1. Fundamentals of Product & Service Costing
Chapter 5

2. Learning Objectives
Explain the fundamental themes underlying the design of cost systems.
Explain how cost allocation is used in a cost management system.
Explain how a basic product costing system works.
Understand how overhead cost is allocated to products.
Explain the operation of a two-stage allocation system for product costing.
Describe the three basic types of product costing systems: job order, process and operations.

3. Cost System Keys to a good cost system
Oriented to the needs of the decision makers
Designed so that benefits exceed costs

4. Cost System Objective
L.O. 1 Explain the fundamental themes underlying the design of cost systems.
Provide information about costs relevant for decision making.
The cost system accumulates and reports costs about processes, products, and services.

5. Why Calculate the Cost of a Product?
For Decision Making
What should we sell?
At what sales price?
What is the cost of goods sold?
What is the cost of inventory?

6. Designing a Cost System
Decision making
Focus
Different information for different purposes
Financial
the past
Managerial
the future
Test
Cost-benefit

7. Cost Allocation $ Direct materials $ Direct labor $ Overhead DM DL OH
L.O. 2 Explain how cost allocation is used in a cost management system.
$ Direct materials
$ Direct labor
$ Overhead DM DL OH
Traced Directly
Allocated using Direct labor $
Product A
Product B

8. The Inventory Accounts
Balance Sheet
Raw Materials
Work-In-Process
Finished Goods
Beg. Inventory
Beg. Inventory
Beg. Inventory
Cost of Goods Completed and Transferred from WIP + +
Purchases
Direct Materials Transferred from Raw Materials +
Raw Materials Available for Production =
Direct Labor +
Goods Available for Sale =
Manufacturing Overhead +
Raw Materials Transferred to WIP -
Raw Materials Transferred to WIP -
Cost of Goods Sold -
Total Manufacturing Costs =
Ending Inventory =
Ending Inventory =
Cost of Goods Completed and Transferred to Finished Goods -
Cost of Goods Completed and Transferred to Finished Goods -
To the income statement
Ending Inventory =

9. A Product Costing System at Work
L.O. 3 Explain how a basic product costing system works.
How costs and units move through inventories.
Beginning Balance
Transfers In
Transfers Out
Ending Balance BB TI TO EB BB TI TO EB BB TI TO EB
True for
Raw Materials RM
Work-In-Process
WIP
Finished Goods FG

10. Product Costing System Continued
How costs and units move through inventories. RM
DM to WIP BB
Purchases EB
IM to OH
WIP DM
Transfers to FG BB DL EB OH FG
Transfers from WIP EB BB
Cost of goods sold
To income statement

11. Product Costing System Continued
Baxter Paint
April WIP Inventory
Units – gallons of paint BB TO EB TI
100,000 gallons
100,000 gallons FG

12. A Product Costing System at Work
Baxter Paint
April WIP Inventory
Costs BB TI TO EB DM
$400,000 $0
$1,000,000 $0 DL
$100,000 OH
$500,000
$1,000,000 FG
Cost per gallon
$1,000,000
$10 per gallon
100,000

13. Work-In-Process Costs
Let’s rewrite the basic cost flow model BB TI TO EB
What are the costs?
Where are the costs at the end of the period? DM DL OH
$400,000
$100,000
$500,000
$1,000,000 $0
$1,000,000 $0 FG

14. Costing with Ending WIP Inventory
Baxter Paint
May WIP
Units BB TI TO EB
110,000 gallons
90,000 gallons
20,000 gallons
These gallons are half finished. FG

15. Equivalent Units Ending WIP Inventory
How do we cost Baxter’s 20,000 gallons of paint that are only half finished?
20,000 gallons
½ finished
Equivalent to
10,000 gallons finished
20,000 .5
90,000
To FG
10,000
Ending WIP
Total equivalent units
100,000

16. Costing a Product Continued
Baxter Paint
May WIP
Costs BB TI TO EB DM
$390,000 ? ? $0 DL
$100,000 OH
$500,000
$990,000 FG
Where is the $990,000?
What is the cost of the 90,000 gallons transferred to FG and the 20,000 gallons still in WIP?

