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product costing.doc

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ACC 406
Anthony Chen

PRODUCT COSTINGA noted earlier all product costs are charged to inventory To facilitate this process manufacturers break inventory into three categories RM inventory WIP inventory and FG inventory There are two categories of direct cost DLDM and then there is overhead which is a catchall term for everything except DL and DM Raw materials are charged to RM inventory when purchased and transferred to WIP inventory when it is used DL is charged directly to WIP Indirect product costs are charged to an overhead account Then just one number is transferred from OH to WIP In a company that produces a variety of products in specific batches the total costs that are charged this way are made up of a series of jobs Think of Kinkos They do thousands of jobseach of them has some DM paper mainly some DL the operator and a lot of OH store rent electricity supplies etc and etcEach job is numberedthe number you see on your invoice They know how much paper was used on a job and how much time it tookFor each individual job DMPages used x cost of paper per pageDLTime taken by operator x hourly wage of operatorThen for the year as a wholeor for a day a week a monththey just add up the costs of all the individual jobs to see how much cost they incurred for that periodThe big problem is how to charge overhead costs to an individual job These accumulate over a year and are all indirect costs ie they arent collected on an individual job like paper and wages These indirect costs need to be spread out over the individual jobs or share among the individual jobs Most businesses use the following method to achieve this spreading out process that is called applying overhead They start by computing an overhead rate using a base like direct labor hours DLHOverhead rateTotal overheadHours worked by operators during the year OHDLHThis rate is then multiplied by the DLH on an individual job and gives the share of overhead applied to that job If total overhead for the year is 800000 and total DLH worked during the year is 40000 hours then the overhead rate will be 20 per direct labor hour If a job takes 5 hours say then it will get charged with 5 x 20 or 100 Clearly added up over a year the shares applied to individual jobs will add back to the total overhead Note that we could also have used something like machine hours as a baseThe problem with this method is that we have to wait to the end of the year before we can figure out the cost of any job during the year Almost all businesses therefore work on an estimated basis They figure an overhead rate in advance using DL hours say
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