1. PPT 4 -1 Don R. Hansen Maryanne M. Mowen COST MANAGEMENT

2. PPT 4 -2 Chapter Four Product and Service Costing: Overhead Application and Job-Order System

3. PPT 4 -3 Learning Objectives l Differentiate the cost accounting systems of service and manufacturing firms and of unique and standardized products. l Discuss the interrelationship of cost accumulation, cost measurement, and cost assignment. l Compute a predetermined overhead rate, and use the rate to assign overhead to production.

4. PPT 4 -4 Learning Objectives (continued) l Explain the difference between job-order and process costing, and identify the source documents used in job-order costing. l Describe the cost flows associated with job-order costing, and prepare the journal entries. l Explain why multiple overhead rates may be preferred to a single, plantwide rate.

5. PPT 4 -5 Manufacturing Firms Versus Service Firms Manufacturing involves putting together materials, labor, and overhead to produce a new product. The good produced is tangible and can be inventoried and transported from the plant to the customer. A service is characterized by its intangible nature. It is not separable from the customer and cannot be inventoried.

6. PPT 4 -6 Interface of Services with the Cost Management System 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity

7. PPT 4 -7 Relationship to Business Impact on Cost Management System *Many of these effects are also true of tangible products. Services cannot be stored. Services cannot be protected through patents. Services cannot readily be displayed or communicated. Prices are difficult to set. There are no inventory accounts. There is a strong ethical code.* Costs must be related to entire organization.* Intangibility

8. PPT 4 -8 Relationship to Business Impact on Cost Management System *Many of these effects are also true of tangible products. Consumer is involved in production. Other consumers are involved in production Centralized mass production of services is difficult. Costs often accounted for by customer type.* System must be generated to encourage consistent quality.* Inseparability

9. PPT 4 -9 Relationship to Business Impact on Cost Management System *Many of these effects are also true of tangible products. Standardization and quality control are difficult. A strong systems approach is needed. Productivity measurement is ongoing.* Total quality management is critical.* Heterogeneity

10. PPT 4 -10 Relationship to Business Impact on Cost Management System *Many of these effects are also true of tangible products. Service benefits expire quickly. Service may be repeated often for one customer. There are no inventories. There needs to be a standardized system to handle repeat customers.* Perishability

11. PPT 4 -11 Relationship of Cost Accumulation, Cost Measurement, and Cost Assignment Cost Accumulation Record Costs: Cost Measurement Classify Costs: Cost Assignment Assign to Cost Objects: Purchase materials Assemblers’ payroll Finishers’ payroll Supervisors’ payroll Depreciation Utilities Property taxes Landscaping Direct Materials Direct Labor Overhead Product 1 Product 2

12. PPT 4 -12 Cost Accumulation Cost accumulation refers to the recognition and recording of costs. The cost accountant needs to develop source documents, which keep track of costs as they occur. A source document describes a transaction. Data from these source documents can then be recorded in a data-base. Well-designed source documents can supply information in a flexible way.

13. PPT 4 -13 Cost Measurement There are two commonly used ways to measure the costs associated with production: actual costing and normal costing. An actual cost system uses actual costs for direct materials, direct labor, and overhead to determine unit cost. Normal costing systems measure overhead costs on a predetermined basis and use actual costs for direct materials and direct labor.

14. PPT 4 -14 Johnson Leathergoods - Example Suppose that Stan Johnson forms a new company, Johnson Leathergoods, which specializes in the production of custom leather products. Stan believes that there is a market for one-of-a-kind leather purses, briefcases, and backpacks. In its first month of operations, he obtains two orders: the first is for 20 leather backpacks for a local sporting goods store; the second is for 10 distinctively tooled briefcases for the coaches of a local college. Stan agrees to provide these orders at a price of cost plus 50 percent.

15. PPT 4 -15 Johnson Leathergoods - Unit Cost Direct materials$1,000 Direct labor1,080 Overhead 240 Total$2,320  number of units  20 Unit cost$ 116 ======

16. PPT 4 -16 Overhead Application a Normal Costing View A predetermined overhead rate is calculated using the following formula: Overhead rate = Budgeted annual overhead/Budgeted annual activity level

17. PPT 4 -17 Choosing the Activity Base 1.Units produced 2.Direct labor hours 3.Direct labor dollars 4.Machine hours 5.Direct materials

18. PPT 4 -18 Choosing the Activity Level Expected activity level is simply the production level the firm expects to attain for the coming year. Normal activity level is the average activity usage that a firm experiences in the long term (normal volume is computed over more than one year). Theoretical activity level is the absolute maximum production activity of a manufacturing firm. Practical activity level is the maximum output that can be realized if everything operates efficiently.

