Product Costing Systems

1
Product Costing Systems

• The two most common systems of product costing
  are
• Job-order costing and
• Process costing.

2
Job-Order Costing

• Job-order costing (or simply job costing)
  allocates costs to products that are readily
  identified by individual units or batches, each
  of which requires varying degrees of attention
  and skill.

3
Process Costing

• Process costing allocates costs to products by
  averaging costs over large numbers of nearly
  identical products.

4
Job-Order-Costing System

• The basic records maintained in a job-costing
  system include
• Job-cost record,
• Materials requisitions, and
• Labor time tickets.

5
Job-Cost Record

• The centerpiece of a job-costing system is the
  job-cost record (also called a job-cost sheet or
  job order).
• All costs for a particular product, service, or
  batch of products are recorded on the job-cost
  record.

6
Materials Requisitions

• Materials requisitions are records of materials
  used in particular jobs and are summarized in the
  job-cost record.

7
Labour Time Tickets

• Labour time tickets (or time cards) record the
  time a particular direct labourer spends on each
  job and are summarized in the job-cost record.

8
Typical Journal Entries for a Job-Costing System

• Transaction 1
• Direct-Materials Inventory 1,900,000
• Accounts Payable 1,900,000
• To record purchase of materials to
• be used directly in the manufacturing
• process.

9
Typical Journal Entries for a Job-Costing System

• Transaction 2
• WIP Inventory 1,890,000
• Direct-Materials Inventory 1,890,000
• To record materials requisitioned
• into the manufacturing process.

10
Typical Journal Entries for a Job-Costing System

• Transaction 3
• WIP Inventory 390,000
• Accrued Payroll 390,000
• To record direct-labor cost
• incurred in the manufacturing
• process.

11
Typical Journal Entries for a Job-Costing System

• Transaction 4a
• Factory Depart. Overhead Control 392,000
• Cash, Accounts Payable, and
• various other balance sheet
• accounts 392,000
• To record factory overhead incurred.
• (Accounting for factory overhead will be covered
  
• later in greater detail.)

12
Typical Journal Entries for a Job-Costing System

• Transaction 4b
• WIP Inventory 375,000
• Factory Depart. Overhead Control
  375,000
• To record factory overhead applied,
• 95,000 280,000 375,000.
• (Accounting for factory overhead will be covered
  
• later in greater detail.)

13
Typical Journal Entries for a Job-Costing System

• Transaction 5
• Finished Goods Inventory 2,500,000
• WIP Inventory 2,500,000
• To transfer cost of goods completed
• from work-in-process inventory to
• finished goods inventory.

14
Typical Journal Entries for a Job-Costing System

• Transaction 6a
• Accounts Receivable 4,000,000
• Sales 4,000,000
• To record sales of merchandise
• on account.

15
Typical Journal Entries for a Job-Costing System

• Transaction 6b
• Cost of Goods Sold 2,480,000
• Finished Goods Inventory 2,480,000
• To record (transfer) the cost of the
• merchandise sold from finished goods
• inventory to cost of goods sold (expense).

16
How Factory Overhead is Applied to Products

• Managers need to know product costs in order to
  make ongoing decisions such as which products to
  emphasize or de-emphasize and the pricing of
  products.

17
How Factory Overhead is Applied to Products

• Ideally, all costs, including overhead, are
  known when these decisions must be made.
• Unfortunately, actual overhead costs are not
  available when managers need them. For this
  reason, budgeted overhead rates are used to apply
  overhead to jobs as they are completed.

18
Budgeted OverheadApplication Rates

• The following steps summarize how to account for
  factory overhead
• 1. Select one or more cost drivers to serve as
  a base for applying overhead costs.
• 2. Prepare a factory-overhead budget for the
  planning period, ordinarily a year. The two key
  items are (1) budgeted overhead and (2) budgeted
  volume of the cost driver.

19
Budgeted OverheadApplication Rates

• 3. Compute the budgeted factory-overhead
  rate(s) by dividing the budgeted total overhead
  for each cost pool by the budgeted cost-driver
  level.
• 4. Obtain actual cost-driver data (such as
  machine-hours) as jobs are produced.
• 5. Apply the budgeted overhead to the jobs by
  multiplying the budgeted rate(s) times the actual
  cost-driver data.

20
Budgeted OverheadApplication Rates

• 6. At the end of the year, account for any
  differences between the amount of overhead
  actually incurred and overhead applied to
  products.

21
Compute BudgetedFactory-Overhead Rate

• A budgeted overhead rate is computed as follows
• budgeted overhead application rate
• total budgeted factory overhead
• total budgeted amount of cost driver

22
Choice of Cost Drivers

• No one cost driver is right for all situations.
• The accountants goal is to find the driver that
  best links cause and effect.

23
Choice of Cost Drivers

• Look for the activity that causes the most
  overhead cost and then keep track of that
  activity.
• For example, if use of machines causes the most
  overhead with depreciation and repairs, then keep
  track of machine-hours used for each job.

24
Normalized Overhead Rates

• A normalized overhead rate is when an annual
  average overhead rate is used consistently
  throughout the year for product costing, without
  altering it from day to day and from month to
  month. The resultant normal product costs
  include an average or normalized chunk of
  overhead.

25
Normalized Overhead Rates

• During the year and at year end, the actual
  overhead amount incurred will rarely equal the
  amount applied.
• The variance between incurred and applied cost
  is due to many factors such as

26
Normalized Overhead Rates

• A different level of volume than the level
  used as a denominator in calculating the
  budgeted overhead rate,
• Poor forecasting,
• Inefficient use of overhead items,
• Price changes in individual items,
• Erratic behavior of individual overhead
  items, and
• Calendar variations.

