Balance Unit Total Unit Total Unit Total Date Units Cost Cost Units Cost Cost Units Cost Cost

6-27 Finished Goods Inventory Record Product No________________ Description____________________ Received From Factory Sold Balance Unit Total Unit Total Unit Total Date Units Cost Cost Units Cost Cost Units Cost Cost Basic Production Records

6-28 Bill of Materials Raw Materials Requirements Per Unit of Product Product No________________ Description___________________ Part Quantity Number Description Per Unit Basic Production Records

6-29 Operations List Production Operations and Times Per Unit of Product Product No_______________ Description___________________ Department Operation Machine/Labor Set-up Operating Number Description Requirements Time Time Basic Production Records

6-30 Job Cost System Records (Production Order) Production Order Job No.___________________ Start Date __________________ Product No_________ Description_________________ Quantity_____ Raw Materials Total Part Number Description Quantity ContinuedContinued

6-31 Operations Department Operation Labor/Machine Start Stop Total Number Description Requirements Time Time Time Authorized by ___________________ Date ________________ Job Cost System Records (Production Order)

6-32 Job-Cost Sheet Job No.___________________ Start Date __________________ Product No_________ Description_________________ Quantity_____ Raw Materials Cost Requisition Total Date Department Number Description Cost ContinuedContinued Job Cost System Records (Job Cost Sheet)

6-33 Conversion Costs: Direct Labor or Machine Work Ticket Total Total Date Department Number Description Time Cost ContinuedContinued Job Cost System Records (Job Cost Sheet)

6-34 Applied Overhead Total Date Department Basis of Application Cost Total Cost of Job Unit Cost Job Cost System Records (Job Cost Sheet)

6-35 Materials Requisition Form Requisition No. _________ Job No. _______ Date _______________ Department __________________ Part Total Unit Total Number Description Quantity Cost Cost Issued by________________ Received by __________________ Job Cost System Records (Material Requisition Form)

6-36 Work Ticket Work Ticket No. _________ Date_________________ Department______________________ Job. No. _____ Time Started _________ Time Completed __________ Employee/Machine Operator _____________________ Office Use Total Time ______ Rate ______ Total Cost ________ Job Cost System Records (Work Ticket)

6-37 Impact of Computers on Manufacturing Automatic identification systems (AIS) allow inventory and production information to be entered into a computer without writing or keying.

6-38 Computer-aided design (CAD) involves the use of computers to design products. Impact of Computers on Manufacturing

6-39 Computer-aided manufacturing (CAM) involves the use of computers to control machine operations. Impact of Computers on Manufacturing

6-40 Flexible manufacturing systems (FMS) are an extension of computer-aided manufacturing techniques through a series of manufacturing operations. Computer-integrated manufacturing (CIM) is the ultimate extension of CAD, CAM, and FMS concepts to a completed automated and computer- controlled factory. Impact of Computers on Manufacturing In their advanced stages, factories utilizing flexible manufacturing systems and computer-integrated manufacturing are sometimes referred to as “lights-out factories” because they can be operated in the dark.

6-41 Basic Manufacturing Cost Flows Beginning balance$ xx (1) Purchases xx Total availablexx Raw Materials Step 1: The cost of purchased raw materials and manufacturing supplies are recorded in Raw Materials and Manufacturing Supplies, respectively. (1) Increase$ xx Accounts Payable

6-42 Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: Beginning balance$ xx (1) Purchases xx Total availablexx Raw Materials (2) Direct materials xx Step 2: As primary raw materials are requisitioned to the factory, direct materials are transferred from Raw Materials to Work-in-Process. Basic Manufacturing Cost Flows Beginning balance$ xx (1) Purchases xx Total availablexx (2) Direct materials -xx Ending balance$ xx Raw Materials

