Management Accounting

Management Accounting
Masters of Business Administration Accounting for Managers Management Accounting Introduction to Management Accounting & Job Order Costing By: Associate Professor Dr. GholamReza Zandi

Directing and Motivating
Work of Management Planning Directing and Motivating Controlling Managers carry out three major activities – planning, directing and motivating, and controlling.

Planning Identify alternatives.
Select alternative that does the best job of furthering organization’s objectives. Develop budgets to guide progress toward the selected alternative. Planning involves selecting a course of action and specifying how the action will be implemented. An important part of planning is to identify alternatives and then to select from among the alternatives the one that does the best job of furthering the organization’s objectives. Once alternatives have been identified, the plans of management are often expressed formally in budgets. Budgets are usually prepared under the direction of the controller, who is the manager in charge of the accounting department. Typically, budgets are prepared annually.

Directing and Motivating
Directing and motivating involves managing day-to-day activities to keep the organization running smoothly. Employee work assignments. Routine problem solving. Conflict resolution. Effective communications. In addition to planning for the future, managers must oversee day-to-day activities to keep the organization running smoothly. Managerial accounting data, such as daily sales reports, are often used in this type of day-to-day decision making.

The control function ensures that plans are being followed.
Controlling The control function ensures that plans are being followed. Feedback in the form of performance reports that compare actual results with the budget are an essential part of the control function. In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback, which signals whether operations are on target, is the key to effective control. One type of feedback that is very helpful to mangers is called a performance report. A performance report compares budgeted to actual results. It suggests where operations are not proceeding as planned and where some parts of the organization may require additional attention.

Planning and Control Cycle
Formulating long-and short-term plans (Planning) Begin Comparing actual to planned performance (Controlling) Implementing plans (Directing and Motivating) Decision Making The work of management, which is known as the planning and control cycle, is summarized on your screen. The process is a continuous loop in many organizations. Once plans are made, they are implemented. The controlling process starts with measuring actual performance, and then comparing those results with planned performance. Corrective action may be necessary if actual results differ significantly from the plan. In some cases, new information may result in altering the plan before the cycle is repeated. Note that decision making is involved in all management activities. Measuring performance (Controlling)

Comparison of Financial and Managerial Accounting
There are seven key differences between managerial accounting and financial accounting: Financial accounting reports are prepared for external parties, whereas, managerial accounting reports are prepared for internal users. Financial accounting summarizes past transactions. Managerial accounting has a future orientation. Financial accounting data are expected to be objective and verifiable. Managerial accountants focus on providing relevant data even if it is not completely objective or verifiable. Financial accounting focuses on precision when reporting to external parties. Managerial accounting aids decision makers by providing good estimates as soon as possible rather than waiting for precise data later. Financial accounting is concerned with reporting for the company as a whole. Managerial accounting focuses more on the segments of the company. Examples of segments include: Product lines, sales territories, divisions, departments, etc. Financial accounting conforms to GAAP. Managerial accounting is not bound by GAAP. Financial accounting is mandatory because various outside parties require periodic financial statements. Managerial accounting is not mandatory.

Manufacturing Overhead
Manufacturing Costs Direct Materials Direct Labor Manufacturing Overhead Manufacturing costs are usually grouped into three main categories: direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product. The Product

Example: A radio installed in an automobile
Direct Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it. Direct materials are raw materials that become an integral part of the finished product and that can be physically and conveniently traced to it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile. Example: A radio installed in an automobile

Example: Wages paid to automobile assembly workers
Direct Labor Those labor costs that can be easily traced to individual units of product. Direct labor consists of that portion of labor cost that can be easily traced to a product. Direct labor is sometimes referred to as “touch labor” since it consists of the costs of workers who “touch” the product as it is being made. Example: Wages paid to automobile assembly workers

Manufacturing Overhead
Manufacturing costs cannot be traced directly to specific units produced. Examples: Indirect materials and indirect labor Materials used to support the production process. Examples: Lubricants and cleaning supplies used in the automobile assembly plant. Wages paid to employees who are not directly involved in production work. Examples: Maintenance workers, janitors and security guards. Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. These costs cannot be easily traced to specific units produced (also called indirect manufacturing cost, factory overhead, and factory burden). Manufacturing overhead includes indirect materials that are part of the finished product, but that cannot be easily traced to it and indirect labor costs that cannot be physically or conveniently traced to the creation of products. Other examples of manufacturing overhead include: maintenance and repairs on production equipment, heat and light, property taxes, depreciation and insurance on manufacturing facilities, and salaries for supervisors, janitors, and security guards.

Classifications of Nonmanufacturing Costs
Selling Costs Costs necessary to get the order and deliver the product. Administrative Costs All executive, organizational, and clerical costs. A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes, most of these other costs are typically classified as selling costs and administrative costs. These costs are also called selling, general and administrative costs, or SG&A. Selling and administrative costs are incurred in both manufacturing and merchandising firms. Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization that are not classified as production or marketing costs.

Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead. Period costs are not included in product costs. They are expensed on the income statement. Inventory Cost of Goods Sold Balance Sheet Income Statement Sale Expense Income Statement Costs can also be classified as product or period costs. Product costs include all the costs that are involved in acquiring or making a product. In the case of manufactured goods, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP, whereby all manufacturing costs are treated as product costs. Period costs include all selling and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees.

Quick Check  Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions. Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions.

Quick Check  Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions. Property taxes on corporate headquarters and sales commissions are period costs. All of the other costs listed are product costs.

Prime Cost and Conversion Cost
Manufacturing costs are often classified as follows: Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost Prime cost consists of direct materials plus direct labor. Conversion cost consists of direct labor plus manufacturing overhead.

Comparing Merchandising and Manufacturing Activities
Merchandisers . . . Buy finished goods. Sell finished goods. Manufacturers . . . Buy raw materials. Produce and sell finished goods. MegaLoMart Merchandising companies purchase finished goods from suppliers for resale to customers. Manufacturing companies purchase raw materials from suppliers and produce and sell finished goods to customers.

Balance Sheet Merchandiser Manufacturer Current Assets Current Assets
Cash Receivables Prepaid Expenses Merchandise Inventory Manufacturer Current Assets Cash Receivables Prepaid Expenses Inventories: Raw Materials Work in Process Finished Goods Now, let’s consider the similarities and differences on the balance sheet for merchandising and manufacturing companies. Both merchandising and manufacturing companies will likely have Cash, Receivables and Prepaid Expenses. However, merchandising companies do not have to distinguish between raw materials, work in process, and finished goods. They report one inventory number on their balance sheet labeled merchandise inventory. Manufacturing companies report three types of inventory on their balance sheets: raw materials, work in process and finished goods.

Materials waiting to be processed. Completed products awaiting sale.
Balance Sheet Merchandiser Current Assets Cash Receivables Prepaid Expenses Merchandise Inventory Manufacturer Current Assets Cash Receivables Prepaid Expenses Inventories: Raw Materials Work in Process Finished Goods Materials waiting to be processed. Partially complete products – some material, labor, or overhead has been added. Part I Raw materials are the materials used to make the product. Part II Work in process consists of units of product that are partially complete, but will require further work to be saleable to customers. Part III Finished goods consists of units of product that have been completed, but not yet sold to customers. Completed products awaiting sale.

The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers. Merchandising companies calculate cost of goods sold as Beginning Merchandise Inventory plus Purchases minus Ending Merchandise Inventory. For manufacturing companies, the cost of goods sold for a period is not simply the manufacturing costs incurred during the period. They calculate cost of goods sold as Beginning Finished Goods Inventory plus Cost of Goods Manufactured minus Ending Finished Goods Inventory. For a manufacturing company, some of the cost of goods sold may be for units completed in a previous period. And some of the units completed in the current period may not have been sold and will still be on the balance sheet as an asset. The cost of goods sold is computed with the aid of a schedule of costs of goods manufactured, which takes into account changes in inventories. The schedule of cost of goods manufactured is not ordinarily included in external financial reports, but must be compiled by accountants within the company in order to arrive at the cost of goods sold. We will learn more about a schedule of costs of goods manufactured later in this chapter.

Additions to inventory
Inventory Flows Beginning balance Additions to inventory + = Ending Withdrawals from inventory The computation of Cost of Goods Sold relies on this basic equation for inventory accounts: beginning inventory balance plus additions to inventory equals ending inventory balance plus withdrawals from inventory. The logic underlying this equation applies to any inventory account. Any units that are in inventory at the beginning of the period appear as the beginning balance. During the period, additions are made to the inventory through purchases or other means. At the end of the period, everything that was in the beginning inventory or that was added must be in the ending inventory account or have been transferred out to another inventory account or to cost of goods sold.

Quick Check  If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? A. $1,000. B. $ C. $1,200. D. $ If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month?

Quick Check  If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? A. $1,000. B. $ C. $1,200. D. $ $1,000 + $100 = $1,100 $1,100 - $300 = $800 Right. $800. This is calculated as beginning inventory of $1,000 plus purchases of $100 minus ending inventory of $300.

Schedule of Cost of Goods Manufactured
Calculates the cost of raw material, direct labor and manufacturing overhead used in production. Calculates the manufacturing costs associated with goods that were finished during the period. The schedule of cost of goods manufactured contains the three elements of costs mentioned previously, namely, direct materials, direct labor, and manufacturing overhead. The purpose of the schedule is to calculate the cost of raw materials, direct labor, and manufacturing overhead used in production. In addition, it is used to calculate the manufacturing costs associated with goods that were finished during the period.