27
Normalized Overhead Rates

• Thus, an annual rate is budgeted and used
  regardless of the month-to-month peculiarities of
  specific overhead costs.
• Because overhead cannot be traced to physical
  products, overhead is applied on an average or
  normalized basis to get representative or normal
  inventory valuations.

28
Normal Costing System

• Hence, we shall label the system a normal
  costing system The cost system in which
  overhead is applied on an average or normalized
  basis, in order to get representative or normal
  inventory valuations.

29
Overapplied Overhead

• When the amount of overhead applied to products
  exceeds the amount of actual overhead incurred by
  departments, the difference is called overapplied
  overhead.

30
Underapplied Overhead

• When the amount of overhead applied to products
  is less than the amount of actual overhead
  incurred by departments, the difference is called
  underapplied overhead.

31
Disposition of Underapplied or Overapplied
Overhead

• At year end, the difference between actual
  overhead incurred and overhead applied is
  disposed of through either
• a write-off or
• proration.

32
Disposition of Underapplied or Overapplied
Overhead

• Illustration using transactions journalized
  earlier
• Transaction
• 4a. Factory overhead incurred 392,000
• 4b. Factory overhead applied 375,000
• Underapplied factory overhead 17,000

33
Immediate Write-Off

• The theory underlying direct write-off is that
  most of the goods worked on have been sold, and a
  more elaborate method of disposition is not worth
  the extra trouble.
• The immediate write-off eliminates the 17,000
  difference with a simple journal entry as follows

34
Immediate Write-Off

• Transaction 7
• Cost of Goods Sold 17,000
• Factory Depart. Overhead Control
  17,000
• To close ending underapplied overhead
• directly to Cost of Goods Sold.

35
Proration Among Inventories

• To prorate underapplied overhead or overapplied
  overhead means to assign it in proportion to the
  sizes of the ending account balances in
  Work-in-Process Inventory, Finished Goods
  Inventory, and Cost of Goods Sold.

36
Proration Among Inventories

• Underapplied overhead is then added to the
  ending balances and overapplied overhead is
  subtracted from the ending balances.

37
Proration Among Inventories

• Theoretically, if the objective is to obtain as
  accurate a cost allocation as possible, all the
  overhead costs of the individual jobs worked on
  should be recomputed, using the actual, rather
  than the budgeted, rates.

38
Proration Among Inventories

• This approach is rarely feasible, so a practical
  attack is to prorate on the basis of the ending
  balances in each of three accounts, WIP, Finished
  Goods, and Cost of Goods Sold.
• In our illustration, the proration is calculated
  as follows

39
Proration Among Inventories

• Unadjusted
• Balance Proration of
• End of 19X2 Underapplied Overhead
• WIP 155,000 155/2,667 x 17,000
• Finished Goods 32,000 32/2,667 x
  17,000
• Cost of Goods Sold 2,480,000 2,480/2,667 x
  17,000
• 2,667,000

40
Proration Among Inventories

• Proration of Adjusted
• Underapplied Balance
• Overhead End of 19X2
• WIP 988 155,988
• Finished Goods 204 32,204
• Cost of Goods Sold 15,808 2,495,808
• 17,000 2,684,000

41
Proration Among Inventories

• The journal entry for the proration follows
• WIP 988
• Finished Goods 204
• Cost of Goods Sold 15,808
• Factory Depart. Overhead Control
  17,000
• To prorate ending underapplied overhead
• among three accounts.

42
Activity-Based Costing in aJob Order Environment

• As is the case with any business, understanding
  profitability means understanding the cost
  structure of the entire business.
• One of the key advantages of an ABC system is
  its focus on understanding how work (activity) is
  related to the consumption of resources (costs).

43
Activity-Based Costing in aJob Order Environment

• In developing an ABC system, begin by focusing
  on the most critical (core) processes across the
  value chain.
• After the initial system is in place, the
  remaining phases of the value chain can be added.

44
Activity-Based Costing in aJob-Order Environment

• To understand product-line profitability, the
  key activities must be identified.
• Once the key activities have been identified,
  appropriate cost drivers are used to allocate
  activity costs to the assembly lines that
  produced the product lines.

45
Product Costing in Service and Nonprofit
Organizations

• The job-costing approach is used in
  nonmanufacturing situations too.
• The focus shifts from the costs of products to
  the costs of services.

46
Product Costing inNonprofit Organizations

• In nonprofit organizations, the product is
  usually called a program or a class of
  service.
• A program is an identifiable group of
  activities that frequently produces outputs in
  the form of services rather than goods.

47
Product Costing inService Organizations

• In service industries each customer order is a
  different job with a special account or order
  number.
• Sometimes only costs are traced directly to the
  job, sometimes only revenue is traced, and
  sometimes both.

48
Job-Order-Costing Systems Track Costs to Products

• The basic records used to accumulate and track
  costs in a job-order-costing system are
• materials requisitions,
• labor time tickets, and
• job-cost records.

49
Job-Order-Costing Systems Track Costs to Products

• The job-cost record summarizes information on
  the direct materials and direct labor used as
  well as the factory overhead applied.

50
Job-Order-Costing Systems Track Costs to Products

• Journal entries that record the basic
  transactions center around the three inventory
  accounts with particular focus on the WIP
  Inventory account.

51
End of Chapter 13