Chapter 4: INTRODUCTION TO COST ACCOUNTING · Chapter 4: INTRODUCTION TO COST ACCOUNTING ... 4....

Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 1

Chapter 4: INTRODUCTION TO COST ACCOUNTING

Test your knowledge 1. A direct cost is able to be traced to a product or service with a high degree of accuracy. Directly traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product. Direct materials and direct labour are the two most common direct costs for a business. Examples are:

• Raw materials used in making gold ring

• Wages of a mechanic in a car repair business

• Parts and supplies used in a panel beating business

• Cost of bottles used in making wine

• Cost of paint used in making a motor cycle

Indirect costs are not so easily traced to a product or service. These are items that are not actually incorporated in the product or are too insignificant to make it worth tracing the cost to the finished product. Examples are:

• Salary of the factory manager

• Local government rates and taxes

• Paint used in making a Dolls House

• Glue used in making furniture

• Oil and lubricants used in maintaining factory machinery

• Insurance of the business premises

2. Some costs may be direct in the making of one cost object and be indirect in the making of another cost object. Therefore the distinction between direct and indirect costs is important as it allows the determination of a cost object to be more accurate.

3. The factor that affects the classification of an item as a direct or indirect cost is whether it is traceable to the finished product. To be traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product.

4. Cost behaviour is how a cost changes in relation to the level of production activity. This is important as the distinction between fixed, variable and mixed costs is important to the accurate determination of the cost of a product or service. With a fixed cost the unit activity cost will change as the level of units produced increases or decreases, while with a variable cost the unit cost does not change. Fixed costs in total are constant as the level of activity increases whereas with a variable cost the total cost does increase as the level of activity increases. This cost behaviour affects the unit cost of a product or service.

5. Fixed costs are those that do not change in total when the level of activity changes. For example, the rent of a factory building will be the same in total no matter how many units are produced. Examples are:

• Depreciation of factory machinery • Office supervisor’s salary • Rent of a shop • Delivery vehicle insurance


A variable cost is one that changes in total as the level of activity changes. For example, the cost of raw materials in total will increase as the level of units produced increases. Examples are:

• Wages for casual staff to make glassware

• Raw materials used in the manufacture of a computer

• Cost of goods sold

• Commission paid to salespeople

Mixed or semi‐variable costs are those costs which contain both fixed and variable elements. For example, a telephone bill will contain the line rental cost, which is a fixed cost, and the cost of phone calls made, which is a variable cost. Examples are:

• Telephone bill

• Maintenance costs

• Electricity

• Water rates

6. Direct materials are those raw materials that are directly traceable to the product being made.

Raw materials are what go into the making of a product. For example, in the making of a men’s suit the raw materials would be such items as the fabric, the lining, buttons and thread. Other examples are in making a bottle of wine the bottle would be a direct material, in making a lounge chair the wood in the chair structure would be a direct material, for a T‐shirt product the cotton material would be a direct material and for shoes the direct material would be leather.

The direct labour cost is the amount paid such as wages, salaries, long‐service leave, sick leave, and payroll tax paid to the employees that is traceable to the finished product. Examples are machine operators in a factory making security screens, panel beaters fixing vehicles and bakers making bread products

Manufacturing overhead represents costs that are not direct materials or direct labour, but which are still part of the manufacturing process. Examples are:

• Indirect materials

• Indirect labour

• Electricity, water and gas used in the production of a product

• Depreciation

• Insurance

• Maintenance of the factory buildings

• Repairs to equipment used in the manufacturing process

7. Costs of operating a business that are not incurred in the manufacturing process are called non‐manufacturing costs. These can be categorised as selling or marketing costs, distribution or transport costs, administration costs and financial costs. Examples are:

• Direct materials used in the making of a surfboard

• Direct labour used in making a diamond ring

• Overheads assigned to the manufacture of a ball gown

8. A product cost includes all those costs that are attributable to a product and are those costs to do with merchandise acquired or manufactured or a service provided. It is recorded as an expense in the period in which the product is sold and this will be recorded as the cost of goods. The product is an asset because it has future economic benefit to the business.


