1. Accounting Systems for Manufacturing Businesses
Chapter 10

2. Managerial Accounting
Focuses on recording and reporting information for use by a company’s management in decision making.
It helps the management to make decisions such as:
What should be the selling price of a product?
Which alternative should the company choose?
What is the cost of manufacturing a product?
Chapters 1–9 have dealt primarily with financial accounting, that focuses on recording transactions and events so
that the general-purpose financial statements can be prepared. These financial statements are primarily used by the external stakeholders of a company. Such stakeholders include creditors, stockholders, and government agencies. The remainder of this text focuses on managerial accounting topics. Managerial accounting records and reports information for use by a company’s management in decision making.

3. Financial and Managerial Accounting Differences
The major differences between managerial accounting and financial accounting are:
Financial accounting records and reports transactions and events using generally accepted accounting principles , while managerial accounting is not restricted by specific rules.
Financial accounting reports information on a periodic basis, while managerial accounting reports information as needed by management for decision making.
Financial accounting reports information for the company as a whole or by segments within the company, while managerial accounting reports information depending upon the type of management decision.

4. Nature of Manufacturing Businesses
Service firms earn revenue from providing services.
Merchandising firms earn revenue from selling merchandise inventory.
Manufacturing firms-
Earn revenue from manufacturing and selling finished goods.
Have three inventories: materials, work in process, and finished goods.
Have manufacturing and non-manufacturing costs
The revenue activities of service businesses involve providing services to customers. A service business may have a cost of services provided on the income statement, but they do not have any inventory accounts on the balance sheet.
The revenue activities of a merchandising business involve the buying and selling of merchandise. The cost of products sold is reported as cost of merchandise sold on the income statement and inventory valuation is an important part of preparing the balance sheet.
A manufacturing business must first produce the products it sells. This entails converting materials into finished products through the use of machinery and labor. Like a merchandising business, manufacturers report sales from selling products. The cost of products sold is reported as cost of goods sold on the income statement. On the balance sheet, a manufacturer reports three types of inventory: materials, products in the process of being manufactured, and finished products. Like merchandise inventory, these inventories are reported as current assets.

5. Manufacturing Overhead
Manufacturing Costs
Direct Materials
Direct Labor
Manufacturing Overhead
The Product

6. Prime and Conversion Costs
Prime Costs: direct material, direct labor costs
Direct materials, direct labor, and factory overhead costs may be grouped together for analysis and reporting. A common grouping is prime costs and conversion costs. Prime costs consist of materials and labor costs. Conversion costs consist of direct labor and factory overhead costs. Often, a highly automated manufacturing process which does not require significant direct labor in the conversion process uses classification of conversion cost to report their direct labor and overhead costs.
Conversion Costs: direct labor and factory overhead costs

7. Nonmanufacturing Costs
Marketing and Selling Cost
Costs necessary to get the order and deliver the product.
Administrative Cost
All executive, organizational, and clerical costs.
R&D

8. 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 Good Sold
Balance Sheet
Income Statement
Sale
Expense
Income Statement

9. Indicate whether each of the following costs of the Proctor & Gamble Company would be classified as direct materials cost, direct labor cost, or factory overhead cost:
Depreciation on the St. Bernard (Cincinnati) soap plant.
Wages paid to Packing Department employees.
Maintenance supplies.
Packaging materials.
Plant manager salary of the Lima, Ohio, liquid soap plant.
Pulp for towel and tissue products.
Wages of Making Department employees.
Scents and fragrances.
Depreciation on disposable diaper converting machines.
Salary of process engineers.

10. Which of the following items are properly classified as part of factory overhead for John Deere & Co.?
Plant manager’s salary at Greeneville, Tennessee, turf care products plant.
Depreciation on Moline, Illinois, headquarters building.
Property taxes on Klemme, Iowa, components plant.
Chief financial officer’s salary.
Steel plate.
Sales incentive fees to dealers.
Amortization of patents on a new welding process.
Interest expense on debt.
Consultant fees for surveying production employee morale.
Factory supplies used in the Kenersville, North Carolina, hydraulic excavator factory.

11. Classify the following costs for Ford Motor Company as either a product cost or a period cost:
Advertising.
Tires.
Assembly employees wages.
Salary of marketing executive.
Depreciation of Dearborn, Michigan, executive building.
CEO’s salary.
Plant manager’s salary.
Depreciation on Atlanta, Georgia, assembly plant.
Maintenance supplies.
Glass.
Property taxes on Kansas City, Missouri, assembly plant.
Shipping costs.
Travel costs used by sales personnel.
Utility costs used in executive building.
Stamping Department employee wages.
Steel.

12. Manufacturing Cost Flows
Balance Sheet Costs Inventories
Income Statement Expenses
Material Purchases
Raw Material
Work in Process
Direct Labor
Manufacturing Overhead
Cost of Goods Sold
Finished Goods
Selling and Administrative
Period Expenses
Selling and Administrative

13. 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

14. Pop Quiz 
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

15. Pop Quiz 
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.

16. Pop Quiz 
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.

17. Pop Quiz 
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And 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.

