Product Costing and the Manufacturing Environment

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Product Costing Product Costing and the and the

Manufacturing Manufacturing EnvironmentEnvironment

Product Costing Product Costing and the and the

Manufacturing Manufacturing EnvironmentEnvironment

CChaptehapterr

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Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

6-2

1. Understand the inventory requirements and the related inventory measurement issues of service, merchandising, and manufacturing organizations.

2. Explain the basic conceptual framework of inventory costing for financial reporting.

3. Describe the manufacturing environment as it relates to product costing systems.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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4. Explain the operation of a basic job costing system.

5. Explain the operation of a basic process costing system.

ObjectivesObjectivesObjectivesObjectives

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Financial Financial AccountiAccounti

ngng

Financial reporting is the process of preparing a

firm’s financial statements in accordance with GAAP.

Financial reporting is the process of preparing a

firm’s financial statements in accordance with GAAP.

These financial reporting concepts include some fundamental techniques and

prototype approaches that managers can apply to a variety of manufacturing

settings and specific products.

These financial reporting concepts include some fundamental techniques and

prototype approaches that managers can apply to a variety of manufacturing

settings and specific products.

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INVENTORY COSTS IN VARIOUS ORGANIZATIONS

Organization Asset ExpenseOrganization Asset Expense

Service Supplies Inventory

Supplies Expense

Merchan-dising

Merchandise Inventory

Supplies Inventory

Cost of Goods Sold

Supplies Expense


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INVENTORY COSTS IN VARIOUS ORGANIZATIONS

Organization Asset ExpenseOrganization Asset Expense

Manu- facturing

Raw Materials Inventory

Manufacturing Supplies Inventory

Office Supplies Expense

Office Supplies Inventory

Work-in Process

Inventory

Finished Goods

Inventory

Cost of Goods Sold

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Product Costs for Product Costs for Financial ReportingFinancial ReportingProduct Costs for Product Costs for

Financial ReportingFinancial Reporting

Raw materials used

Manufacturing supplies used

Production employees’ wages

Depreciation on plant

Expired insurance on plant

Production supervisors’ salaries

Plant maintenance

Plant utilities

Production equipment rent

Plant office supplies used

Raw materials used

Manufacturing supplies used

Production employees’ wages

Depreciation on plant

Expired insurance on plant

Production supervisors’ salaries

Plant maintenance

Plant utilities

Production equipment rent

Plant office supplies used

These costs are assigned

to the asset

inventory

These costs are expensed

when inventory

is sold

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Period Costs for Period Costs for Financial ReportingFinancial Reporting

Period Costs for Period Costs for Financial ReportingFinancial Reporting

Nonfactory office supplies used

General and administrative salaries

Depreciation on showroom

Expired insurance on showroom

President’s salary

Showroom maintenance

Nonfactory office utilities

Nonfactory office rent

Nonfactory office supplies used

General and administrative salaries

Depreciation on showroom

Expired insurance on showroom

President’s salary

Showroom maintenance

Nonfactory office utilities

Nonfactory office rent

These items are expensed as incurred

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THREE PRODUCT COSTS

Work-in-Process Inventory

Direct LaborDirect Labor Factory OverheadFactory OverheadFactory OverheadFactory Overhead

Cost of the primary raw materials used in

production

Wages earned by production employees

for the actual time spent working on the product

All other manufacturing costs

Finished Goods Inventory

Cost of Goods Sold

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A Closer Look At Manufacturing Overhead

A Closer Look At Manufacturing Overhead

Possibly the biggest challenge in measuring the cost of a product is

determining the amount of overhead incurred to produce it.

Possibly the biggest challenge in measuring the cost of a product is

determining the amount of overhead incurred to produce it.

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Problems Resulting From Measuring Problems Resulting From Measuring Product Cost Using Actual OverheadProduct Cost Using Actual Overhead Problems Resulting From Measuring Problems Resulting From Measuring Product Cost Using Actual OverheadProduct Cost Using Actual Overhead

Actual manufacturing overhead cost may not be

known until days or weeks after the end of the period,

delaying the calculation of unit product cost.

Actual manufacturing overhead cost may not be

known until days or weeks after the end of the period,

delaying the calculation of unit product cost.

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Also, some costs that are seasonal are not incurred each period, thus making the actual cost of product produced in one

month greater than that of another, even though nonseasonal costs may have been

identical for both months.