As items are removed from raw materials inventory and placed into the production process, they are called direct materials. At first glance, the schedule of cost of goods manufactured appears complex. However, it is all quite logical. The schedule of cost of goods manufactured contains the three types of product costs that we discussed earlier—direct materials, direct labor, and manufacturing overhead. The raw materials cost is not simply the cost of raw materials purchased during the period—rather it is the cost of materials used during the period. Raw material purchases made during the period are added to the beginning raw materials inventory balance to determine the cost of materials available for use during the period. The ending materials inventory is deducted from this amount to arrive at the cost of raw materials used in production. As items are removed from raw materials inventory and placed into the production process, they are called direct materials.

Conversion costs are costs incurred to convert the direct material into a finished product. After we calculated the raw materials used in production, we take that amount and add the conversion costs (direct labor and manufacturing overhead) to get total manufacturing costs for the period. As items are removed from raw materials inventory and placed into the production process, they are called direct materials.

After we calculate our total manufacturing costs, we take beginning work in process inventory, add to that, total manufacturing costs, and we get the total work in process for the period. All manufacturing costs incurred during the period are added to the beginning balance of work in process.

Finally, we subtract ending work-in-process inventory from work in process for the period to get cost of goods manufactured. Completed goods are transferred to finished goods inventory. Costs associated with the goods that are completed during the period are transferred to finished goods inventory.

Cost of Goods Sold You can see that the cost of goods manufactured is added to the beginning finished goods inventory to get the cost of goods available for sale. The ending finished goods inventory is subtracted to arrive at the cost of goods sold.

Manufacturing Cost Flows
Balance Sheet Costs Inventories Income Statement Expenses Material Purchases Raw Materials Manufacturing Overhead Work in Process Direct Labor Finished Goods Cost of Goods Sold Part I Let’s briefly look at the flow of costs in a manufacturing company. This will help us understand how product costs move through the various accounts and how they affect the balance sheet and the income statement. Raw materials are purchased and placed into raw materials inventory. Part II Raw materials are requisitioned out of raw materials inventory into work in process. Direct labor and manufacturing overhead are charged directly to work in process inventory. Part III When we complete the product, the product and its costs are transferred out of work in process inventory into finished goods. All raw materials, work in process and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet. Part IV As finished goods are sold, their costs are transferred to cost of goods sold on the income statement. Part V Selling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported in the income statement for the period the cost is incurred. Selling and Administrative Selling and Administrative Period Costs

Quick Check  Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? A. $276,000 B. $272,000 C. $280,000 D. $ 2,000 Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?

Quick Check  Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? A. $276,000 B. $272,000 C. $280,000 D. $ 2,000 Right. $280,000. Take a minute and review the solution before proceeding.

Quick Check  Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month? A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined. Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?

Quick Check  Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month? A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined. Right. $835,000. Take a minute and review the solution before proceeding.

Quick Check  Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? A. $1,160,000 B. $ 910,000 C. $ 760,000 D. Cannot be determined. Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?

Quick Check  Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? A. $1,160,000 B. $ 910,000 C. $ 760,000 D. Cannot be determined. Right. $760,000. Take a minute and review the solution before proceeding.

Quick Check  Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month? A. $ 20,000. B. $740,000. C. $780,000. D. $760,000. Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month?

Quick Check  Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month? A. $ 20,000. B. $740,000. C. $780,000. D. $760,000. $130,000 + $760,000 = $890,000 $890,000 - $150,000 = $740,000 Right. $740,000. Take a minute and review the solution before proceeding.

Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of business activity. Total variable costs change when activity changes. Total fixed costs remain unchanged when activity changes. Managers often need to be able to predict how costs will change in response to changes in activity. The activity might be the output of goods or services or it might be some measure of activity, internal to the company, such as the number of purchase orders processed during a period. In this chapter, nearly all of the illustrations assume that the activity is the output of goods or services. In later chapters, other measures of activity will be introduced. Cost behavior refers to how a cost will react to changes in the level of activity within the relevant range. The most commonly used classifications of cost behavior are variable and fixed costs, which we will discuss in this chapter. The total of just about any cost will change if there is a big enough change in activity. There is some controversy concerning the proper definition of the “relevant range.” Some refer to the relevant range as the range of activity within which the company usually operates. We refer to the relevant range as the range of activity within which the assumptions about variable and fixed costs are valid. Either definition could be used—our choice was dictated by our desire to highlight the notion that fixed costs can change if the level of activity changes enough.

Total Long Distance Telephone Bill
Total Variable Cost Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked Total Long Distance Telephone Bill A variable costs varies, in total, in direct proportion to changes in the level of activity. For example, your long distance telephone bill may be based on how many minutes you talk—the total bill varies with the number of minutes used.

Per Minute Telephone Charge
Variable Cost Per Unit The cost per long distance minute talked is constant. For example, 10 cents per minute. Minutes Talked Per Minute Telephone Charge Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, the cost per long distance minute may be ten cents a minute.

Monthly Basic Telephone Bill
Total Fixed Cost Your monthly basic telephone bill probably does not change when you make more local calls. Number of Local Calls Monthly Basic Telephone Bill A fixed cost remains constant, in total, within the relevant range, regardless of changes in the level of the activity. In other words, fixed costs do not change as long as the activity level falls within the “relevant range.” For example, your monthly basic telephone bill probably is a set amount and does not change based on the number of local calls you make.