Costs that are not product costs are period costs. Period costs are an expense and therefore shown in the business income statement in the period in which they are incurred. A period cost is a cost that relates to the current accounting period and which does not have a future economic benefit to the business. Period costs are not carried forward with the product until the time of sale. Examples are:

• Advertising • Wages paid to sales personnel

• Office rent • Office contents insurance

9. Cost accounting is the measuring, analysing, recording and reporting on the cost of a product or service. Cost accounting is useful to both financial and managerial accounting for such purposes as:

• determining profitability – management can determine if it is worth producing or selling the product or service.

• the setting of selling prices – often set with reference to the cost of the product or service • control of costs – comparing actual product costs with planned costs and, if necessary, taking corrective action so that the predetermined targets are met in the future

• planning – using past product costs to estimate future product costs

• inventory valuation – calculating the value of products that are complete (finished goods) and products that are partially complete (work in progress) at the end of each accounting period for inclusion in the financial statements

10. Absorption costing is the method whereby all fixed manufacturing costs and variable manufacturing costs are included in the product cost.

11. Job order costing is the process of recording all the costs of a distinct product or service. A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements. Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client.

12. A predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced.

The predetermined overhead rate is calculated as = budgeted manufacturing overhead cost budgeted allocation base

13. A normal costing system determines the cost of a product or service with job order costing using actual direct materials, actual direct labour and a predetermined overhead rate. These figures are applied to the actual quantity related to a job. The predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced.

14. Standard costing is a system of product costing where the cost of a product is based on standard costs for direct materials, direct labour and manufacturing overheads. A standard cost is a predetermined cost and based on some preconceived benchmark of what is considered appropriate to the making of a product. Therefore, the direct materials, direct labour and manufacturing overhead are not actual costs but rather estimates based on a standard cost.

15. Variance analysis is the comparison of the actual results compared to the standard amount or value called the flexible budget. The flexible budget is the standard quantity or hours allowed for output multiplied by the standard price or rate

16. The markup is the amount (either in dollars or percentage) added to the unit cost price of a product or service to determine its selling price. Therefore the selling price = cost + (markup percentage × cost)

17. As there are too many possible answers to this question, students should check their answers with their teacher.


Test your understanding 4.1

Item Manufacturing or Non‐manufacturing cost

Direct or Indirect cost

Fixed or Variable costor Mixed cost

Product or Period cost

Clothing factory equipment maintenance Manufacturing cost Indirect cost Mixed cost (fixed and variable costs) Product cost

Wages of vehicle factory assembly workers Manufacturing cost Direct cost Variable cost Product cost

Salaries of marketing staff Non‐manufacturing cost N/A Fixed cost Period costDepreciation of office equipment in a law practice Non‐manufacturing cost N/A Fixed cost Period cost

Surfboard factory supervisor’s salary Manufacturing cost Indirect cost Fixed cost Product costGlue used in the production of chairs Manufacturing cost Indirect cost Variable cost Product costLinen cloth used in the upholstery of a chair Manufacturing cost Direct cost Variable cost Product costStationery used in the administration office of an architect Non‐manufacturing cost N/A Fixed cost Period cost

Salary of the business accountant for a chain of jewellery stores Non‐manufacturing cost N/A Fixed cost Period cost

Wages of factory store personnel Manufacturing cost Indirect cost Fixed cost Product costDepreciation of factory machinery Manufacturing cost Indirect cost Fixed cost Product costElectricity used in a factory brewing beer Manufacturing cost Indirect cost Variable cost Product costInsurance of business delivery vehicles Non‐manufacturing cost N/A Fixed cost Period costVarnish paint used in making furniture Manufacturing cost Indirect cost Variable cost Product costDye used in making t‐shirts Manufacturing cost Indirect cost Variable cost Product cost

4.2 Item Manufacturing or Non‐

manufacturing cost Direct or

Indirect cost Fixed or Variable cost

Or Mixed cost Product or Period cost

Paper used in the making of a textbook Manufacturing cost Direct cost Variable cost Product costDepreciation of factory machinery Manufacturing cost Indirect cost Fixed cost Product costSales commission paid to sales staff Non‐manufacturing cost N/A Variable cost Period costWages paid to factory assembly workers Manufacturing cost Direct cost Variable cost Product costWages paid to workers making pizzas in a fast food shop Manufacturing cost Direct cost Variable cost Product cost