Also, some costs that are seasonal are not incurred each period, thus making the actual cost of product produced in one

month greater than that of another, even though nonseasonal costs may have been

identical for both months.


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Another point… When there is a significant amount of fixed overhead, the costs assigned to products will vary from period

to period, depending on the overall volume of activity.

Another point… When there is a significant amount of fixed overhead, the costs assigned to products will vary from period

to period, depending on the overall volume of activity.


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Using Predetermined Overhead RatesUsing Predetermined Overhead RatesUsing Predetermined Overhead RatesUsing Predetermined Overhead Rates

To overcome these problems, most firms use a

predetermined manufacturing overhead

rate to assign manufacturing overhead costs to products.

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Predetermined Predicted total manufacturingmanufacturing overhead cost for the yearoverhead rate Predicted total direct labor per direct hours for the year labor hour

=


A predetermined overhead rate based on direct labor hours

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Manufacturing Predetermined overhead Actual direct manufacturing assigned to labor hours overhead rateWork-In-Process per direct labor Inventory hour

= x


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Using a predetermined manufacturing overhead rate based on direct labor hours,

we can compute the assignment of overhead to Work-in-Process Inventory.

Using a predetermined manufacturing overhead rate based on direct labor hours,

we can compute the assignment of overhead to Work-in-Process Inventory.


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Late in 2004, Harmon Manufacturing Company Late in 2004, Harmon Manufacturing Company predicted a 2005 activity level of 25,000 direct labor predicted a 2005 activity level of 25,000 direct labor

hours with manufacturing overhead totaling $187,500.hours with manufacturing overhead totaling $187,500.

Predetermined Predicted total manufacturingmanufacturing overhead cost for the yearoverhead rate Predicted total direct labor per direct hours for the year labor hour

=


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$187,500 25,000 direct-labor hours=


Late in 2004, Harmon Manufacturing Company Late in 2004, Harmon Manufacturing Company predicted a 2005 activity level of 25,000 direct labor predicted a 2005 activity level of 25,000 direct labor

hours with manufacturing overhead totaling $187,500.hours with manufacturing overhead totaling $187,500.

$7.50 per direct

labor hour

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If 2,000 direct labor hours were used in September, If 2,000 direct labor hours were used in September, what would be the applied overhead?what would be the applied overhead?

2,000 x $7.50 = $15,000


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The Manufacturing EnvironmentThe Manufacturing EnvironmentThe Manufacturing EnvironmentThe Manufacturing Environment

In process manufacturing, a

single product (or a closely related set of

products) is produced on a

continuous basis

In process manufacturing, a

single product (or a closely related set of

products) is produced on a

continuous basis

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In job order production, products are

manufactured in singles units or in

batches of identical units.

In job order production, products are

manufactured in singles units or in

batches of identical units.


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The production order contains a job’s

unique identification number and assigns a unique identification

number to a job

The production order contains a job’s

unique identification number and assigns a unique identification

number to a job


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A job-cost sheet is a document used to

accumulate the cost for a specific job in a

job-cost system

A job-cost sheet is a document used to

accumulate the cost for a specific job in a

job-cost systemJob Cost Sheet

Direct Materials

Direct Labor

Factory Overhead

July 1 100 lbs. @ $ 0.25 = $ 25

3 75 oz. @ $1.40 = 105

July 1 3 hrs. @ $10.00 = $ 30

3 7 hrs @ $10.00 = 70

July 7 10 dlh x $2 = $ 20


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Production Files and RecordsProduction Files and RecordsProduction Files and RecordsProduction Files and Records

A file is simply a collection of

related records.

A file is simply a collection of

related records.

A record is a related set of

alphabetic and/or numeric data items.

A record is a related set of

alphabetic and/or numeric data items.

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Basic Production RecordsBasic Production RecordsBasic Production RecordsBasic Production Records

Raw Materials Inventory Record

Part No________________ Description_________________

Purchased Issued Balance Unit Total Unit Total Unit Total

Date Units Cost Cost Units Cost Cost Units Cost Cost

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Finished Goods Inventory Record

Product No________________ Description____________________

Received From Factory Sold Balance Unit Total Unit Total Unit Total

Date Units Cost Cost Units Cost Cost Units Cost Cost


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Bill of Materials

Raw Materials Requirements Per Unit of Product

Product No________________ Description___________________

Part Quantity Number Description Per Unit


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Operations List

Production Operations and Times Per Unit of Product

Product No_______________ Description___________________

Department Operation Machine/Labor Set-up Operating Number Description Requirements Time Time