Monthly Basic Telephone Bill per Local Call
Fixed Cost Per Unit The average fixed cost per local call decreases as more local calls are made. Number of Local Calls Monthly Basic Telephone Bill per Local Call When expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. In other words, for a fixed cost, the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per local call decreases as more local calls are made.

Cost Classifications for Predicting Cost Behavior
It is helpful to think about variable and fixed cost behavior in a two by two matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs.

Quick Check  Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers. Which of the following costs would be variable with respect to the number of cones sold at a Baskins and Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.

Quick Check  Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers. Right. The cost of ice cream and the cost of napkins for customers would be variable costs. As Baskins and Robbins sells more ice cream cones, we would expect the total cost of ice cream and napkins to increase.

Assigning Costs to Cost Objects
Direct costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: Direct material and direct labor Indirect costs Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Example: Manufacturing overhead A cost object is anything for which cost data are desired including products, customers, jobs, organizational subunits, etc. For purposes of assigning costs to cost objects, costs are classified two ways: Direct costs are costs that can be easily and conveniently traced to a unit of product or other cost object. Examples of direct costs are direct material and direct labor. Indirect costs are costs that cannot be easily and conveniently traced to a unit of product or other cost object. An example of an indirect cost is manufacturing overhead. Common costs are indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.

Cost Classifications for Decision Making
Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant to the decision. All other costs and benefits can and should be ignored. It is important to realize that every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant to the decision. All other costs and benefits are irrelevant and can and should be ignored. To make decisions, it is essential to have a grasp on three concepts: Differential costs, opportunity cost, and sunk cost. Let’s take a look at each of these on the next few slides.

Differential Costs and Revenues
Costs and revenues that differ among alternatives. Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. Differential costs (or incremental costs) is a difference in cost between any two alternatives. A difference in revenue between two alternatives is called differential revenue. Differential costs can be either fixed or variable. For example, assume you have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. In this example, the differential revenue is $500 and the differential cost is $300. The net differential benefit associated with accepting the new job is $200. Differential revenue is: $2,000 – $1,500 = $500 Differential cost is: $300 Net Differential Benefit is: $200

Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000. An opportunity cost is the potential benefit that is given up when one alternative is selected over another. These costs are not usually entered into the accounting records of an organization, but must be explicitly considered in all decisions.

Sunk Costs Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost. A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed, they cannot be differential costs; therefore, sunk costs should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people, they often have difficulty putting this idea into practice.

Quick Check  Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant. Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland?

Quick Check  Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant. Yes, it should be considered because the cost of the train ticket is relevant.

Quick Check  Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant. Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision?

Quick Check  Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant. No, the licensing cost is not relevant.

Quick Check  Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost. Suppose that your car could be sold now for $5,000. Is this a sunk cost?

Quick Check  Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost. No, it is not a sunk cost.

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 process cost system is best used by companies that produce many units of a single product and when one unit of output is indistinguishable from any other unit of output. Because the units of output are identical, the company will probably use an average cost system to determine product cost.

Process Costing Job-order Costing Example companies: 1. Weyerhaeuser (paper manufacturing) 2. Reynolds Aluminum (refining aluminum ingots) 3. Coca-Cola (mixing and bottling beverages) An example of a company that may consider a process cost system is Weyerhaeuser, a manufacturer of paper products. When we think of paper manufacturing, we generally think about continuous production of a single roll of paper that may eventually be cut into sizes needed by customers. Other companies that would benefit from process costing are Reynolds Aluminum and Coca-Cola. Certainly, the desire of all three of these companies is to make each unit of output consistent with the quality standards established. Coca-Cola bottled in California should taste identical to the same product bottled in New York City.

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. A company would use a job-order costing system when many different products are produced each period. The products are usually manufactured to customers’ specifications. The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

Process Costing Job-order Costing Example companies: 1. Boeing (aircraft manufacturing) 2. Bechtel International (large scale construction) 3. Walt Disney Studios (movie production) Companies that may benefit from using job-order cost systems include Boeing, Bechtel International, and Walt Disney Studios. Bechtel is perhaps the largest international construction company. The company works on huge projects that are unique to customer needs.

Comparing Process and Job-Order Costing
This table presents an overview of the differences between a job-order and process costing system. With job-order costing, many jobs are worked on during the period; with process costing, a single product is produced for a long period of time. With job-order costing, costs are accumulated by individual jobs; with process costing, costs are accumulated by departments. With job-order costing, average unit costs are computed by job; with process costing, average unit costs are computed for a particular operation or by department.

Quick Check  Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels. See if you can identify those types of companies that would benefit from the use of a job-order cost system. There may be more than one company in the list.

Quick Check  Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels. How did you do? The paper and ketchup manufacturers would probably use a process costing system rather than a job-order system.