18. 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.

19. Types of Product Costing Systems
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 and are unique in nature.

20. Materials Requisition Form

21. Employee Time Ticket

22. Job Cost Sheet

23. Application of Overhead
• In a job-order costing system, the cost of a job consists of:
1. Actual direct material costs traced to the job.
2. Actual direct labor costs traced to the job.
3. Manufacturing overhead applied to the job using a predetermined overhead rate. Actual overhead costs are not assigned to jobs.

24. Predetermined Overhead Rate Formula
The formula for computing a predetermined overhead rate is:

25. Predetermined Overhead Rate Formula
The company in the preceding example applies overhead costs to jobs on the basis of direct labor-hours. In other words, direct labor-hours is the allocation base.
At the beginning of the year the company estimated that it would incur $320,000 in manufacturing overhead costs and would work 40,000 direct labor-hours. The company’s predetermined overhead rate is:

26. Application of Overhead to Jobs
The process of assigning overhead to jobs is known as applying overhead.
In the preceding example, Job 2B47 required 27 direct labor-hours. Therefore, $216 of overhead cost was applied to the job as follows:

27. Practice with Overhead
Actual manufacturing overhead $340,000
Budgeted machine hours ,000
Budgeted direct labor hours ,000
Budgeted direct labor rate $14
Budgeted manufacturing oh $364,000
Actual machine hours ,000
Actual direct labor hours ,000
Actual direct labor rate $15
POHR - Machine hours
POHR - direct labor hours
POHR - direct labor dollars

28. Pop Quiz 
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.

29. An Example Goodwell Printers
Goodwell Printers, a producer of textbooks, has two jobs in process during December, the last month of its fiscal year. Job 71, a special order of 1,000 textbooks titled American History, was started during November. By the end of November, $3,000 in manufacturing costs had been recorded for the job. Job 71 was the only job in process at the end of November. Job 72, an order for 4,000 textbooks titled Algebra, was started in December.

30. Goodwell Printers (cont)
On December 1, Goodwell Printers had $6,500 in raw materials inventory. During the month the company purchased an additional $10,500 in raw materials on account.
During December, $13,000 in raw materials was requisitioned from the storeroom for use in production. $2,000 of the direct materials requisitioned was used in Job 71, and $11,000 in Job 72.
During December, Goodwell Printers incurred 850 direct labor hours on Jobs 71 (350 hours) and 72 (500 hours). The direct labor costs were $11,000, divided into $3,500 for Job 71 and $7,500 for Job 72.
The following factory overhead costs were incurred in December:
Utilities (heat, water and power) $ 900
Indirect Material
Indirect Labor ,000
Total $3,400

31. Goodwell Printers (cont)
Goodwell recorded depreciation on factory equipment in the amount of $1,200 in December.
Goodwell Printers applies manufacturing overhead to jobs on the basis of direct labor hours. Prior to the beginning of this fiscal year, Goodwell had estimated its total manufacturing overhead for the year to be $50,000 and its total direct labor hours for the same period to be 10,000.
Goodwell incurred Selling and Administrative salaries expenses in the amount of $3,500 in December. There were no other S&A expenses during the month.
Goodwell Printers completed Job 71 during December. The beginning Finished goods inventory was $20,000, and consisted of 2,000 textbooks of Engineering Mechanics.
The 2,000 textbooks of Engineering Mechanics were sold to customers by the end of December at $14 each.

32. Goodwell Printers (cont)
Required
Prepare accounting entries to record the transactions for the month.
Calculate the actual overhead and the over applied/under applied for December.
Prepare an accounting entry to close the over applied/under applied into cost of goods sold, assuming that the Factory Overhead account had a negative balance of $200 through November.
Prepare an income statement for Goodwell Printers for the month ending December 31.
Compute an ending balance in each inventory account.

33. Overhead Application Example
RoseCo applies overhead based on direct- labor hours. Total estimated overhead for the year is $640,000. Total estimated labor cost is $1,400,000 and total estimated labor hours are 160,000.
What is RoseCo’s predetermined overhead rate?

34. Overhead Application Example
RoseCo’s actual overhead for the year was $650,000 and a total of 170,000 direct-labor hours were worked.
Using RoseCo’s predetermined overhead rate of $4.00 per direct-labor hour, how much overhead was applied to all of RoseCo’s jobs during the year?

35. Overapplied and Underapplied Manufacturing Overhead - Summary

36. Pop Quiz 
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. Tiger’s manufacturing overhead is
a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied.