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Job Cost System RecordsJob Cost System Records(Production Order)(Production Order)


Production Order

Job No.___________________ Start Date __________________

Product No_________ Description_________________ Quantity_____

Raw Materials

Total Part Number Description Quantity


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Operations

Department Operation Labor/Machine Start Stop Total Number Description Requirements Time Time Time

Authorized by ___________________ Date ________________



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Job-Cost Sheet

Job No.___________________ Start Date __________________

Product No_________ Description_________________ Quantity_____

Raw Materials Cost

Requisition TotalDate Department Number Description Cost


Job Cost System RecordsJob Cost System Records(Job Cost Sheet)(Job Cost Sheet)


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Conversion Costs: Direct Labor or Machine

Work Ticket Total TotalDate Department Number Description Time Cost




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Applied Overhead

TotalDate Department Basis of Application Cost

Total Cost of Job Unit Cost



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Materials Requisition Form

Requisition No. _________ Job No. _______ Date _______________

Department __________________

Part Total Unit Total Number Description Quantity Cost Cost

Issued by________________ Received by __________________

Job Cost System RecordsJob Cost System Records(Material Requisition Form)(Material Requisition Form)

Job Cost System RecordsJob Cost System Records(Material Requisition Form)(Material Requisition Form)

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Work Ticket

Work Ticket No. _________ Date_________________

Department______________________ Job. No. _____

Time Started _________ Time Completed __________

Employee/Machine Operator _____________________

Office Use

Total Time ______ Rate ______ Total Cost ________

Job Cost System RecordsJob Cost System Records(Work Ticket)(Work Ticket)

Job Cost System RecordsJob Cost System Records(Work Ticket)(Work Ticket)

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Impact of Computers on Impact of Computers on ManufacturingManufacturing


Automatic identification systems (AIS) allow inventory

and production information to be

entered into a computer without writing or keying.

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Computer-aided design (CAD)

involves the use of computers to

design products.



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Computer-aided manufacturing Computer-aided manufacturing (CAM) (CAM) involves the use of computers involves the use of computers

to control machine operations.to control machine operations.



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Flexible manufacturing systems (FMS) are an extension

of computer-aided manufacturing techniques

through a series of manufacturing operations.

Flexible manufacturing systems (FMS) are an extension

of computer-aided manufacturing techniques

through a series of manufacturing operations.

Computer-integrated manufacturing (CIM) is the

ultimate extension of CAD, CAM, and FMS concepts to a completed

automated and computer-controlled factory.

Computer-integrated manufacturing (CIM) is the

ultimate extension of CAD, CAM, and FMS concepts to a completed

automated and computer-controlled factory.


Impact of Computers on Impact of Computers on ManufacturingManufacturingIn their advanced stages, factories

utilizing flexible manufacturing systems and computer-integrated

manufacturing are sometimes referred to as “lights-out factories”

because they can be operated in the dark.

In their advanced stages, factories utilizing flexible manufacturing systems and computer-integrated

manufacturing are sometimes referred to as “lights-out factories”

because they can be operated in the dark.

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Basic Manufacturing Cost FlowsBasic Manufacturing Cost FlowsBasic Manufacturing Cost FlowsBasic Manufacturing Cost Flows

Beginning balance $ xx(1) Purchases xxTotal available xx

Raw MaterialsStep 1Step 1: The cost of purchased : The cost of purchased

raw materials and raw materials and manufacturing supplies manufacturing supplies are recorded in are recorded in Raw Raw MaterialsMaterials and and Manufacturing Manufacturing SuppliesSupplies, respectively., respectively.(1) Increase $ xx

Accounts Payable

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Beginning balance $ xxCurrent manufacturing costs:



Beginning balance $ xx(1) Purchases xxTotal available xx

Raw Materials

(2) Direct materials xx

Step 2Step 2: As primary raw : As primary raw materials are materials are requisitioned to the requisitioned to the factory, direct factory, direct materials are materials are transferred from transferred from Raw MaterialsRaw Materials to to Work-in-Process.Work-in-Process.


Beginning balance $ xx(1) Purchases xxTotal available xx(2) Direct materials -xxEnding balance $ xx

Raw Materials

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(2) Direct materials $xx



(2) Direct materials $xx

(3) Current employee earnings $ xx

Wages Payable

(3) Direct labor xx

Indirect labor to Manufacturing Overhead

(NEXT SLIDE)

Step 3Step 3: Direct labor costs are assigned to : Direct labor costs are assigned to Work-in-ProcessWork-in-Process on the basis of on the basis of time devoted to processing raw time devoted to processing raw materials. Other labor costs materials. Other labor costs associated with production associated with production employees are initially assigned employees are initially assigned to to Manufacturing Overhead.Manufacturing Overhead.