Job-Order Costing—An Overview
Charge direct material and direct labor costs to each job as work is performed. Direct Materials Job No. 1 Direct Labor Job No. 2 In a job-order costing system, direct materials and direct labor are both assigned to individual jobs on which the materials were used and the labor incurred. Manufacturing Overhead Job No. 3

Job-Order Costing—An Overview
Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job. Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing overhead includes indirect materials and indirect labor as well as other manufacturing costs, like the power used to run the machinery in the factory. Manufacturing overhead cannot be traced directly to specific jobs; rather, it is allocated to jobs on the basis of a predetermined rate. Overhead is applied to each job that’s in process using the predetermined rate. We’ll see how to calculate the rate in a few minutes. Manufacturing Overhead Job No. 3

Job Cost Sheet The accounting department relies upon a job cost sheet for tracking the direct and indirect costs associated with a given job. Here is a job cost sheet for a hypothetical company called PearCo. A job number uniquely identifies each job. Direct material, direct labor and manufacturing overhead costs are accumulated for each job. And, the job cost sheet is a subsidiary ledger to the Work in Process account.

Materials Requisition Form
Once a sales order has been received and a production order issued, the Production Department prepares a materials requisition form to specify the type, quantity, and total cost of materials (e.g., $116) to be drawn from the storeroom, and the job number (e.g., A-143) to which the cost of the materials is to be charged. For an existing product, the production department can refer to a bill of materials to determine the type and quantity of each item of materials needed to complete a unit of product.

Job Cost Sheet The Accounting Department records the total direct material cost (e.g., $116) on the appropriate job cost sheet. Notice that the material requisition number (e.g., X7-6890) is included on the job cost sheet to provide easy access to the source document.

Employee Time Ticket Workers use time tickets to record the amount of time that they spent on each job and the total cost assigned to each job. We can see that on March 5, I. M. Skilled worked for 8 hours on job A-143. The hourly pay rate is $11, so $88 of direct labor will be charged to our job, A-143. Notice that the supervisor approves to the accuracy of the time ticket.

Job Cost Sheet The Accounting Department records the labor costs from the time tickets (e.g., $88) on to the job cost sheet.

Application of Manufacturing Overhead
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: It is impossible or difficult to trace overhead costs to particular jobs. Manufacturing overhead consists of many different items ranging from the grease used in machines to a production manager’s salary. Many types of manufacturing overhead costs are fixed even though output fluctuates during the period. Part I Manufacturing overhead is applied to all jobs that are in process. We apply overhead using a base which we believe causes overhead costs to be incurred. Some companies allocate manufacturing overhead using direct labor hours, direct labor dollars, or machine hours. Part II We must allocate overhead costs to jobs for a variety of reasons. First, it is difficult, if not impossible, to actually trace overhead costs to a particular job. The cost of grease for machinery to manufacture our product is part of our manufacturing costs. It would be impossible to accurately trace the amount of grease consumed to manufacture one unit of output. Manufacturing overhead also includes a number of different costs and it would be very difficult to gather all of them together in time to charge them to a particular job. A job may be complete and sold before we can determine the actual overhead costs incurred. Finally, many types of overhead are fixed in nature even though output fluctuates during the period.

The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = To facilitate the allocation of manufacturing overhead to each job, we calculate a predetermined overhead rate before the period begins. The rate is calculated by dividing the total estimated amount of manufacturing overhead for the coming period by the estimated quantity of the allocation base for the coming period. For example, if our allocation base is machine hours, we would estimate the total number of machine hours used in production in the coming period. Ideally, the allocation base should be a cost driver, that is, it causes overhead to be incurred. Ideally, the allocation base is a cost driver that causes overhead.

Using a predetermined overhead rate (POHR) makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until sometime after the period has ended. Actual overhead costs can fluctuate seasonally, thus misleading decision makers. It simplifies record keeping. $ Predetermined overhead rates that rely on estimated data are often used because actual overhead costs for the period are not known until sometime after the end of the period; thereby inhibiting the ability to estimate job costs during the period. Actual overhead costs can fluctuate seasonally, thus misleading decision makers. Therefore, using a predetermined overhead rate simplifies record keeping.

Based on estimates, and determined before the period begins. Overhead applied = POHR × Actual activity Manufacturing overhead is applied to jobs using the predetermined overhead rate multiplied by the actual amount of the allocation base used completing the job (this is called a normal costing system). Actual amount of the allocation based upon the actual level of activity (this is called a normal costing system).

Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = $640,000 160,000 direct labor hours (DLH) POHR = For example, assume PearCo applies overhead to jobs based on direct labor hours and the estimated total overhead for the year is $640,000. If estimated total direct labor hours for the year is 160,000 hours, then PearCo’s predetermined overhead rate is $4 per direct labor hour. POHR = $4.00 per DLH For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

On the job cost sheet, the amount of overhead that would be applied to the job cost sheet for Job A-143 is $32 (8 direct labor hours × $4 per hour).

Completing the Job Cost Sheet
The total direct material, direct labor, and manufacturing overhead costs assigned to Job A-143 is $236. Since this particular job included two units of production, the average cost per unit is $118.