Leather used in making shoes Manufacturing cost Direct cost Variable cost Product costSalary paid to business director of chain of music stores Non‐manufacturing cost N/A Fixed cost Period cost

Wages paid to delivery drivers in a transport company Non‐manufacturing cost N/A Variable cost Period cost

Wages paid to pizza delivery drivers in a fast food business Non‐manufacturing cost N/A Variable cost Period cost

Plumbing materials used in a plumbing business Non‐manufacturing cost N/A Variable cost Period cost

Electricity used in repairing a vehicle in a panel beating workshop Non‐manufacturing cost N/A Variable cost Period cost

Oil used by a mechanic in servicing and repairing vehicles Non‐manufacturing cost N/A Variable cost Period cost

Steel used to make pergolas Manufacturing cost Direct cost Variable cost Product cost


4.3 a) Predetermined overhead rate = $90 000/4 350 direct labour hours

Therefore = $20.69 per direct labour hour

b) Job Number 56

Direct Materials $11 000

Direct Labour ($50 per hour X 600 hours) $30 000

Manufacturing Overhead (600 hours X $20.69) $12 414

Total cost Job 56 $53 414

4.4 a) Predetermined overhead rate

Budgeted Factory Overhead

Indirect Materials $ 78 000

Indirect Labour $ 64 000

Other overheads $110 000

$ 252 000

Therefore = $252 000/11 350 direct labour hrs


b) Job Number 658


Direct Labour $ 70 000

Manufacturing Overhead (250 hours X $22.20) $ 5 550

Total cost Job 658 $ 53 414


Budgeted Factory Overhead

Indirect Materials $ 83 000

Indirect Labour $ 67 000

Other overheads $130 000

$ 280 000

Therefore = $280 000/2 150 machine hrs



b) Job Number 130


Direct Labour $ 3 600



c) $26 392/10 000 = $2.64 per bottle for choc milk

4.6 a) Predetermined overhead rate = $154 000/2 300 machine hrs

Therefore = $66.96 per machine hour

b) Batch Number 15 Hand Lotion


Direct Labour ($55 per hour X 50 hours) $ 2 750



Batch Number 16 After Shave Lotion


Direct Labour ($55 per hour X 70 hours) $ 3 850



c) Batch number 15 $23 107/1 000 = $23.11 per bottle of hand lotion

Batch number 16 $43 885/1 500 = $29.26 per bottle of after shave lotion

4.7 a) Predetermined overhead rate = $74 000/4 000 direct labour hrs


b) Job Number 134

Direct Materials $ 650





Job Number 135





Job Number 136





4.8 a) Predetermined overhead rates

Mixing Department = $35 000/600 machine hrs


Cooking Department = $56 000/1 000 machine hrs


Packaging Department = $25 000/6 300 direct labour hrs


b) Direct Materials

Mixing Department Sugar $2 500

Citric Acid $ 50

Gelatine $ 80

Essence $ 60

Food Colouring $ 45

Packaging Department Plastic $ 300

Paper boxes $ 200

Total Direct Materials cost $3 775

Direct labour

Mixing Department 12 hours @ $45 per hour $ 540

Cooking Department 25 hours @ $55 per hour $ 1 375

Packaging Department 42 hours @ $40 per hour $ 1 680

Total Direct labour cost $ 3 595


Manufacturing overheads

Mixing Department 10 machine hours @ $58.33 per hour $ 583

Cooking Department 23 machine hours @ $56 per hour $1 288

Packaging Department 42 direct labour hours @ $3.97 per hour $ 167

Total Manufacturing overhead $2 038

Total cost of a batch of Jelly Beans $9 408

c) Cost of a packet of Jelly Beans $9 408/1 000 = $9.41


Set‐up Department = $43 000/5 500 direct labour hrs


Print Department = $67 000/2 900 machine hrs


b) Costs for Job 271 from before July 2011:

Total of incomplete jobs $ 5 700

Job 269 ($2 800 – 1 000) ($1 800)

Job 270 ($2 700)