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Manufacturing Overhead

Beginning balance $ xxCurrent:

(3) Indirect labor $xx



(3) Indirect labor $xx


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(3) Indirect materials $xx(4) Manufacturing. Supplies xx(5) Depreciation xx(6) Miscellaneous xx -xx

Total $ xx




Total $ xx

Manufacturing Supplies

Beginning balance $ xx(1) Purchases xxTotal available xx(4) Issued -xxEnding balance $ xx

Accumulated Depreciation: Factory Assets

(5) Increase +xx

Other Payables

(6) Increase +xx

Steps 4, 5, and 6Steps 4, 5, and 6: Other production : Other production related costs are also assigned to related costs are also assigned to Manufacturing OverheadManufacturing Overhead..


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Total $ xx(7) Applied overhead -xx

Ending balance $ xx




Total $ xx(7) Applied overhead -xx

Ending balance $ xx



(2) Direct materials $xx(3) Direct labor xx(7) Applied overhead xx



(2) Direct materials $xx(3) Direct labor xx(7) Applied overhead xx

Steps 7Steps 7: Costs assigned to : Costs assigned to Manufacturing Manufacturing OverheadOverhead are periodically are periodically reassigned (applied) to reassigned (applied) to Work-in-Work-in-Process.Process.


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(2) Direct materials $xx(3) Direct labor xx(7) Applied overhead xx +xx

Total work-in-process $ xx(8) Cost of goods mfg. -xx

Ending balance $ xx



(2) Direct materials $xx(3) Direct labor xx(7) Applied overhead xx +xx

Total work-in-process $ xx(8) Cost of goods mfg. -xx

Ending balance $ xx

Steps 8Steps 8: When products are completed, : When products are completed, their accumulated production their accumulated production costs are totaled on a job cost costs are totaled on a job cost sheet and transferred from sheet and transferred from Work-in-ProcessWork-in-Process to to Finished Finished Goods Inventory.Goods Inventory.



Beginning balance $ xx(8) Cost of goods mfg. -xxTotal available xx


Beginning balance $ xx(8) Cost of goods mfg. -xxTotal available xx

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Beginning balance $ xx(8) Cost of goods mfg. -xxTotal available xx(9) Cost of goods sold -xxEnding balance $ xx


Beginning balance $ xx(8) Cost of goods mfg. -xxTotal available xx(9) Cost of goods sold -xxEnding balance $ xx

Cost of Goods Sold

(9) Cost of goods sold $xx

Steps 9Steps 9: Later when the products are : Later when the products are sold, their costs are transferred sold, their costs are transferred from from Finished Goods InventoryFinished Goods Inventory to to Cost of Goods Sod.Cost of Goods Sod.


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Exhibit 6-7

Examine Exhibit 6-6 in the textbook for a possible pattern of cost flows for a factory containing

only machine-intensive manufacturing operations.

Examine Exhibit 6-6 in the textbook for a possible pattern of cost flows for a factory containing

only machine-intensive manufacturing operations.

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Job CostingJob CostingJob CostingJob Costing

A critical concept in job costing is the relationship between the job cost sheets

and the account Work-in-Process

Job Cost Sheet

Led

ger

Job Cost Sheet

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When costs are assigned to work-in-process the costs are also assigned to job cost sheets

When jobs are completed the costs are determined by looking at the sheet for the completed job. That amount is transferred from work-in-process to finished goods inventory

The balance in work-in-process is equal to the costs assigned to the jobs in process


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Job 425 Job 426 Job 427 Total

Beginning balance $58,600 $51,300 $ 0 $109,900

Current costs:

Direct materials 4,800 3,600 23,500 31,900

Direct labor 6,000 9,000 10,000 25,000

Applied overhead 2,400 3,600 4,000 10,000Total $71,800 $67,500 $37,500 $176,800

This information is used to determine the total cost of goods manufactured.