Interpreting the Average Unit Cost
The average unit cost should not be interpreted as the costs that would actually be incurred if an additional unit were produced. Fixed overhead would not change if another unit were produced, so the incremental cost of another unit may be somewhat less than $118. The average unit cost should not be interpreted as the costs that would actually be incurred if another unit were produced. The fixed overhead would not change if another unit were produced, so the incremental cost of another unit would be less than $118.

Quick Check  Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730. Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? This problem may take a while to solve, but it will be well worth your time to complete the computations.

Quick Check  Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730. The cost of job WR53 is $730. This consists of direct materials of $200, direct labor of $150, and manufacturing overhead of $380.

Job-Order Costing Document Flow Summary
Let’s summarize the document flow in a job-order costing system. Now let’s look at the document flow in a job-order cost system.

A sales order is the basis of issuing a production order. A production order initiates work on a job. The entire accounting process begins when a sales order is received from a customer. Once the sales order is received and approved, a production order is drafted to initiate work on a job.

Materials used may be either direct or indirect. Direct materials Job Cost Sheets Materials Requisition From the production order, we are able to determine the direct and indirect materials we will need to requisition from the store room. A materials requisition form is used to draw direct and indirect materials from the storeroom. We now know that the materials requisition form is a critical source document in the preparation of the job cost sheet. Direct material costs are charged to specific jobs. Indirect material costs are included in manufacturing overhead. Indirect materials Manufacturing Overhead Account

An employee’s time may be either direct or indirect. Direct Labor Job Cost Sheets Employee Time Ticket As employees work on the job covered by the production order, time tickets are prepared for recording both direct and indirect labor costs. Direct labor costs are charged to specific jobs. Indirect labor costs are included in manufacturing overhead. Indirect Labor Manufacturing Overhead Account

Employee Time Ticket Indirect Labor Other Actual OH Charges Manufacturing Overhead Account Applied Overhead Job Cost Sheets Indirect materials and indirect labor are parts of manufacturing overhead. Other overhead costs are charged to the manufacturing overhead account, as incurred. The predetermined overhead rate is used to apply manufacturing overhead costs to jobs. Indirect Material Materials Requisition

Job-Order Costing—The Flow of Costs
Let’s examine the transactions in T-account and journal entry forms in a job-order costing system. Now, let’s examine the transactions in T-account and journal entry form that capture the flow of costs in a job-order costing system.

Summary of Cost Flows Raw Materials Work in Process (Job Cost Sheet)
Direct Materials Material Purchases Indirect Materials Mfg. Overhead Part I Here is a T-account approach to looking at the cost flows in a job-order cost system. When raw materials are purchased, they are debited to the raw materials inventory account and credited to accounts payable (not shown). Part II The cost of direct material requisitions is debited to Work in Process and added to the job cost sheet, which serves as a subsidiary ledger. Part III The manufacturing overhead account is debited and the raw materials inventory is credited for the indirect materials used. Actual Applied

Journal Entry – Material Purchases
Raw material purchases are recorded in an inventory account. Here is an example of the general journal entry to record the purchase of raw materials on account. We debit raw materials and credit accounts payable.

Journal Entry – Material Usage
Direct materials issued to a job increase Work in Process and decrease Raw Materials. Indirect materials used are charged to Manufacturing Overhead and decrease Raw Materials. When materials are requisitioned from raw materials inventory, we debit work in process (job cost sheet) for direct materials, and we debit manufacturing overhead for indirect materials.

Salaries and Wages Payable
Summary of Cost Flows Salaries and Wages Payable Work in Process (Job Cost Sheet) Direct Labor Direct Materials Direct Labor Indirect Labor Indirect Labor Mfg. Overhead Part I Wages and salaries are initially recorded in a payable account. Part II Direct labor is charged to work in process inventory through the Job-Cost Sheet. Indirect labor is charged to manufacturing overhead. Actual Applied Indirect Materials

Journal Entry – Labor Costs
The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead. Here is an example of the entry to charge direct and indirect labor to the work in process inventory account and the manufacturing overhead account.

Summary of Cost Flows Mfg. Overhead In addition to indirect materials and indirect labor, other actual manufacturing overhead costs are debited to the Manufacturing Overhead account. Actual Applied Indirect Materials Indirect Labor Other Overhead Other actual manufacturing overhead costs are debited to Manufacturing Overhead. The credit side of the entry is the various liability accounts (e.g., Accounts Payable and Property Taxes Payable), prepaid asset accounts (e.g., Prepaid Insurance) and contra-asset accounts (e.g., Accumulated Depreciation).

Journal Entry – Actual Overhead
In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred. This journal entry represents the accumulation of other actual overhead amounts like property taxes on the manufacturing plant, insurance on the plant structure and depreciation of manufacturing assets. Manufacturing Overhead is debited and various other accounts are credited as shown.