17. Costing a Product Continued
Cost Flow Diagram
Product Costing at Baxter Paints DM DL OH
$390,000
$100,000
$500,000
Total $990,000
90,000 gallons
10,000 gallons
Equivalent Gallons
(90%)
(10%)
100,000 FG
WIP
$891,000
$99,000

18. Costing Multiple Products
Sammy’s Skis and Boards
Units
Skis
Snowboards
Total
500
150
650
Units produced
4,000
900
4,900
Direct labor hours
2,000
450
2,450
Machine hours
Costs
75,000
15,000
90,000
Direct Material
100,000
22,500
122,500
Direct Labor

19. Costing Multiple Products
Direct Materials
Direct Labor
$90,000
$122,500
Cost Pools
Direct
Direct
Cost Objects
Skis
Snowboards
$75,000
$15,000
$100,000
$22,500

20. Predetermined Overhead Rates
L.O. 4 Understand how overhead cost is allocated to products.
OH is indirect. Where do indirect costs belong?
With the skis?
Or with the boards?
Indirect costs are allocated using a predetermined overhead rate.
POHR
POHR is the cost per unit of the allocation base used to charge overhead to products. $
POHR
Base

21. Predetermined Overhead Rates Continued
What are the estimated costs?
Estimated overhead $
POHR
Estimated allocation base
What activity drives the overhead costs?
Why use estimates?
We need to cost products during the period.
We don’t know the exact amount of indirect costs until the end of the period.

22. Sammy’s Skis and Boards
Snowboards
Total
4,000
900
4,900
Direct Labor hours
Estimated Overhead Costs
$98,000
$98,000
POHR
$20 / DLH
4,900

23. Allocating OH to the Products
Cost Pool OH
$98,000
Cost Allocation Rule
$20 / DLH
Direct Labor Hours
Cost Objects
Skis
Snowboards
$80,000
$18,000
4,000DLH
$20
900DLH
$20

24. Sammy’s Skis and Boards
Snowboards
Total
Units
Units produced
500
150
650
Direct Labor hours
4,000
900
4,900
Costs
Direct Material
$75,000
$15,000
$90,000
Direct Labor
100,000
22,500
122,500
$20/DLH
80,000
18,000
98,000
Total
$255,000
$55,500
$310,500
Cost per unit
$510
$370

25. Two-Stage Allocation Systems
L.O. 5 Explain the operation of a two-stage allocation system for product costing.
Cost Pool
Overhead
$98,000
Intermediate Cost Pools
Labor-related
Machine-related
$73,500
$24,500
Cost Allocation Rule
Direct Labor Hours
Machine Hours

26. Two-Stage Allocation Systems Continued
Intermediate Cost Pools
Labor-related
Machine-related
$73,500
$24,500
Cost Allocation
Direct Labor Hours
Machine Hours
4,900
2,450
$15/DLH
$10/MH
Cost Objects
Skis
Snowboards
$60,000
$13,500 DL
$20,000
$4,500 MH
Allocated Overhead
$18,000
$80,000

27. Sammy’s Skis and Boards
Costs
Skis
Snowboards
Total
Direct Material
$75,000
$15,000
$90,000
Direct Labor
100,000
22,500
122,500
$15/DLH
60,000
13,500
73,500
$10/MH
20,000
4,500
24,500
Total
$255,000
$55,500
$310,500
Cost per unit
$510
$370

28. Product Costing Systems
L.O. 6 Describe the three basic types of product costing systems: job order, process, and operations.
Job Costing
Process Costing
An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods.
An accounting system used when identical units are produced through a series of uniform production steps.
Custom Homes
Cornflakes
Movies
Facial Tissues
Services
Paint

29. Product Costing Systems
Job Costing
Operation Costing
Process Costing
An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods.
A hybrid costing system often used in manufacturing of goods that have some common characteristics plus some individual characteristics.
An accounting system used when identical units are produced through a series of uniform production steps.
Automobiles
Computers
Clothing

30. Chapter 5
The End