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Chapter 3

MGT223H5 Chapter Notes - Chapter 3: Activity-Based Costing, Deutsche Luft Hansa, Cost Driver

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Kathy Falk

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Job order Costing : Chapter 3
Product costing: process of assigning costs to g&s provided by company
Purpose of managerial costing system = provide cost data to help managers plan, control, direct
and make decisions
Absorption Costing (aka full costing): all manufacturing costs (fixed and variable) are assigned
to units of product – units are said to fully absorb manufacturing costs.  used for financial
reporting and tax reporting, popular approach for determining COGS and cost of inventories
Process Costing: used in those manufacturing situations where single, homogenous product (e.g.
cement, oil) flows out in continuous stream out of production process
Total manufacturing cost
Total units produced(liters , kilograms , bottles)
= Unit product cost (per litre, klg, etc)
Each unit assigned same average cost that applies to homogenous units flowing in continuous
stream out of production process.
Job Order Costing: used in situations where many different products, jobs, or services are
produced each period. While same concepts apply, he only difference for service organization =
lack of raw materials in cost of their services as they are not producing physical items.
Measuring Direct Materials Cost
Bill of Material: record that lists type and quantity of each item of material needed to complete a
unit of product
Production order: issued when agreement has been reached w/ customer concerning quantities,
prices and shipment date
Materials Requisition Form: detailed source doc that specifies type and quantity of materials that
are to be drawn from storeroom and identifies the job to which costs of materials are to be
charged  serves as means for controlling flow of materials into production and making entries
into accounting records
Raw Materials: ingredients that are converted into finished product, semi-finished materials can
be considered direct materials if were important enough to be directly traced to the job, but they
will not be raw materials. Therefore, raw materials can be direct materials but all direct materials
are not necessarily raw materials
Job Cost Sheet: form prepared for each job that records the materials, labour, and overhead costs
charged to job  after DM issues, costs are recorded directly on job cost sheet
Time ticket: detailed source doc that is used to record an employee’s hour by hour activities
during the day
Calculating Predetermined Manufacturing Overhead Rates
MO must be included w/ DM and DLon job cost sheet as it is a product cost however assigning
MO to units of product can be difficult – here’s why
1. MO = indirect cost  difficult to trace these costs directly to particular product/job
2. Consists of many different items, ranging from grease used in machines to annual salary
of production manager
3. Even though output may fluctuate due to several factors, MO costs tend to remain
constant due to fixed costs
4. Timing of payment of manufacturing overhead costs often varies – some items such as
property tax for land on which factory built may be paid once per year while others paid
quarterly, etc. but we produce finished items continuously and rather uniformly all year

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Job order Costing : Chapter 3
Allocation base = measure such as direct labour hours (DLH) or machine hours (MH) is used to
assign overhead costs to products and services
Predetermined Overhead Rate: rate used to charge overhead costs to jobs, rate is established in
advance for each period by use of estimates of total manufacturing overhead cost and of the total
allocation base for period  computed before period begins and used to apply overhead cost to
jobs throughout period. Process of assigning overhead cost to jobs called overhead application
Predetermined overhead rate =
estimated total manufacturing overhead cost
estimated totalunitsallocation base
Overhead applied to particular job = predetermined overhead rate x amt of allocation base
incurred by job
e.g. MO costs = 320,000 and total direct labour hours = 40,000. Predetermined overhead rate for
year would be $8 per direct labour hour
= $8 per direct labour hour
Normal cost system: costing system in which overhead costs are applied to jobs by multiplying
predetermined overhead rate by actual amt of allocation base incurred by job
Reasons to use predetermined overhead rates instead of overhead rates
1. Managers would like to know accounting system’s valuation of completed jobs before
end of accounting period (helps compute overhead rate, calculate COGS)
2. If actual overhead rates were computed frequently, seasonal factors in overhead costs or
in allocation base could produce fluctuations in overhead rates. E.g. two identical jobs,
one completed in winter and other in spring would be assigned different costs if overhead
computed monthly or quarterly. Managers feel that fluctuations in overhead rates and
costs serve no useful purpose and are mislead
3. Use of predetermined overhead rate simplifies record keeping
Allocation base used in predetermined overhead rate should drive overhead cost
Cost driver: factor that causes overhead costs, such as machine-hours, beds occupied, computer
time or flight hours. If based used to compute overhead rates tht does not “drive” overhead costs,
then result = inaccurate overhead rates and distorted product costs
(e.g. if direct labour hours used to allocate overhead, but in reality overhead has little to do with
direct labour hours, then products w/ high direct labour hour requirements will be allocated too
much overhead and ergo, overcosted)
Activity based costing= costing technique that is desgined to reflect more accurately the deands
that products, customers and other cost objects make on overhead resources
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