Summary of Manufacturing Overhead Cost Flows
Work in Process (Job Cost Sheet) Mfg. Overhead Actual Applied Direct Materials Indirect Materials Overhead Applied to Work in Process Direct Labor Indirect Labor Overhead Applied Other Overhead Manufacturing overhead is applied to each job in work in process inventory by debiting Work in Process and crediting Manufacturing Overhead for the amount of applied overhead based on the predetermined overhead rate. Actual manufacturing overhead costs are not debited to Work in Process, nor are they charged to jobs via the job cost sheets. The Manufacturing Overhead account is a clearing account. The actual amount of overhead incurred during the period (debit side of the account) will not be equal to the amount applied to the Work in Process account (credit side of the account). Any variance between actual and applied will be accounted for as a year-end adjusting entry. This requires a year-end adjusting entry that will be discussed shortly. If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.

Journal Entry – Overhead Applied
Work in Process is increased when Manufacturing Overhead is applied to jobs. Recording applied overhead requires a debit to Work in Process and a credit to Manufacturing Overhead.

Accounting for Nonmanufacturing Costs
Nonmanufacturing costs are not assigned to individual jobs, rather they are expensed in the period incurred. Income Statement Expense nonmanufacturing costs as incurred. We previously discussed the treatment of selling and administrative salaries expense during the period. Other nonmanufacturing costs are charged as expense in the period incurred. Companies that use job-order cost systems to assign manufacturing costs to products also incur nonmanufacturing costs. Nonmanufacturing costs should not go into the Manufacturing Overhead account. Nonmanufacturing costs are not assigned to individual jobs, rather, they are expensed in the period incurred.

Journal Entry – Accounting for Nonmanufacturing Costs
Nonmanufacturing Cost Examples: 1. Salary expense of employees that work in a marketing, selling, or administrative capacity. 2. Advertising expenses are expensed in the period incurred. For example, the salary expense for employees that work in a selling or administrative capacity are expensed in the period incurred. And, advertising expenses are expensed in the period incurred. This journal entry illustrates the expensing of nonmanufacturing costs in the current period.

Summary of Goods Manufactured Cost Flows
Work in Process (Job Cost Sheet) Finished Goods Cost of Goods Mfd. Direct Materials Cost of Goods Mfd. Direct Labor Overhead Applied The sum of all amounts transferred from work in process to finished goods represents the cost of goods manufactured for the period. The Work in Process account is credited and the Finished Goods account is debited.

Journal Entry – Cost of Goods Manufactured
As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process. The transfer is accomplished with a debit to finished goods inventory and a credit to work in process inventory.

Summary of Job-Order System Cost Flows
Work in Process (Job Cost Sheet) Finished Goods Cost of Goods Sold Cost of Goods Mfd. Direct Materials Cost of Goods Mfd. Direct Labor Overhead Applied Cost of Goods Sold When a finished job is sold to the customer, the cost of that job is transferred from finished goods inventory to cost of good sold. Recall that cost of goods sold is an income statement account. If only a portion of the units associated with a particular job are shipped, then the unit cost figure from the job cost sheet is used to determine the amount of the journal entry.

Journal Entry – Sales When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods. Assuming the company uses a perpetual inventory system, two journal entries are required to record the sale. The first entry is to debit either accounts receivable or cash and credit sales for the selling price of the job completed. The second entry is to debit cost of goods sold and credit finished goods inventory for the cost incurred to complete the job. The difference between the selling price and cost is the company’s gross margin on the job.

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. There are two complications relating to overhead application: defining and computing underapplied and overapplied overhead. When we apply overhead on the basis of a predetermined overhead rate, there is always the chance that the amount of overhead applied will be different from the amount of overhead actually incurred during the period. When there is a difference, we refer to the amount as either underapplied overhead 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.

Overhead Application Example
PearCo’s actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour. Part I Let’s assume that PearCo incurred actual overhead of $650,000 during the period and worked a total of 170,000 direct labor hours. Recall that PearCo applies overhead at the rate of $4 per direct labor hour worked. How much overhead did PearCo apply to jobs during the period? Part II PearCo would have applied $680,000 of overhead during the period. That is $4 per direct labor hour times the 170,000 direct labor hours actually worked. Can you see our problem? Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

Overhead Application Example
PearCo’s actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCo’s jobs during the year? Use PearCo’s predetermined overhead rate of $4.00 per direct labor hour. PearCo has overapplied overhead for the year by $30,000. What will PearCo do? 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. PearCo incurred actual overhead of $650,000 and applied $680,000, so the company overapplied $30,000 of overhead for the year. How do we dispose of this overapplied overhead? Overhead Applied During the Period Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

Quick Check  Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. What is Tiger’s over- or underapplied overhead? a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. What is Tiger’s over- or underapplied overhead?

Applied Overhead $4.00 × 290,000 hours = $1,160,000
Quick Check  Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. What is Tiger’s over- or underapplied overhead? a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied. Applied Overhead $4.00 × 290,000 hours = $1,160,000 Tiger, Inc. has underapplied overhead of $50,000.

