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Lecture 4

Week 4 - 5 chapter notes

5 pages24 viewsSummer 2010

Financial Accounting
Course Code
Liang Chen

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Chapter 5 Job Costing Notes
Product Costs and Cost Flows
x product costs are costs involved in making or purchasing a product, and they are called manufacturing, or inventoriable, costs
x period costs are the operating costs that are not part of making or purchasing a product, such as sales and admin expenses
x service companies provide services or intangible products and thus do not incur product costs and do not have inventory
x merchandising companies purchase merchandise for resale as part of business operations; they incur merchandising costs, and
they may have leftover inventory, if all merchandise purchased during the period was not sold by end of accounting period
x manufacturing companies purchase raw materials and components and process them and make them into finished goods
x therefore, manufacturing companies may have leftover inventories in the raw materials account, the work-in-process (partially
finished products) account, and the finished goods account at the end of an accounting period
x managers in merchandising companies need to prepare the schedule of COGS as a part of preparing the income statement
x managers in manufacturing companies need to prepare not only schedule of COGS but also schedule of COG manufactured
x what goes into making a product consists of 3 main components: (1) direct materials that become part of a product (cost object),
(2) direct labour that includes the wages paid to the operator or assembly workers, and (3) manufacturing overhead, which
includes all indirect expenses that go into making the product, such as utilities, machine amortization, plant insurance,
maintenance and repair, indirect materials, indirect labour, etc.
x direct materials and direct labour combined are referred to as prime cost; direct labour and manufacturing overhead combined are
referred to as conversion cost, reflecting the fact that these two costs covert materials into finished goods
Product Cost Flows
Measuring and Monitoring Product Costs
x managers necessarily measure past costs when producing financial statements and other reports of an organization’s profits
x outsiders, such as shareholders, use profitability to assess management performance and to make investment and other decisions
x managers also use past cost information to monitor operations, develop estimated costs for bids, and sometimes make long-term
decisions such as whether to introduce a new product—for all these decisions it is important to distinguish costs
Assigning Product Costs to Individual Goods or Services
x product costs Æ direct and indirect production costs that are assigned to the cost of inventory on the balance sheet and then
expensed as part of costs of goods sold when units are sold
Process Costing
x when goods or services are uniform and are mass produced, tracing costs to individual units is inefficient, if not impossible
x process costing Æ method for allocating direct and overhead costs to continuous-flow processing lines; it is approach used for
mass-produced products; direct and indirect costs are traced and allocated to production departments, and then allocated to units
Job Costing
x when goods or services are customized, many costs are easily traced to individual products
x job costing Æ process of assigning costs to custom products or services
x direct materials and direct labour are traced to individual jobs, and production overhead is allocated
Job Costing in Manufacturing
Assigning Direct Costs
x accounting records are used to trace the costs of direct materials and direct labour to each job
x source documents Æ manual or electronic records created to capture and provide information about transactions or events;
examples include employee time records and raw material requisitions
x the cost and activity information gathered from source documents is used to record costs in a subsidiary ledger for each new job
x job cost record Æ manual or electronic record that contains all of the costs traced and allocated to a specific job
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Computerized and Manual Job Costing Systems
x maintaining detailed job cost records can be slow and prone to clerical error, so, they are often part of software package
x direct labour and direct material data are entered into electronic source documents (time records and material requisitions)
x from there, the data are automatically posted into the job cost record and the general ledger system
x this approach allows managers to immediately view job costs, even before the job is completed
Allocating Overhead
x overhead includes all production costs except direct materials and direct labour
x allocating overhead to individuals products is a 2-stage process: (1) a variety of overhead costs are collected in an overhead cost
pool; and (2) costs are allocated from the cost to individual jobs
x cost pool Æ group of individual costs that are accumulated in the accounting system for a particular purpose
Steps in Allocating Overhead
x successful completion of 2 stages of allocating overhead requires 4 steps: (1) identify the relevant cost object; (2) identify one or
more overhead cost pools and allocation bases; (3) for each overhead cost pool, calculate an overhead allocation rate; and (4) for
each overhead cost pool, allocate costs to the cost object
x in a job costing system, the cost object is a job, which may consist of an individual project or a batch of projects
x overhead costs are accumulated in one or more cost pools, some have fixed and variable overhead costs or only one of the two
x fixed overhead costs include costs such as production management salaries and space rental
x variable overhead costs include any cost that varies with activity levels, such as supplies and, sometimes, electricity
x if work is performed in separate departments or work areas, separate overhead cost pools may be used for each
x the choice of overhead cost pools depends on the organization of production, the nature, and the usefulness of different types
x for each overhead cost pool, an allocation base is chosen to assign overhead costs to cost objects
x allocation base Æ measure of activity, preferably a cost driver, used to allocate costs to a cost object; examples include number
of units, labour hours, labour costs, machine hours, number of parts, and sales
x for a fixed overhead cost pool, accountants choose an allocation base that is related to activities
x manufacturing job costing systems allocate overhead using one of bases: direct labour hours, direct labour costs, machine hours
x allocation rate Æ dollar amount per unit of allocation base used to allocate overhead to each cost object
x actual overhead allocation rate Æ calculated by dividing actual overhead cost by the actual quantity of the allocation base
x estimated allocation rate Æ calculated by dividing estimated overhead cost by the estimated quantity of the allocation base
x overhead costs are allocated by multiplying the overhead allocation rate by the quantity of the allocation base used by each job
Actual and Normal Costing
x actual costing Æ method for allocating overhead costs using the actual allocation rate and actual quantity of the allocation base
x because managers often need cost information before total actual cost and resource use information is available at the end of the
period, estimates are typically used to allocate overhead
x normal costing Æ method for allocating overhead costs using an estimated allocation rate and actual quantity of allocation base
x info from normal costing is used to prepare interim income statements, manage costs, and estimate costs for bids during period
Similarities and Differences between Actual and Normal Costing
Actual Costing Normal Costing
Direct costs recorded Actual cost of direct materials and direct
labour Actual cost of direct materials and direct
Overhead cost allocation rate
Overhead allocation Actual allocation rate × Actual quantity of
allocation base Estimated allocation rate × Actual
quantity of allocation base
General Ledger Entries for a Manufacturer
x ledger in manufacturer’s job costing system includes inventory accounts for raw materials, work in process, and finished goods
x purchases of raw materials are recorded in the raw materials inventory account
x as direct materials are traced to a job, the cost of the materials is transferred to work-in-process inventory; yet, some types, such
as supplies, are not traced to individual jobs when they are used; these costs are transferred into an overhead cost pool
x as direct labour employees report work time, cost of wages is debited to jobs they work on, and wages payable is credited
x overhead allocated to individual jobs is debited to work in process and credited to the control account
x the total cost of a completed job can be transferred to finished goods inventory
x finally, when revenue for the job is earned, the total cost is transferred from finished goods to COGS
Overapplied and Underapplied Overhead
x overapplied overhead Æ occurs when actual costs are less than the total amount of overhead allocated to inventory accounts
x underapplied overhead Æ occurs when actual costs are greater than the total amount of overhead allocated to inventory accounts
x the balance of overapplied or underapplied overhead must be removed through an adjustment at the end of the accounting period
x if the amount of the adjustment is material, it is prorated among work in process, finished goods (if any), and COGS
x if the amount is immaterial, however, it is simply assigned to COGS
x there are 2 proration methods: (1) use ending balances in work-in-process, finished goods, and COGS accounts as basis; (2) if
amount of overhead allocated and remaining overhead in each of work-in-process, finished goods, and COGS accounts at end of
period are known, then balances of overhead amounts in each account should be used as basis
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