6-43 Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx (3) Current employee earnings $ xx Wages Payable (3) Direct labor xx Indirect labor to Manufacturing Overhead (NEXT SLIDE) Step 3: Direct labor costs are assigned to Work-in-Process on the basis of time devoted to processing raw materials. Other labor costs associated with production employees are initially assigned to Manufacturing Overhead. Basic Manufacturing Cost Flows

6-44 Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect labor$xx Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect labor$xx Basic Manufacturing Cost Flows

6-45 Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect materials$xx (4) Manufacturing. Suppliesxx (5) Depreciationxx (6) Miscellaneous xx -xx Total$ xx Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect materials$xx (4) Manufacturing. Suppliesxx (5) Depreciationxx (6) Miscellaneous xx -xx Total$ xx Manufacturing Supplies Beginning balance$ xx (1) Purchases xx Total availablexx (4) Issued -xx Ending balance$ xx Accumulated Depreciation: Factory Assets (5) Increase +xx Other Payables (6) Increase +xx Steps 4, 5, and 6: Other production related costs are also assigned to Manufacturing Overhead. Basic Manufacturing Cost Flows

6-46 Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect materials$xx (4) Manufacturing. Suppliesxx (5) Depreciationxx (6) Miscellaneous xx -xx Total$ xx (7) Applied overhead -xx Ending balance$ xx Manufacturing Overhead Beginning balance$ xx Current: (3) Indirect materials$xx (4) Manufacturing. Suppliesxx (5) Depreciationxx (6) Miscellaneous xx -xx Total$ xx (7) Applied overhead -xx Ending balance$ xx Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx (3) Direct laborxx (7) Applied overheadxx Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx (3) Direct laborxx (7) Applied overheadxx Steps 7: Costs assigned to Manufacturing Overhead are periodically reassigned (applied) to Work-in- Process. Basic Manufacturing Cost Flows

6-47 Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx (3) Direct laborxx (7) Applied overhead xx +xx Total work-in-process$ xx (8) Cost of goods mfg. -xx Ending balance$ xx Work-in-Process Inventory Beginning balance$ xx Current manufacturing costs: (2) Direct materials$xx (3) Direct laborxx (7) Applied overhead xx +xx Total work-in-process$ xx (8) Cost of goods mfg. -xx Ending balance$ xx Steps 8: When products are completed, their accumulated production costs are totaled on a job cost sheet and transferred from Work-in-Process to Finished Goods Inventory. Basic Manufacturing Cost Flows Finished Goods Inventory Beginning balance$ xx (8) Cost of goods mfg. -xx Total availablexx Finished Goods Inventory Beginning balance$ xx (8) Cost of goods mfg. -xx Total availablexx

6-48 Finished Goods Inventory Beginning balance$ xx (8) Cost of goods mfg. -xx Total availablexx (9) Cost of goods sold -xx Ending balance$ xx Finished Goods Inventory Beginning balance$ xx (8) Cost of goods mfg. -xx Total availablexx (9) Cost of goods sold -xx Ending balance$ xx Cost of Goods Sold (9) Cost of goods sold $xx Steps 9: Later when the products are sold, their costs are transferred from Finished Goods Inventory to Cost of Goods Sod. Basic Manufacturing Cost Flows

6-49 Exhibit 6-7 Examine Exhibit 6-6 in the textbook for a possible pattern of cost flows for a factory containing only machine-intensive manufacturing operations.

6-50 Job Costing A critical concept in job costing is the relationship between the job cost sheets and the account Work-in-Process

6-51 When costs are assigned to work-in-process the costs are also assigned to job cost sheets When jobs are completed the costs are determined by looking at the sheet for the completed job. That amount is transferred from work-in-process to finished goods inventory The balance in work-in-process is equal to the costs assigned to the jobs in process Job Costing

6-52 Job 425 Job 426 Job 427 Total Beginning balance$58,600$51,300$ 0$109,900 Current costs: Direct materials4,8003,60023,50031,900 Direct labor6,0009,00010,00025,000 Applied overhead 2,400 3,600 4,000 10,000 Total$71,800$67,500$37,500$176,800 This information is used to determine the total cost of goods manufactured. Job Costing