Disposition of Under- or Overapplied Overhead
PearCo’s Mfg. Overhead PearCo’s Cost of Goods Sold Actual overhead costs $650,000 Overhead applied to jobs $680,000 Unadjusted Balance $30,000 Part I The simplest way to close out any remaining balance in the Manufacturing Overhead account is to close it out to Cost of Goods Sold. Part II The journal entry, in T-account form, to close out PearCo’s $30,000 of overapplied overhead into Cost of Goods Sold would be to debit Manufacturing Overhead and credit Cost of Goods Sold. $30,000 overapplied Adjusted Balance

Quick Check  What effect will the adjustment of the overapplied overhead have on PearCo’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease. What effect will adjustment of the overapplied overhead have on PearCo’s net operating income?

Quick Check  What effect will the adjustment of the overapplied overhead have on PearCo’s net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease. How did you do? Net operating income will increase. This is because Cost of Goods Sold was reduced for the overapplied overhead, which results in an increase in gross profit, and thus, an increase in net operating income.

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. Part I We have assumed that the company has used one single predetermined overhead rate for the entire factory; such a rate is called a plantwide overhead rate. Part II In larger companies, multiple predetermined overhead rates are often used. For example, each production department may have its own predetermined overhead rate. Part III Using multiple predetermined overhead rates is more complex. Part IV When a company uses multiple rates, it promotes greater accuracy in the allocation process because it provides recognition to differences across departments in how overhead costs are incurred.

Job-Order Costing in Service Companies
Job-order costing is used in many difference types of service companies. Although our attention has focused on manufacturing applications, it bears re-emphasizing that job-order costing is also used in services industries. For example, in a law firm, each client represents a “job.” Legal forms and similar inputs represent direct materials. The time expended by attorneys represents direct labor. The costs of secretaries, clerks, rent, depreciation, and so forth, represent the overhead.

Assigning Overhead Costs to Products
When cost systems were developed in the 1800s, the emphasis was on simplicity because: 1. Cost and activity data had to be collected by hand and all calculations were done with paper and pencil. 2. Most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product. When cost systems were developed in the 1800s, the emphasis was on simplicity because: Cost and activity data had to be collected by hand and all calculations were done with paper and pencil. Most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product.

Plantwide Overhead Rate
Plantwide Overhead Rate A single overhead rate used throughout an entire factory. Direct labor has often been used as the allocation base for overhead because: 1. Direct labor information was already being recorded. 2. Direct labor was a large component of product costs. 3. Managers believed direct labor and overhead costs were highly correlated. In the interest of simplicity, companies often established a single overhead pool for an entire factory that used direct labor as the allocation base. Direct labor was the obvious choice because: Direct labor information was already being recorded. Direct labor was a large component of product costs. Managers believed direct labor and overhead costs were highly correlated.

Plantwide Overhead Rate
Today, direct labor may no longer be a satisfactory base for allocation of overhead. Most companies sell a large variety of products that consume differing amounts of overhead. As a percentage of total costs, direct labor has been shrinking and overhead has been increasing. Many of the new overhead costs may not be correlated with direct labor. Technology advancements have reduced the cost and complexity of gathering diverse sources of data. Conditions have changed in three ways. Most companies sell a large variety of products that consume differing amounts of overhead. As a percentage of total costs, direct labor has been shrinking and overhead has been increasing. Many of these growing overhead costs may not be correlated with direct labor. Technology advancements have reduced the cost and complexity of gathering diverse sources of data. These changes suggest that a plantwide overhead allocation system may not be optimal for many companies in today’s business environment. A plantwide overhead allocation system may not be optimal for many companies in today’s business environment.

Departmental Overhead Rates
Many companies have a system in which each department has its own overhead rate. The allocation base depends on the nature of the work performed in each department. In the machining department, overhead may be based on machine-hours, but in the assembly department, overhead may be based on labor-hours. Finishing Department Many companies use departmental overhead rates, instead of a plantwide overhead rate. The nature of the work performed in a department will determine the department’s allocation base. For example: Overhead costs in a machining department may be allocated using machine hours. Overhead costs in an assembly department may be allocated using direct labor hours. Painting Department Shipping Department

Departmental Overhead Rates
Departmental rates will not correctly assign overhead in situations where a company has a range of products and complex overhead costs. The departmental approach relies exclusively on volume-related allocation bases while some overhead costs may be caused by factors that are not related to the volume of production. Part I Departmental overhead rates will not correctly assign overhead costs in situations where a company has a range of products and complex overhead costs. Part II This is because the departmental approach relies exclusively on volume-related allocation bases. Some overhead costs may be caused by factors that are not related to the volume of production. Part III A more sophisticated approach, such as activity-based costing, is required to account for these other factors. Activity-base costing is required to account for these other factors.

The End End of Chapter 1.

Management Accounting

Similar presentations

Presentation on theme: "Management Accounting"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Management Accounting

Similar presentations

Presentation on theme: "Management Accounting"— Presentation transcript:

Similar presentations

About project

Feedback