Job 271 therefore $ 1 200

Current Months Manufacturing costs for Job Number 271

Direct Materials

Set‐up Department $ 90

Print Department $1 900

Total Direct Materials cost $1 990

Direct labour

Set‐up Department 18 hours @ $45 per hour $ 810

Print Department 3 hours @ $25 per hour $ 75

Total Direct labour cost $ 885

Manufacturing overheads

Mixing Department 2 machine hours @ $7.82 per hour $ 16

Cooking Department 12 machine hours @ $23.10 per hour $ 277

Total manufacturing overhead $ 293

Total cost of Job number 271 $3 168


4.10 Total Overheads

Electricity costs incurred $ 4 500

Water costs incurred $ 1 800

Cleaning costs incurred $ 15 000

Repairs and maintenance of equipment $ 2 900

Deprecation of equipment $ 12 600

Indirect materials used $ 35 600

Rent cost incurred $ 27 800

Insurance cost incurred $ 5 100

Hairdresser manager $ 67 000

Miscellaneous costs incurred $ 16 450

$188 750

Predetermined overhead rate

Direct labour hours 7.5 X 5 X 9 X 52 = 17 550

Therefore 188 750/17 550 = 10.75

Cost of the ladies style cut

Direct materials $ 3.50

Direct labour ($26 per hour X 30 minutes) $13.00

Overheads ($10.75 X 30 minutes) $ 5.38

$21.88

4.11 a) Total cost of labour:

Partners $250 000 X 4 = $1 000 000

Seniors $140 000 X 5 = $ 700 000

Juniors $ 80 000 X 5 = $ 400 000

$2 100 000

Apportion of overheads:

Partners 1 000 000/2 100 000 = 48%

Seniors 700 000/2 100 000 = 33%

Juniors 400 000/2 100 000 = 19%

Partners 48% X 490 000 = $235 200

Seniors 33% X 490 000 = $161 700

Juniors 19% X 490 000 = $ 93 100


Overheads to be covered by each category of lawyer

Partners 235 200/4 = 58 800 Seniors 161 700/5 = 32 340

Juniors 93 100/5 = 18 620

Overheads to be covered each hour:

Partners 58 800/1 700 = 34.59 per hour Seniors 32 340/1 700 = 19.01 per hour

Juniors 18 620/1 700 = 10.95 per hour

Direct labour cost per category of lawyer

Partners 250 000/1 700 = 147.06 per hour Seniors 140 000/1 700 = 82.35 per hour

Juniors 80 000/1 700 = 47.06 per hour

Charge our rate for each category of lawyer:

Partners 34.59 + 147.06 = 181.65 Seniors 19.01 + 82.35 = 101.36

Juniors 10.95 + 47.06 = 58.01

b) Amount to charge Brian Epstein Pty Ltd

Partner 30 hours X 181.65 = $5 449.50 Senior 25 X 101.36 = $2 534

Juniors 30 X 58.01 = $1 740.30

Total = $9 724

4.12 a) Predetermined overhead rate:

Total of budgeted overheads

Electricity costs incurred $ 8 700

Water costs incurred $ 2 800

Cleaning costs incurred $ 34 000

Repairs and maintenance of equipment $ 7 400

Repairs and maintenance of warehouse $ 9 600

Deprecation of equipment $ 11 000

Deprecation of warehouse $ 15 000

Insurance costs incurred $ 7 600

Warehouse manager $ 88 000

Security guards and dogs $ 55 000

Miscellaneous costs incurred $165 000

$404 100

Predetermined overhead rate: 404 100/17 000 = $23.77


b) Rate to charge of fuel per kilometre

Cost of fuel: $1.50 per litre of fuel X 150 kilometres = $225

Therefore $225/900 kilometres = 25 cents (0.25) to charge per kilometre

c) Job – Amber Pty Ltd

Direct Materials Fuel – 4 000 kilometres X 0.25 $1 000

Direct Labour 5 days X 12 hours X $70 per hour $4 200

Accommodation – 4 nights X $90 per night $ 360

Food allowance – 4 breakfasts X $15 $ 60

4 lunches X $15 $ 60

4 dinners X$25 $ 100

Overheads – 60 hours X $23.77 per hour $1 426

Total cost $7 206

Job – Lucky Pty Ltd

Direct Materials Fuel – 3 500 kilometres X 0.25 $ 875

Direct Labour 4.5 days X 12 hours X $70 per hour $3 780

Accommodation – 4 nights X $90 per night $ 360

Food allowance – 4 breakfasts X $15 $ 60

4 lunches X $15 $ 60

4 dinners X$25 $ 100

Overheads – 54 hours X $23.77 per hour $1 284

Total cost $6 519

4.13 Standard Cost Men’s Shirt

Direct Materials

Cotton – 2 metres per shirt X $7.00 per metre $14.00 per shirt

Buttons – 3 buttons X 0.50 per button $1.50 per shirt

Direct labour

0.5 hours per shirt X $30.00 per hour $15.00 per shirt

Overheads

$160 000/18 000 direct labour hours = $8.80 per direct labour hour

Therefore – 0.5 hours per shirt X $8.80 per direct labour hour $4.40 per shirt

Total standard cost of making a shirt $34.90 per shirt

Cost of making a batch of 5 000 shirts is:

5 000 X $34.90 per shirt = $174 500


4.14 Predetermined overhead rate


Standard cost of a batch of incense burners

Direct materials

Clay – 500 kilos X $8.00 per kilo $ 4 000

Glaze – 300 litres X $2.00 per litre $ 600

Paint – 80 litres X $5.00 per litre $ 400

Sealant – 200 litres X $3.50 per litre $ 700

Total direct materials cost $ 5 700

Direct labour

200 hours X $30.00 per hour $ 6 000

Overheads

200 direct labour hours X $6.86 per direct labour hour $ 1 372

Standard cost of a batch $13 072

Cost of making one incense burner:

$13 072/2 000 = $6.54

4.15 Predetermined overhead rate

Leather goods factory:


Farming

$200 000/5 000 = $40 per Crocodile

Slaughter, drying and cutting

$90 000/5 000 = 18 per Crocodile

Standard cost of farming each crocodile

Direct materials $100 per crocodile

Direct labour $ 80 per crocodile

Overheads $ 40 per crocodile

Total cost of farming one crocodile $220


Standard cost of slaughtering, drying and cutting each crocodile

Direct materials $ 50 per crocodile

Direct labour $ 60 per crocodile

Overheads $ 40 per crocodile

Total cost of slaughtering, drying and cutting one crocodile $150

Standard cost of direct materials relating to one crocodile:

Farming $220

Slaughtering, drying and cutting $150

Total cost $370

Standard cost of making a batch of handbags

Small Handbags

Direct materials

Crocodile skin – $370/16 $23.13

Lining – half a metre at $5.00 per metre $ 2.50

Studs – 6 @ 30 cents per stud $ 1.80

Zip – one @ $3.00 pre zip $ 3.00

Rings – four @ 30 cents per ring $ 1.20

Latch – one @ 80 cents per latch $ 0.80

$32.43

Direct labour

Time to make one small bag – 300 hours/400 items = ¾ hour @ $26.00 per hour $19.50

Overheads

¾ hour @ $37.04 per direct labour hour $27.78

Total cost of making one small handbag $79.71

Large Handbags

Direct materials

Crocodile skin – $370/8 $ 46.25

Lining – one a metre at $5.00 per metre $ 5.00

Studs – 12 @ 30 cents per stud $ 3.60

Zip – one @ $3.00 pre zip $ 3.00

Rings –four @ 30 cents per ring $ 1.20

Latch – one @ $1.00 cents per latch $ 1.00

$ 60.00


Direct labour Time to make one small bag

– 400 hours/400 items =One hour @ $26.00 per hour $ 26.00

Overheads

1 hour @ $37.04 per direct labour hour $ 37.04

Total cost of making one small handbag $123.04


Overhead costs

Factory building depreciation $ 18 000

Electricity incurred (15 000 X 0.75) $ 11 250

Factory office costs $ 35 000

Cleaning costs incurred (26 000 X 0.75) $ 19 500

Repairs and maintenance of factory machinery and equipment $ 12 000

Repairs and maintenance of factory $ 9 500

Insurance costs incurred (13 500 X 0.75) $ 10 125

Factory manager $110 000

Security guards and dogs $ 54 000

Miscellaneous factory costs incurred $ 77 000

Finance costs (19 400 X 0.75) $ 14 550

Total overhead costs $370 925

Therefore $370 925/3 500 = 105.98 per machine hour 25 cents 424

Allocation to departments

Stage 1 Department 105.98 X 30% = $31.79 per machine hour



b) Direct materials cost

Stage 1 Department $2 010 000 X 35% = $703 500/10 500 000 = 67 cents per litre @2 litres = $1.34 DM per tub