6-53 Job 428 Job 429 Job 430 Total Beginning balance$ 0$ 0$ 0$ 0 Current costs: Direct materials22,40010,0008,20040,600 Direct labor9,4503,8002,80016,050 Applied overhead 3,780 1,520 1,120 6,420 Total$35,630$15,320$12,120$63,070 This information indicates ending balance in Work in Process Inventory Job Costing

6-54 The job-cost sheets for completed jobs provide the cost of each job, allowing management to properly cost and price the job. The job-cost sheets for incomplete jobs should sum to the ending balance in the Work-in-Process Inventory account. Review Job Costing

6-55 Fox Brothers, Inc. Statement of Cost of Goods Manufactured For the Month Ending August 31, 2004 Current manufacturing costs: Cost of materials placed in production: Raw materials, 8/1/04$36,000 Purchases 30,000 Total available$66,100 Raw materials, 8/31/04 -11,800$54,300 Direct labor34,450 Manufacturing overhead 13,780$102,530 Work-in-Process, 8/1/04 109,900 Total costs in process$212,430 Work-in-Process, 8/31/ ,630 Cost of goods manufactured$176,800 Transfer to the income statement STATEMENT OF COST OF GOODS MANUFACTURED

6-56 Fox Brothers, Inc. Income Statement For the Month Ending August 31, 2004 Sales$400,000 Cost of goods sold: Finished goods inventory, 8/1/04$75,000 Cost of goods manufactured176,800 Total goods available for sale$251,800 Finished goods inventory, 8/31/04-37, ,300 Gross profit$185,700 Selling and administrative expenses - 90,000 Net income$ 95,700 From the statement of cost of goods manufactured INCOME STATEMENT

6-57 If products are produced in a continuous manufacturing environment, where production does not have a distinct beginning and end, it is necessary to use a process costing system. Process Costing The cost of a single unit is equal to the total product costs assigned a “process” or “department” during an accounting period divided by the number of units produced.

6-58 Cost of Production Report A cost of production report is the key document. It is a useful way of organizing and accounting for costs in a process costing environment. A cost of production report contains--  Summary of units in process  Equivalent units  Total costs to be account for and cost per equivalent unit  Accounting for total cost  Summary of units in process  Equivalent units  Total costs to be account for and cost per equivalent unit  Accounting for total cost

6-59 Assume 90 units in the ending inventory are 40 percent complete. The equivalent units are determined as follows: 90 units in ending inventory x 0.40 = 36 Cost of Production Report

6-60 Micro System Co. Cost of Production Report For the Month Ending July 31, 2004 Summary of units in process: Beginning4,000 Units started 36,000 In process40,000 Completed-35,000 Ending5,000 Top Cost of Production Report

6-61 Equivalent units in process: Materials Conversion Units completed35,00035,000 Plus equivalent units in end. inv. 5,000 1,000 Equivalent units in process40,00036,000 Total cost to be accounted for and cost per equivalent units/process: Materials Conversion Total Work-in-Process, beginning$ 16,000$ 9,000$ 25,000 Current cost 144, , ,900 Total cost in process$160,000$117,900$277,900 Equivalent units in process  40,000  36,000 Cost per equivalent unit in process$ 4.00$ 3.275$ Middle Cost of Production Report

6-62Bottom Accounting for total cost Transferred out (35,000 x $7.275)$254,625 Work-in-Process, ending: Materials$20,000 Conversion (1,000 x $3.275) 3,275 23,275 Total cost accounted for$277,900 Cost of Production Report Matches total cost in process

6-63 Work-in-Process Inventory Beginning balance$ 25,000 Current manufacturing costs: Direct materials$144,000 Direct labor62,200 Applied overhead 46, ,900 Total$277,900 Cost of goods manufactured-254,625 Ending balance$ 23,275 The flow of Costs Through Work-in- Process Inventory is as follows:

6-64C hapter 6 The End

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