Chapter Two

Manufacturing Costs and

Job-Order Costing Systems

What Does it Cost to Make Something? In Accounting 284, all inventory was

purchased from another entity In Accounting 285, we will learn how to

cost a product that is manufactured All cost associated with the production

process are called product costs and go through inventory accounts

Product and Period Costs Product costs are

Direct material Direct labor Manufacturing

Overhead Indirect material Indirect labor Utilities Depreciation Any other

manufacturing cost

Period Costs are Selling cost Administrative cost

Product Costs and Period Costs

Product Cost

Period Cost

InventoryAccounts

Cost of Goods

Sold

SellingGeneral and

AdministrativeExpense

Income StatementBalance Sheet

Three Inventory Accounts

Material inventory includes the cost of materials purchased but not yet put into production

Work in Process (WIP) includes the cost of material, labor and manufacturing overhead of goods started but not yet completed

Finished goods included the cost of good completed but not yet sold

Cost Flows Through Inventory

Rawmaterial

Directlabor

Overhead

Workin

Process

FinishedGoods

Cost ofGoodsSold

Flow Through AccountsMaterial WIP Finished

Goods Beginning Material Beginning WIP Beginning

Finished goods + Purchases +Direct Material

used + Direct Labor + MOH

+ Cost of goods manufactured

= Material Available =Total cost to account for

=Goods available for sale

- Ending Material - Ending WIP - Ending Finished Goods

= Cost of material used

= Cost of goods manufactured

=Cost of goods sold

Job-order versus Process CostingJob-order costing keeps track of the cost of materials and labor used on each job and then applies manufacturing overhead to each job.

Process costing keeps track of total costs and divides by output for a period to get an average unit cost.

Job Order versus Process Costing

Use Job order costing for non-repetitive, high cost unique orders

Use Process costing for large numbers of homogeneous products

Which would home builder, tomato cannery, and automobile manufacturer use?

Job Order Costing

Keep payroll records according to jobs to know direct labor cost of each job

Use material requisitions for all materials to know the direct material cost for each job

Put all overhead (including indirect materials and indirect labor) into the overhead account and “apply” it to jobs

Actual versus Normal Overhead

The big problem in job order costing is relating overhead to production

To solve this, overhead is applied to production on the basis of some activity driver

Actual costing waits until the end of the period and then determines the actual overhead and the actual level of the driver.

Normal costing estimates the level of the driver and overhead in advance and then applies it throughout the period.

Problems with Actual Costing If done on shorter than an annual period

- say monthly - overhead rates can vary greatly from month to month.

If done annually, must wait until end of year to determine costs of all units during the year

No estimates are available for bidding, which is how job order costers normally obtain jobs.

Normal Costing

Use a predetermined overhead rate so that products can be costed as the period goes along, not at the end

Rate is developed by using the cost formula for overhead, estimating activity and developing a rate

This is called NORMAL COSTING

Developing Overhead Rate

1) Determine overhead application basis

2) Estimate activity level

3) Estimate overhead costs at that level

4) Divide estimated costs by activity to get rate

Rate Example

1) Activity driver is direct labor hours

2) Estimated activity level is 25,000 hours

3) Estimated costs at 25,000 hours is $250,000

4) Rate is 250,000/25,000 = $10/DLHr

Applying Overhead

1) Multiply actual activity by predetermined overhead rate - this is applied overhead

2) Compare to the actual overhead - if the applied is greater overhead is overapplied, if it is less it is under applied. Being overapplied is favorable.

3) The amount of under or overapplied overhead is assigned to cost of goods sold or prorated between inventories

Applied Overhead Example1) Assume that actual hours worked were

26,000 and actual overhead was $257,000

2) Applied overhead would be 26,000 * $10 or $260,000

3) Overhead would be overapplied by $3,000

Why might this be the case?

Causes of Under/overapplied Assume that overhead was $150,000 +

$4/direct labor hours so that at a volume of 25,000 hours overhead was estimated to be $250,000 (150,000+(4*25,0000))

The rate of $10 consists of $6 fixed and $4 variable.

When we work 26,000 hours, its like more people coming to the party in that we keep applying the overhead even though we shouldn’t still be incurring it.

More analysis Overhead was overapplied by $3,000

(Actual overhead was $257,000 and applied was $260,000)

Overhead for 26,000 hours should have been 150,000 + (4)(26,000) = 254,000

Thus we spent $3,000 more than we should have, but made up for it by working 1,000 extra hours and applying $6,000 in fixed overhead that we should not have incurred

You Try it

Driver is DL hours Overhead is expected to be

$200,000 + $6/DLHr Expected hours are 40,000 Actual hours are 42,000 Actual overhead is $455,000

What are the: the overhead application rate, the amount of under/overapplied

overhead, the amount of overhead expected for the

volume achieved, the deviation from expected overhead the impact of missing the volume

Overhead Application Rate

The rate is:

$200,000 +(6)(40,000) = $11/hour

40,000

Under/overapplied overhead

Actual hours x predetermined rate

42,000 x $11 = $462,000

Actual overhead is $455,000

Overhead is overapplied by $7,000

The amount of overhead expected for the volume achieved

The budget formula for overhead was OH = $200,000 + $6/DLHr

Actual hours were 42,000

Budget for volume achieved was200,000 + (42,000)(6) = $452,000

The deviation from expected overhead

The overhead for the actual volume that we worked was $455,000 and the budget for that volume was $452,000

Thus, we spent $3,000 more than we should have

The impact of missing the volumeThe expected volume was 40,000 and the

actual volume was 42,000 direct labor hours

The extra 2,000 hours times the $5/DLHr fixed overhead ($200,000/40,000) gives us $10,000 in extra applied overhead

The overhead was $7,000 overapplied even though we spent $3,000 more than we should have because we worked more that enough extra hours to cover it

Costing Individual Job

Assume Job ANZ used $5,000 worth of material, 150 labor hours at $15/hour; what is the cost of this job?

Direct material $5,000 Direct labor $2,250 Overhead (150*$10) $1,500 Total Cost $8,750

Just In Time Production Goal is to minimize inventories

to allow quicker response to customer needs

Requires more frequent smaller delivers tied to when the input is needed in production

Allows simpler accounting procedures as there are fewer inventories

Total Quality Management

Continuous improvement Do it right the first time Listen to the needs of customers Empowering employees to make good

products or provide good service