Stage 2 Department $900 000 X 35% = $315 000/1 000 000 = 31.5 cents per gram @ 2 grams = 63 cents DM per tub

Stage 3 Department $360 000 X 35% = $126 000/256 000 = $1.02 DM per tub

Direct materials cost total = $2.99 DM per tub


c) Direct labour

Stage 1 Department $450 000 X 30% = $135 000/5 400 hours = $25/278 tubs = 9 cents DLH per tub 135 000/25/

Stage 2 Department $360 000 X 30% = $108 000/4 909 hours = 22/314 tubs = 7 cents DLH per tub

Stage 3 Department $300 000 X 30% = $90 000/4 500 hours 20/100 = 20 cents DLH per tub

Total Direct Labour cost = 36 cents DLH per tub

d) Overhead cost per tub

Stage 1 Department $31.79 per machine hour/425 = 7 cents per tub



Total overhead cost per tub = 24 cents per tub

(e) Total cost of making a tub of supreme ice cream

Direct materials $2.99 per tub

Direct Labour $0.36 per tub

Overhead $0.24 per tub

Total cost per tub $3.59 per tub

4.17 Direct materials price and quantity variances

Actual results Flexible budget Actual quantity of inputs X actual price 950 square metres X $11.00 per sq metre = $10 450

Actual quantity of inputs X standard price 950 square metres X $10.00 = $9 500

Standard quantity allowed for output X standard price 1 000 square metres (1 000 outdoor deck chairs x 1 sq metre per chair) X $10.00 = $10 000

Price variance is $950 U Quantity variance is $500 F

Direct labour rate and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate 550 hours X $18.30 per hour wage rate = $10 065

Actual hours of inputs X standard rate 550 hours X $18.00 per hour = $9 900

Standard hours allowed for output X standard rate 500 (1 000 outdoor deck chairs x ½ hour per chair) hours X $18.00 per hour = $9 000

Rate variance is $165 U Efficiency variance is $900 U


4.18 a) and b) Direct materials price and quantity variances

Distilled Water Actual results Flexible budget

Actual quantity of inputs X actual price 650 litres X $30.00 per litre = $19 500

Actual quantity of inputs X standard price 650 litres X $29.00 = $18 850

Standard quantity allowed for output X standard price 600 litres ((120 mLs X 5 000 items)/1 000) X $29.00 per litre = $17 400

Price variance is $650 U Quantity variance is $1 450 U

Alcohol Actual results Flexible budget



Standard quantity allowed for output X standard price 400 litres ((80 mLs X 5 000)/1 000 litres X $41.00 = $16 400

Price variance is $380 F Quantity variance is $820 F

Lavender fragrance Actual results Flexible budget



Standard quantity allowed for output X standard price 250 litres ((50 mLs X 5 000)/1 000 litres X $61.00 = $15 250

Price variance is $260 F Quantity variance is $610 U

c) and d) Direct labour rate and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate 300 hours X $23.00 per hour wage rate = $6 900

Actual hours of inputs X standard rate 300 hours X $23.00 per hour = $6 900

Standard hours allowed for output X standard rate 312.5 hours (5 000/16) X $23.00 per hour = $7 187.50

Rate variance is $0 Efficiency variance is $287.50 F

4.19 a) and b) Fixed overhead spending and production volume variances

Actual results Budgeted Flexible budget Allocated fixed overhead applied $70 000

Budgeted amount regardless of output $60 000


Standard hours allowed for output X standard rate625 direct labour hours (5 000 deserts X 7 ½ minutes per desert) X $87.27 per direct labour hour = $54 543.75

Spending variance is $10 000 U Production volume variance is $9 000 U


Overhead application rate

Budgeted Direct labour hours

5 500 X 7 ½ minutes per desert = 687.5 hours

Budgeted Fixed Overhead costs $60 000/687.50 = $87.27 per direct labour hour

c) and d) Variable overhead spending and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate $80 000 (600 labour hours X $133.33 per hour*)

