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Chapter 4

chapter 4 notes

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ACC 410
Maurizio Di Maio

Chapter 4 Chapter Overview The chapter includes descriptions of how managers need to rely upon different classifications of costs for different purposes. This chapter emphasizes four main purposes of cost classification: • For preparing external reports such as the balance sheet and income statement. • To predict cost behaviour—how costs will react to changes in activity. • For purposes of assigning costs to cost objects such as products or departments. • To aid in making business decisions Additionally, a portion of this chapter is on the use of job-order costing to track costs of products or services in organizations that offer many different products or services. 1. Assignment of costs is done by using: • documents such as materials requisitions forms and labour time tickets to assign direct materials and direct labour costs • predetermined overhead rates to assign manufacturing overhead costs to help smooth out fluctuations and ensure timeliness of overhead application 2. Cost flows are summarised in the schedules of costs of goods manufactured and cost of goods sold. 3. Underapplied or overapplied overhead costs are closed to the appropriate accounts. Costing Systems. Two major types of costing systems are used in manufacturing and many service firms: process costing and job-order costing. 1. Process Costing. A process costing system is used where a single, homogeneous product or service is produced. In a process costing system, total manufacturing costs are divided by total number of units produced during a given period. The unit cost that results is a broad, average figure. 2. Job-Order Costing. Job-order costing is used when different types of products, jobs, or batches are produced, typically over a rather short period of time. In a job- order costing system, direct materials costs and direct labour costs are usually 1 www.notesolution.com “traced” directly to jobs. Overhead is applied to jobs using a predetermined rate. Actual overhead costs are not “traced” to jobs. Overview of Job-Order Costing. Cost and other data are recorded on materials requisition forms, time tickets, and job cost sheets. Many companies now enter cost and other data directly into computer databases and have dispensed with these paper documents. 1. Job Cost Sheet. Each job has its own job cost sheet on which are recorded the costs that have been charged to the job. The job cost sheet will have some code or descriptive data to identify the particular job and will contain spaces to collect costs of materials, labour, and overhead. 2.Materials Costs. When a job is started, materials that are needed to complete the job are withdrawn from the storeroom. The document that authorizes these withdrawals and that specifies the types and amounts of materials withdrawn is called the materials requisition form. The materials requisition form identifies the job to which the materials are to be charged. Care must be taken when charging materials to distinguish between direct and indirect materials. 3.Labour. Labour costs are recorded on a document called a time ticket or a time sheet. Each employee records the amount of time he or she spends on each job and each task on a time ticket. The time spent on a particular job is considered direct labour and its cost is “traced” to that job. The cost of time spent on other tasks, not traceable to any particular job, is usually considered part of manufacturing overhead. 4. Manufacturing Overhead. Manufacturing overhead includes all of those costs incurred in the manufacturing process which are not “traced” to a particular job. By definition, manufacturing overhead usually consists of all manufacturing costs other than direct materials and direct labour. Since manufacturing overhead costs are not traced to jobs, they must be allocated to jobs if absorption costing is used. a. In order to allocate overhead costs, some type of allocation base common to all products being produced must be identified. The most widely used allocation bases are direct labour-hours, direct labour costs, and machine-hours. In the costing system illustrated in the chapter, a predetermined overhead rate is computed by dividing the estimated total overhead for the upcoming period by the estimated total amount of the allocation base. b. Ideally overhead cost should be strictly proportional to the allocation base; in other words, an X% change in the allocation base should cause an X% change 2 www.notesolution.com in the overhead cost. Only then will the allocated overhead costs be useful in decision-making and in performance evaluation. c. The actual amount of the allocation base incurred by a job is recorded on the job cost sheet. The actual amount of the allo
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