19. PPT 4 -19 Basic Concept of Overhead Application In attempting to understand the concept of applied overhead, there are two points that should be emphasized. 1.Applied overhead is the basis for computing per-unit overhead cost. 2.Applied overhead is rarely equal to a period’s actual overhead.

20. PPT 4 -20 Overhead Application Example Suncalc, Inc., produces two unique, solar-powered products: a pocket calculator and a currency translator used to convert foreign currency exchange rates into dollars and vice versa. The company has the following estimated and actual data for 2001: Budgeted overhead$360,000 Normal activity (in direct labor hours)120,000 Actual activity (in direct labor hours)100,000 Actual overhead$320,000

21. PPT 4 -21 Overhead Application Example (continued) Now assume that the firm bases its predetermined overhead rate on normal activity measured in direct labor hours (DLH). Thus, for 2001: Predetermined overhead rate = Budgeted overhead/Normal activity = $360,000/120,000 direct labor hours = $3 per DLH Using the overhead rate, applied overhead for 2001 is: Applied overhead = Overhead rate x Actual activity usage = $3 per DLH x 100,000 DLH = $300,000

22. PPT 4 -22 Overhead Application Example (continued) PocketCurrency CalculatorTranslator Units produced80,00090,000 Direct labor hours40,00060,000 Overhead applied to production ($3 x DLH)$120,000$180,000 Overhead per unit$1.50$2.00

23. PPT 4 -23 Overhead Variance The difference between actual overhead and applied overhead an overhead variance. If actual overhead is greater than applied overhead, then the variance is called underapplied overhead. If applied overhead is greater than actual overhead, the the variance is called overapplied overhead. The firm has underapplied overhead by ($320,000 - $300,000) or $20,000

24. PPT 4 -24 Disposition of Overhead Variance The overhead variance is disposed of in one of two ways. 1.All overhead variance is allocated to cost of goods sold. 2.The overhead variance is allocated among work in process, finished goods, and cost of goods sold.

25. PPT 4 -25 Comparison of Job-order and Process Costing Job-Order CostingProcess Costing 1.Wide variety of distinct1.Homogeneous products products 2.Cost accumulated by job2.Costs accumulated by process or department 3.Unit cost computed by 3.Unit cost computed by dividing total job costs dividing process costs ofby units produced on that the period by the unitsjob produced in the period

26. PPT 4 -26 A Job-Order Cost Sheet Item Description: _________ Job Order Number: _______ Quantity Completed: ______ Date Started: _____________ Date Completed:_________ Direct Materials Direct Labor Overhead Req. No. Amount Ticket # Hours Rate Amt. Hours Rate Amt. 24-A $500 49 40 $10 $400 40 $1.60 $64 46-B 650 71 30 8 240 30 3.00 90 Cost Summary Direct Materials_______ Total Cost_________ Direct Labor _______ Unit Cost _________ Overhead _______ $1,150 $640 $154 $1,944 $19.44 Drill Bits 100 16-C 1/25/2000 1/31/2001

27. PPT 4 -27 A Material Requisition Form Requisition No._______ Date:______ Department_________ Job No._____ Description Quantity Cost/unit Total Cost Delivered By___________ Received by______________ 24-A 1/25/01Fabrication16-C Steel Stock 100$5.00$500 J. Jones D. Reller

28. PPT 4 -28 A Job Time Ticket Employee No.______ Name____________ Date_________ Start Time Stop Time Total Time Rate Amt. Job No. 10:00 a.m. 4:00 p.m. 6.0 hours $10 $60 16-C Ticket No._________ 49 101 F. Flintstone 1/24/2001 Approved by

29. PPT 4 -29 Job-Order Costing – Material Purchases A.Raw materials account is debited for the cost of materials purchased Raw MaterialsWork in Process (A)

30. PPT 4 -30 Exercise 4-9 Materials were purchased on account for $23,175. Raw Materials23,175 Accounts Payable23,175

31. PPT 4 -31 Job-Order Costing – Material Requisitions B.Raw Materials is credited for the cost of materials issued to jobs. Work in Process is debited for the cost of materials issued to jobs. Raw MaterialsWork in Process (A) (B) (B)