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Job 428 Job 429 Job 430 Total

Beginning balance $ 0 $ 0 $ 0 $ 0

Current costs:

Direct materials 22,400 10,000 8,200 40,600

Direct labor 9,450 3,800 2,800 16,050

Applied overhead 3,780 1,520 1,120 6,420Total $35,630 $15,320 $12,120 $63,070

This information indicates ending balance in Work in Process Inventory


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The job-cost sheets for completed jobs provide the cost of each job, allowing management to properly cost and price the job.

The job-cost sheets for incomplete jobs should sum to the ending balance in the Work-in-Process Inventory account.

ReviewReview


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Fox Brothers, Inc.Statement of Cost of Goods Manufactured

For the Month Ending August 31, 2004Current manufacturing costs:

Cost of materials placed in production:Raw materials, 8/1/04 $36,000Purchases 30,000Total available $66,100Raw materials, 8/31/04 -11,800 $54,300

Direct labor 34,450Manufacturing overhead 13,780 $102,530

Work-in-Process, 8/1/04 109,900Total costs in process $212,430Work-in-Process, 8/31/04 - 35,630Cost of goods manufactured $176,800

Transfer to the income statement

STATEMENT OF COST OF GOODS MANUFACTURED

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Fox Brothers, Inc.Income Statement

For the Month Ending August 31, 2004

Sales $400,000Cost of goods sold:

Finished goods inventory, 8/1/04 $75,000Cost of goods manufactured 176,800Total goods available for sale $251,800Finished goods inventory, 8/31/04 -37,500 214,300

Gross profit $185,700Selling and administrative expenses - 90,000Net income $ 95,700

From the From the statement of statement of cost of goods cost of goods manufacturedmanufactured

From the From the statement of statement of cost of goods cost of goods manufacturedmanufactured

INCOME STATEMENT

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If products are produced in a continuous manufacturing

environment, where production does not have a distinct beginning

and end, it is necessary to use a process costing system.

If products are produced in a continuous manufacturing

environment, where production does not have a distinct beginning

and end, it is necessary to use a process costing system.

Process CostingProcess CostingProcess CostingProcess Costing

The cost of a single unit is equal to the total product costs assigned a “process” or “department” during an

accounting period divided by the number of units produced.

The cost of a single unit is equal to the total product costs assigned a “process” or “department” during an

accounting period divided by the number of units produced.

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Cost of Production ReportCost of Production ReportCost of Production ReportCost of Production Report

A cost of production report is the key document. It is a useful

way of organizing and accounting for costs in a process

costing environment.

A cost of production report is the key document. It is a useful

way of organizing and accounting for costs in a process

costing environment.A cost of production report contains--A cost of production report contains--A cost of production report contains--A cost of production report contains--

Summary of units in process Equivalent units Total costs to be account for

and cost per equivalent unit Accounting for total cost

Summary of units in process Equivalent units Total costs to be account for

and cost per equivalent unit Accounting for total cost

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Assume 90 units in the ending inventory are 40 percent

complete. The equivalent units are determined as follows:

Assume 90 units in the ending inventory are 40 percent

complete. The equivalent units are determined as follows:

90 units in ending inventory x 0.40 = 3690 units in ending inventory x 0.40 = 36


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Micro System Co.Cost of Production Report

For the Month Ending July 31, 2004

Summary of units in process:

Beginning 4,000Units started 36,000In process 40,000Completed -35,000Ending 5,000

TopTop


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Equivalent units in process: Materials Conversion

Units completed 35,000 35,000Plus equivalent units in end. inv. 5,000 1,000Equivalent units in process 40,000 36,000

Total cost to be accounted for andcost per equivalent units/process: Materials Conversion TotalWork-in-Process, beginning $ 16,000 $ 9,000 $ 25,000Current cost 144,000 108,900 252,900Total cost in process $160,000 $117,900 $277,900Equivalent units in process 40,000 36,000Cost per equivalent unit in process $ 4.00 $ 3.275 $ 7.275

MiddleMiddle


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BottomBottom

Accounting for total cost

Transferred out (35,000 x $7.275) $254,625Work-in-Process, ending:

Materials $20,000Conversion (1,000 x $3.275) 3,275 23,275

Total cost accounted for $277,900


Matches Matches total cost total cost in processin process

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Beginning balance $ 25,000Current manufacturing costs:

Direct materials $144,000Direct labor 62,200Applied overhead 46,700 252,900

Total $277,900Cost of goods manufactured -254,625Ending balance $ 23,275

The flow of Costs Through Work-in-Process Inventory is as follows:

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CChapter

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The The EndEndThe The EndEnd

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Documents

Product Costing and the Manufacturing Environment