37. Cost Evaluation and Control
Job order cost systems can be used to evaluate an organization’s cost performance
Job 63 used 100 more board feet of wood to manufacture the same number of guitars. Why?
Comparing Data from Job Cost Sheets
Since a job order costing system accumulates and records product costs by job. The resulting total and unit costs can be compared for similar jobs, compared over time or compared to expected costs. In this way, job order cost systems can be used by managers for cost evaluation and control.
To illustrate, Job 54 and Job 63 both produced 40 Jazz Series guitars. However, the materials used for Job 63 were $1,000 greater than Job 54. Further review reveals that Job 63 used 500 board feet while Job 54 used only 400 board feet to produce same number of guitars. An investigation should be undertaken to determine the cause of the extra 100 board feet used in Job 63.

38. Cost Evaluation and Control (cont)
Possible reasons for the extra use of materials for Job 63:
Inexperienced labor
Poor quality materials
Cutting tools needed repair
Carelessness
Incorrect instructions
Possible explanations for the extra costs on Job 63 could be:
A new employee, not properly trained in cutting, resulting in excess waste or scrap
Wood was purchased from a new supplier and not the same quality as the wood used on Job 54, resulting in more waste and scrap
Cutting tools not being maintained resulting in wood having to be re-cut, resulting in more waste and scrap
Job instructions not clear or not followed, resulting in more waste and scrap
Careful analysis reveals production problems that must be addressed and corrected.

39. Job Order Costing in a Service Business
John Meyer, CPA, does tax and audit work. He estimates his overhead costs for the current year will be:
Wages paid to receptionist $17,000
Supplies ,000
Depreciation on office equipment ,000
Advertising ,300
Rent and utilities ,000
$32,300
John uses direct labor hours to allocate overhead costs to jobs performed for clients. He estimates that he will work 1,900 hours conducting audits and preparing tax returns this year. John uses $25 per hour for his wage rate when computing the cost of any work performed for a client.
John spent 12 hours preparing a tax return for Sharon Ward. What was the cost to prepare Sharon’s return?

40. Activity-Based Costing (ABC)
Uses multiple overhead rates to allocate factory overhead more accurately than using a single, plant-wide rate.
Costs are initially accounted for in cost pools – each cost pool has its own rate.
In today’s complex manufacturing systems, product costs can be distorted if inappropriate predetermine overhead rates are used. Activity-based costing improves the allocation of factory overhead by using activity cost pools.
Activity-based costing method uses costs of activities and allocates those costs to products or services. Under this method, costs are accumulated into activity cost pools related to a given activity.
Any business can use activity based costing, whether a manufacturer or a service based business. Like manufacturing businesses, service companies need to determine the costs of their services in order to properly price those services and monitor costs. Since services consist of activities, many service companies use activity-based costing for determining the cost of providing services to customers. 

41. Activity Cost/ Budget / Estimated = Rate
Admitting
$720,000
4,000 admissions
$ 180
Radiological testing
$960,000
3,000 images
320
Operating room
$1,600,000
8,000 hours
200
Pathological testing
$600,000
5,000 specimens
120
Dietary and laundry
$3,000,000
20,000 days
150

42. Cost Pools and Rates for Hopewell Hospital
In this illustration, Hopewell Hospital uses activity-based costing to allocate hospital overhead to patients. The first step is to identify the activity cost pools. Hopewell has identified 5 activity cost pools: Admission, Radiological Testing, Operating Room, Pathological Testing, and Dietary and Laundry. Then, Hopewell determines the activity rate for each cost pool. Each activity cost pool has estimated activity base and an activity rate. The activity rate for each cost pool is determined by dividing the budgeted activity cost and activity-base. For example, in the Radiological Testing activity, the budgeted activity cost amount to $960,000 and activity-base usage is 3,000 radiological images. So, the activity rate for the Radiological Testing activity is $320 per radiological image
The activity rates for the other activities are calculated in a similar manner.
Once the activity rates have been calculated overhead can be allocated to patients based on activity usage.

43. MARY WILSON Activity Activity-Base Usage  Rate = Cost
Admitting
1 admission
$180 per admission
$ 180
Radiological testing
2 images
320 per image
640
Operating room
4 hours
200 per hour
800
Pathological testing
1 specimen
120 per specimen
120
Dietary and laundry
7 days
150 per day
1,050
Total
$2,790

44. Adcock, Kim Birini, Brian Conway, Don Wilson, Mary
HOPEWELL HOSPITAL
Customer (Patient) Profitability Report
For the Period Ending December 31, 2004
Adcock,
Kim
Birini,
Brian
Conway,
Don
Wilson, Mary
Revenues
$9,500
$21,400
$5,050
$3,300
Less patient costs:
Drugs and supplies
$ 400
$1,000
$ 300
$ 200
Admitting
180
Radiological testing
1,280
2,560
640
Operating room
2,400
6,400
1,600
800
Pathological testing
240
600
120
Dietary and laundry
4,200
14,700
1,050
Total patient costs
$8,700
$25,440
$4,530
$2,990
Income from operations
$ 800
$(4,040)
$ 520
$ 310