32. PPT 4 -32 Exercise 4-9 (continued) Materials totaling $19,000 were requisitioned for use in production. Work in Process19,000 Raw Materials19,000

33. PPT 4 -33 Job-Order Costing – Direct Labor Incurred C.Wages Payable is credited for direct labor. Work in Process is debited for the cost of direct labor. Wages PayableWork in Process (C) (C)

34. PPT 4 -34 Exercise 4-9 (continued) Direct labor payroll for the month was $17,850 with an average wage of $8.50 per hour. Work in Process17,850 Wages Payable17,850

35. PPT 4 -35 Job-Order Costing – Actual Overhead D.Overhead Control is debited for actual overhead. Overhead ControlWork in Process (D)

36. PPT 4 -36 Exercise 4-9 (continued) Actual overhead of $15,500 was incurred and paid. Overhead Control15,500 Cash15,500

37. PPT 4 -37 Job-Order Costing – Applied Overhead E.Overhead Control is credited for applied overhead. Work in Process is debited for applied overhead. Overhead ControlWork in Process (D) (E)

38. PPT 4 -38 Exercise 4-9 (continued) Factory overhead is charged to production at the rate of $7.00 per direct labor hour. Work in Process14,700 Overhead Control14,700

39. PPT 4 -39 Job-Order Costing – Transfer of Completed Goods F.Credit Work in Process for the COGM. Debit Finished Goods for the COGM. Work in Process Finished Goods (B) (C) (E) (F)

40. PPT 4 -40 Exercise 4-9 (continued) Completed units costing $36,085 were transferred to finished goods. Finished Goods36,085 Work in Process36,085

41. PPT 4 -41 Job-Order Costing – Recognition of Expense G.Credit Finished Goods for value of units sold. Debit Cost of Goods Sold for value of units sold. Finished Goods Cost of Goods Sold (G)

42. PPT 4 -42 Exercise 4-9 (continued) Bags costing $30,000 were sold on account for $36,000. Cost of Goods Sold30,000 Finished Goods30,000 Accounts Receivable36,000 Sales Revenue36,000

43. PPT 4 -43 General Contractor Example Direct MaterialsHouse #1$ 90,000 House #2100,000 House #330,000 Direct LaborHouse #1$ 65,000 House #270,000 House #315,000 Overhead is applied at 50 percent of DLC. Houses #1 and #2 are completed during the period House #1 is sold for $200,000 cash.

44. PPT 4 -44 General Contractor Example – Solution Work in Process Finished Goods (1)220,000(4)187,500 (2)150,000(4)187,500(5)205,000(6)187,500 (3)75,000(5)205,000 52,500205,000 Cost of Goods Sold (6) 187,500 187,500

45. PPT 4 -45 Job Cost Sheets for Example (1) 90,000 (2) 65,000 (3) 32,500 (1) 110,000 (2) 70,000 (3) 35,000 187,500 205,000 House #1 House #2 House #3 (1) 30,000 (2) 15,000 (3) 7,500 52,500

46. PPT 4 -46 Accounting for Spoilage If the defective work was a consequence of the demanding nature of this particular job, then rework (spoilage) is assigned to the job. On the other hand, if the defective work was a consequence of assigning new, untrained labor to the job, then the rework (spoilage) is assigned to overhead control.

47. PPT 4 -47 End of Chapter 4

48. PPT 4 -48 Don R. Hansen Maryanne M. Mowen COST MANAGEMENT

49. PPT 4 -49 Product and Service Costing: A Process Systems Approach Chapter Five

50. PPT 4 -50 Learning Objectives l Describe the basic characteristics of process costing, including cost flows, journal entries, and the cost of production report. l Describe process costing for settings without work in process inventories. l Define equivalent units, and explain their role in process costing.

51. PPT 4 -51 Learning Objectives (continued) l Prepare a departmental production report using the FIFO method. l Prepare a departmental production report using the weighted average method. l Prepare a departmental production report with transferred-in goods and changes in output measures. l Describe the basic features of operation costing.

