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Prepared byDiane TannerUniversity of North Florida

Chapter 2

Product Costing

Assigning Costs to Cost Objects

  Actual Costing

Normal Costing

Standard Costing

Direct Materials Actual Actual Budgeted*

Direct Labor Actual Actual Budgeted*

Manufacturing Overhead Actual Budgeted Budgeted*

• Three methods– Actual costing – Normal costing– Standard costing

• Differ in how product costs are assigned to products or services

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Normal Vs. Actual Costing• Normal costing

– Used effectively when there are multiple products– Allocates manufacturing overhead to individual

products based on a ‘predetermined’ rate calculation

–Based on estimates

• Actual costing– Allocates manufacturing overhead to individual

products based on an end of period rate calculation

–Based on actual amounts

Estimated MOHEstimated Activity

Actual MOHActual Activity

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How Costs Get Assigned to Products• Direct materials and direct labor

– Traced to a product or service provided– Because it is easy to determine which

product/service to which the cost belongs – By definition, direct costs are directly associated

• Manufacturing overhead– Consists solely of indirect costs– Indirect costs cannot be easily identified with one

specific product or service– Allocated to products and services

Production Departments 5

Materials Storeroom Factory/Production Area

Costs in departments correlate to inventory

accounts.

Raw Materials

Work in Process

Finished Goods

Ready for

Sale

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Acquiring Raw MaterialsThe Purchasing Manager fills out an electronic

purchase order to order materials from a supplier

When materials are received, the Materials Storeroom Clerk records and stocks the

materials in the storeroom.

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The Materials Storeroom Clerk sends the receiving report to Accounting for

payment.

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Materials Storeroom

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Debit Raw MaterialsCredit Cash or Accounts Payable

Materials Requisition 7

The production supervisor fills out a materials requisition form.

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The materials storeroom clerk delivers the

requested materials to the production area.

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The processed form is sent to Accounting.

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Factory/Production Area

PearCo Materials Requisition Form

Requisition No. X7 - 6890 Date March 3Job No. A - 143Department B3

Description Quantity Unit Cost Total Cost2 x 4, 12 feet 12 3.00$ 36.00$ 1 x 6, 12 feet 20 4.00 80.00

116.00$

Authorized Signature

A materials requisition form authorizes the use of materials

on a product or job

DIRECT MATERIALSDebit Work in ProcessCredit Raw Materials

INDIRECT MATERIALSDebit Manufacturing OverheadCredit Raw Materials

Direct Labor8

• Employees fill out time tickets which indicate the hours worked on each product

• Time tickets = source documents• Direct labor cost = gross wages + fringe benefits Gross wages = [Hourly rate] × [Number of hours worked] Fringe benefits

Normally included as part of the direct labor ‘rate’ Overtime premium (the extra ‘half’ time paid)

If the result of production problems, treat as manufacturing overhead

If the result of accepting a rush order, treat as direct labor Idle time

Treat as overheadIncur direct labor costs Debit Work in Process Credit Cash or Wages Payable

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Manufacturing OverheadIncludes indirect materials, indirect labor, and factory

(production facility) related costs

Incur factory-related costs• Debit Manufacturing Overhead• Credit Cash, Payables, Prepaids, etc.

Requisition indirect materials to production• Debit Manufacturing Overhead• Credit Raw Materials

Incur indirect labor costs• Debit Manufacturing Overhead• Credit Cash, Salaries payable, etc.

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Accounting for Overhead in a Normal Costing System

• When actual overhead costs are incurred– Debit to MOH expense account

• Apply (allocate) overhead to products– Predetermined MOH rate(s)

• Traditional method - use a single rate • Activity based costing – use multiple rates

– Multiply the rate(s) times the actual activity• Debit WIP• Credit MOH expense

• When is overhead applied? – As the activity occurs

This chapter assumes a single rate

Assigning OverheadNORMAL COSTING• Overhead rate is determined at the beginning of

the period using estimated amounts• MOH is ‘applied’ (allocated) to products

– During production

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ACTUAL COSTING• Overhead rate is determined at the end of the

period using actual amounts• MOH is ‘applied’ (allocated) to products

– At the end of the period

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Selecting an Activity • The denominator of the pre-determined overhead rate

is ‘estimated activity’• Common estimated activities include

– Number of units to be produced– Number of direct labor hours to be used– Number of direct labor dollars to be incurred– Number of machine hours to be used

• Based on management’s best guess of what causes costs to increase

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Applying Overhead Based on UnitsMcAlister Company provided the following amounts:

Estimated MOH costs = $50,000Actual MOH costs = $49,500Estimated units to be produced = 4,000Actual units produced = 4,100

The company allocates overhead based on units produced.

Step 1: Determine the allocation rate (POHR) =$50,000/4,000 = $12.50/unit

Step 2: Apply overhead: Applied = $12.50 x 4,100 = $51,250

MOH

49,500 51,250

1,750 overapplied

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Applying Overhead Based on DL Hours

Step 1: Determine an allocation rate (POHR) =$50,000/12,500 = $4.00/DL hour

Step 2: Apply overhead: Applied = $4.00 x 12,400 = $49,600

MOH

49,500 49,600

100 overapplied

McAlister Company provided the following amounts:Estimated MOH costs = $50,000Actual MOH costs = $49,500Estimated direct labor hours = 12,500Actual direct labor hours = 12,400

The company allocates overhead based on DL hours.

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Applying Overhead Based on DL Cost

Step 1: Determine an allocation rate (POHR) =$50,000/156,250 = $0.32 per DL$

Step 2: Apply overhead: Applied = $0.32 x $153,600 = $49,152

MOH

49,500 49,152

Underapplied 348

McAlister Company provided the following amounts:Estimated MOH costs = $50,000Actual MOH costs = $49,500Estimated direct labor cost = $156,250Actual direct labor cost = $153,600

The company allocates based on DL hours.

Why is Normal Costing Better than Actual Costing?

• Overhead is applied during production– Enables managers to know product and job

costs as production occurs, i.e., on a timely basis• Waiting until the end of the period when

actual costs are known makes information untimely

– Useful for making decisions such as pricing, product changes, etc.

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Overhead cannot be traced to products because it is impractical or impossible to

identify these costs with a particular product.

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Completing Products The cost of completed goods is transferred out

of Work in Process Debit Finished Goods Credit Work in Process

The cost transferred out is called Cost of Goods Manufactured

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Selling Products Transfer the cost of products sold out of Finished

Goods Debit Cost of Goods Sold Credit Finished Goods

Recognize the sale Debit Cash or AR Credit Sales Revenue

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The End