Product Costing and Cost Accumulation in a Batch Production Environment Chapter 3 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Product and Service Costing Financial Accounting Product costs are used to value inventory and to compute cost of goods sold. Managerial Accounting and Cost Management Product costs are used for planning, control, directing, and management decision making. 3-2

Flow of Costs in Manufacturing Firm 3-3

F Used for production of large, unique, high-cost items. F Built to order rather than mass produced. F Many costs can be directly traced to each job. F TWO TYPES: F Job-shop operations F Products manufactured in very low volumes or one at a time. F Batch-production operations F Multiple products in batches of relatively small quantity. Process Costing Job-Order Costing Types of Product-Costing Systems 3-4

F Typical job-order cost applications: v Special-order printing v Building construction F Also used in the service industry v Hospitals v Law firms Process Costing Job-Order Costing Types of Product-Costing Systems 3-5

Process Costing Job-Order Costing F Used for production of small, identical, low cost items. F Mass produced in automated continuous production process. F Costs cannot be directly traced to each unit of product. F Typical process cost applications: F Petrochemical refinery F Paint manufacturer F Paper mill Types of Product-Costing Systems 3-6

Overhead is applied to jobs using a predetermined overhead rate (POHR) based on estimates made at the beginning of the accounting period. POHR = Budgeted manufacturing overhead cost Budgeted amount of cost driver (or activity base) Overhead applied = POHR × Actual activity Based on estimates, and determined before the period begins Actual amount of the allocation base, such as direct labor hours, incurred during the period Manufacturing Overhead Costs 3-7

Overhead is applied to jobs using a predetermined overhead rate (POHR) based on estimates made at the beginning of the accounting period. POHR = Budgeted manufacturing overhead cost Budgeted amount of cost driver (or activity base) Overhead applied = POHR × Actual activity Recall the Aluminum Boat example where: Overhead applied = $30 per DLH × 600 DLH = $18,000 Manufacturing Overhead Costs 3-8

Let’s examine the cost flows in a job-order costing system. We will use T-accounts and start with materials. Job-Order System Cost Flows 3-9

Raw Materials Material Purchases Direct Material Mfg. Overhead Indirect Material Work in Process (Job-Cost Record) Job-Order System Cost Flows 3-10

Next let’s add labor costs and applied manufacturing overhead to the job-order cost flows. Are you with me? Job-Order System Cost Flows 3-11

Direct Labor Mfg. Overhead Indirect Material Direct Material Indirect Labor Direct Labor Indirect Labor Wages Payable Work in Process (Job-Cost Record) Job-Order System Cost Flows 3-12

Direct Labor Mfg. Overhead Indirect Material Direct Material Overhead Applied to Work in Process If actual and applied manufacturing overhead are not equal, a year-end adjustment is required. We will look at the procedure to accomplish this later. Indirect Labor Direct Labor Overhead Applied Indirect Labor Wages Payable Work in Process (Job-Cost Record) Job-Order System Cost Flows 3-13

Now let’s complete the goods and sell them. Still with me? Job-Order System Cost Flows 3-14

Cost of Goods Mfd. Finished Goods Cost of Goods Sold Cost of Goods Mfd. Cost of Goods Sold Direct Material Direct Labor Overhead Applied Work in Process (Job-Cost Record) Job-Order System Cost Flows 3-15

Let’s return to AFB Company and see what we will do if actual and applied overhead are not equal. Job-Order System Cost Flows 3-16

Actual Overhead costs for the year: $5,050,000 Actual direct labor hours worked for the year: 170,000 Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $30.00 per DLH × 170,000 DLH = $5,100,000 Applied overhead exceeds actual overhead by $50,000 This difference is called overapplied overhead. Overhead Application Example 3-17

Work in Process Finished Goods Cost of Goods Sold $50,000 may be allocated to these accounts. $50,000 may be closed directly to cost of goods sold. Cost of Goods Sold AFB Company’s Method OR Overapplied and Underapplied Manufacturing Overhead 3-18

Actual overhead costs $5,050,000 $50,000 overapplied Unadjusted Balance $50,000 Adjusted Balance Overhead Applied to jobs $5,100,000 AFB’s Mfg. Overhead for the year AFB’s Cost of Goods Sold for the year Overapplied and Underapplied Manufacturing Overhead 3-19

Overapplied and Underapplied Manufacturing Overhead - Summary 3-20

Schedule of Cost of Goods Manufactured 3-21

Schedule of Cost of Goods Sold 3-22

Actual direct material and direct labor combined with actual overhead. Actual direct material and direct labor combined with predetermined overhead. Using a predetermined rate makes it possible to estimate total job costs sooner. Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period. Actual overhead for the period is not known until the end of the period. Actual and Normal Costing 3-23

Cost pools Stage One: Costs assigned to pools Indirect Labor Indirect Materials Other Overhead Department 1 Department 2 Department 3 Two-Stage Cost Allocation 3-24

Departmental Overhead Rates Department 1 Department 2 Department 3 Products Cost pools Direct Labor Hours Machine Hours Raw Materials Cost Stage One: Costs assigned to pools Stage Two: Costs applied to products Departmental Allocation Bases Indirect Materials Other Overhead Indirect Labor 3-25

Contracts Missions Programs Cases THE JOB Job-Order Costing in Nonmanufacturing Organizations 3-26

Changing Technology in Manufacturing Operations Computerized data interchange has eliminated much of the paperwork associated with job-order cost systems. Scanning devices have simplified data entry to record material and labor use. 3-27