52. PPT 4 -52 Job-Order CostingProcess Costing 1.Wide variety of distinct1.Homogeneous products products 2.Cost accumulated by job2.Costs accumulated by process or department 3.Unit cost computed by 3.Unit cost computed by dividing total job costs dividing process costs ofby units produced on that the period by the unitsjob produced in the period Comparison of Job-Order and Process Costing

53. PPT 4 -53 Characteristics of Process Costing l Homogeneous units pass through a series of similar processes. l Each unit in each process receives a similar dose of manufacturing costs. l Manufacturing costs are accumulated for a process for a given period of time.

54. PPT 4 -54 Characteristics of Process Costing (continued) l There is a work in process account for each process. l Manufacturing cost flows and the associated journal entries are generally similar to job-order costing. l The departmental production report is the key document for tracking manufacturing activity and costs. l Unit costs are computed by dividing the departmental costs of the period by the output for the period.

55. PPT 4 -55 Process Costing Cost Flow Direct Materials Direct Labor Applied Overhead PickingEncapsulatingBottling Finished Goods

56. PPT 4 -56 Service Organization Without Work in Process Inventories To illustrate how services without work in process inventories are costed using a process approach, consider the teeth cleaning process offered by most dentists. The production costs and the number of cleanings (patients served) for the month of March are given below: Direct materials$ 200 Hygienist salary2,500 Overhead 1,800 Total production cost$4,500 ===== Number of cleanings300 Unit cost = $4,500/300 = $15 per cleaning

57. PPT 4 -57 Steps for Costing Out Production in Process Costing 1.Analysis of the flow of physical units 2.Calculation of equivalent units 3.Computation of unit cost 4.Valuation of inventories (goods transferred out and ending work in process) 5.Cost reconciliation

58. PPT 4 -58 A Cost Analysis Cost of Units Started Work in Process Costs added to EWIP Cost of Units Completed Cost added to BWIP 1,000 units - $5,000 materials added; $10,000 conversion costs added 10,000 units; $23,000 mat’l added; $120,175 conversion cost added 1,500 units - $8,000 materials added; $13,000 conversion costs added 9,500 units Input Costs = Output Costs $158,175 = $158,175

59. PPT 4 -59 Units Started Work in Process Units in EWIP Units Completed Units in BWIP 1,000 units - 20% materials added; 60% conversion costs added 10,000 units; 1,500 units - 1/3 materials added; 50% conversion costs added 9,500 units Units of Input = Units of Output Units in BWIP + Units Started = Units in EWIP + Units Completed 1,000 + 10,000 = 1,500 + 9,500 The Concept of Equivalent Units

60. PPT 4 -60 Equivalent Units Calculation: MaterialsConversion Costs Units Completed 9,500 9,500 Ending WIP 500 750 Total Units Processed *10,000 *10,250 Beg. WIP Inventory(200)(600) Units Processed This Period **9,800 **9,650 ==== ==== *Equivalent units for weighted average (total units worked on) ** Equivalent units for FIFO (units worked on this period) The Concept of Equivalent Units (continued)

61. PPT 4 -61 Materials are added at the beginning of the process. Units started24,000 Units completed and transferred out20,000 Units in process, May 31, 25% complete4,000 Costs: Cost Added Materials$126,000 Conversion Costs42,000 Example No Beginning Inventory

62. PPT 4 -62 Step 1 - Physical Flow: Units to account for: Units, BWIP0 Units started24,000 Total24,000 ===== Units accounted for: Units completed20,000 Units, EWIP4,000 Total24,000 ==== Example No Beginning Inventory (continued)

63. PPT 4 -63 Example No Beginning Inventory (continued) Step 2 - Equivalent units: MaterialsConversion Units completed20,00020,000 EWIP 4,000 1,000 Total Equivalent Units24,00021,000 ========

64. PPT 4 -64 Example No Beginning Inventory (continued) Step 3 - Unit Cost: Unit Cost=$126,000/24,000 + $42,000/21,000 =$5.25 + $2.00 =$7.25

65. PPT 4 -65 Example No Beginning Inventory (continued) Step 4 - Valuation of Inventories: Goods Transferred Out: $7.25 x 20,000 = $145,000 Ending Work in Process: ($5.25 x 4,000) + ($2.00 x 1,000 = $23,000

66. PPT 4 -66 Example No Beginning Inventory (continued) Step 5 - Cost Reconciliation: Cost Assigned: Goods transferred$145,000 EWIP 23,000 $168,000 ======= Cost to Account For: BWIP$126,000 Cost added 42,000 $168,000 =======

67. PPT 4 -67 FIFO Costing Example Production: Units in process, October 1, 70% complete10,000 Units completed and transferred out60,000 Units in process, October 31, 40% complete20,000 Costs: Work in process, October 1: Materials$ 1,000 Conversion costs 350 Total work in process$ 1,350 ====== Current costs; Materials$12,600 Conversion costs 3,050 Total current costs$15,650 ======

68. PPT 4 -68 FIFO Costing Method Under the FIFO costing method the equivalent units and manufacturing costs in beginning work in process are excluded from the current-period unit cost calculation. Thus, FIFO recognizes that the work and costs carried over from the prior period legitimately belong to that period.

69. PPT 4 -69 FIFO Costing (continued) Step 1- Physical Flow Analysis Inputs: Outputs: BWIP10,000EWIP20,000 Started70,000Completed 60,000 Total80,000Total80,000===== * Step one is the same for weighted average and FIFO

70. PPT 4 -70 Step 2 - Calculation of Equivalent Units MaterialsConversion EWIP 20,0008,000 Completed 60,00060,000 Units Worked On in Total 80,00068,000 BWIP 10,000 7,000 Units Worked On this Period 70,00061,000===== FIFO Costing (continued)

71. PPT 4 -71 FIFO Costing (continued) Step 3 - Computation of Unit Cost Calculation MaterialsConversionTotal Beginning WIP$ 1,000$ 350$ 1,350 Added this period 12,600 3,050 15,650 Total$ 13,600$ 3,400$17,000 Added this period$ 12,600 $ 3,050 $15,650 Equivalent units  70,000  61,000 Unit cost$ 0.18$ 0.05$ 0.23 ====================

72. PPT 4 -72 FIFO Costing (continued) Step 4 - Value of Goods Completed and EWIP (Short-cut method) Total Input Costs $17,000 Less: EWIP Materials (20,000 x $0.18)$3,600 Conversion Cost (8,000 x $0.05) 400 4,000 Cost of Goods Completed $13,000 ======

73. PPT 4 -73 FIFO Costing (continued) Manufacturing costs are reconciled as follows: Costs to account for: Beginning work in process$ 1,350 Incurred during the period: Materials$12,600 Conversion costs 3,050 15,650 Total costs to account for$17,000 ====== Costs accounted for: Goods transferred out: Units, beginning work in process$ 1,500 Units started and completed11,500 Goods in ending work in process 4,000 Total costs accounted for$17,000 ====== Step 5 - Cost Reconciliation

74. PPT 4 -74 Journal Entries Work in Process--Mixing12,600 Materials12,600 To record requisitions of materials for October. Work in Process--Mixing3,050 Conversion Cost Control3,050 To record the application of overhead and incurrence of direct labor. Work in Process--Tableting13,000 Work in Process--Mixing13,000 To record the transfer of cost of goods completed from Mixing to Tableting.

75. PPT 4 -75 Step 1- Physical Flow Analysis Inputs: Outputs: BWIP10,000EWIP20,000 Started70,000Completed 60,000 Total80,000Total80,000===== * Step one is the same for weighted average and FIFO Weighted Average Costing

76. PPT 4 -76 Weighted Average Costing (continued) Step 2 - Calculation of Equivalent Units MaterialsConversion EWIP 20,0008,000 Completed 60,00060,000 Equivalent units80,00068,000=====

77. PPT 4 -77 Weighted Average Costing (continued) Step 3 - Computation of Unit Cost Calculation MaterialsCCTotal Beginning WIP$ 1,000$ 350$ 1,350 Added this period 12,600 3,050 15,650 Total$ 13,600$ 3,400$17,000 Equivalent units  80,000  68,000 Unit cost$ 0.17$ 0.05$ 0.22 ====================

78. PPT 4 -78 Weighted Average Costing (continued) Step 4 - Valuation of Inventories Cost of Goods Transferred Out (0.22 x 60,000 ) =$13,200 Ending Work in Process: Materials: ( $0.17 x 20,000)$3,400 Conversion: ($0.05 x 8,000) 400 3,800 Total $17,000 ======

79. PPT 4 -79 Basics of Operation Costing Operation costing is a blend of job and process costing procedures applied to batches of homogeneous products. This costing system uses job-order procedures to assign materials costs to batches and process procedures to assign conversion costs. Work orders are used to collect production costs for each batch.

80. PPT 4 -80 End of Chapter 5