Actual hours of inputs X standard rate $81 000 (600 labour hours X $135.00 per hour)

Standard hours allowed for output X standard rate $84 375 (625 direct labour hours X $135.00 per hour)

Spending variance is $1 000 F Efficiency variance is $3 375 F

* $80 000/600 = $133.33

4.20 a) and b) Fixed overhead spending and production volume variances

Actual results Budgeted Flexible budget Allocated fixed overhead applied $50 000



Standard hours allowed for output X standard rate3 360 machine hours (420 units X 8 machine hours per unit) X $12.20 per machine hour = $40 992

Spending variance is $10 000 U Production volume variance is $992 F


Budgeted Fixed Overhead costs $40 000/3 280 = $12.20 per machine hour

c) and d) Variable overhead spending and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate $165 000 (3 465 machine hours X $47.62 per hour*)

Actual hours of inputs X standard rate $173 250 (3 465 machine hours X $50.00 per hour)

Standard hours allowed for output X standard rate $168 000 (3 360 machine hours X $50.00 per machine hour)

Spending variance is $8 250 F Efficiency variance is $5 250 U

* $165 000/3 465 = $47.62

4.21 a) and b) Direct materials price and quantity variances

Actual results Flexible budget Actual quantity of inputs X actual price 99 200 square metres (31 sq metres X 3 200) X $0.33 per sq metre = $32 736

Actual quantity of inputs X standard price 99200 square metres (31 sq metres X 3 200) X $0.30 = $29 760

Standard quantity allowed for output X standard price 96 000 square metres (30 sq metres X 3 200) X $0.30 = $28 800

Price variance is $2 976 U Quantity variance is $960 U


c) and d) Direct labour rate and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate 800 hours (3 200 frames X 15 minutes per frame) X $24.00 per hour wage rate = $19 200

Actual hours of inputs X standard rate 800 hours (3 200 frames X 15 minutes per frame) X $22.00 per hour = $17 600

Standard hours allowed for output X standard rate 853.33 hours (3 200 frames X 16 minutes per frame) X $22.00 per hour = $18 773.26

Rate variance is $165 U Efficiency variance is $1 173.26 F

g) and h) Fixed overhead spending and production volume variances Actual results Budgeted Flexible budget Allocated fixed overhead applied

Actual hours of inputs X actual rate $14 080 (1 600 machine hours X $8.80 per machine hour)

Budgeted amount regardless of output $13 496 (1 400 machine hours X $9.64 per machine hour)


Standard hours allowed for output X standard rate $14 395.70 (1 493.33 machine hours (3 200 frames X 28 minutes per frame) machine hours X $9.64 per machine hour)

Spending variance is $584 U Production volume variance is $899.70 F

e) and f) Variable overhead spending and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate $13 280 (1 600 machine hours (3 200 X 30 minutes) $8.30 per machine hour)

Actual hours of inputs X standard rate $13 712 (1 600 machine hours (3 200 X 30 minutes) X $8.57 per machine hour

Standard hours allowed for output X standard rate $12 797.84 (1 493.33 hours (3 200 frames X 28 minutes) machine hours X $8.57 per machine hour)

Spending variance is $432 F Efficiency variance is $914.16 U

4.22 Direct materials price and quantity variances

Actual results Flexible budget Actual quantity of inputs X actual price 7 200 square metres X $210 per sq metre = $1 512 000

Actual quantity of inputs X standard price 7 200 square metres X $200 per sq metre = $1 440 000

Standard quantity allowed for output X standard price 6 900 square metres (3 sq metres X 2 300 rugs) X $200 per sq metre = $1 380 000

Price variance is $72 000 U Quantity variance is $60 000 U

Direct labour rate and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate 4 400 hours X $22.00 per hour wage rate = $96 800

Actual hours of inputs X standard rate 4 400 hours X $21.00 per hour = $92 400

Standard hours allowed for output X standard rate 4 600 hours (2 300 rugs x 2 hour per rug) X $21.00 per hour = $96 600

Rate variance is $4 400 U Efficiency variance is $4 200 F


Fixed overhead spending and production volume variances Actual results Budgeted Flexible budget Allocated fixed overhead applied

Actual hours of inputs X actual rate $60 000 (50 000 machine hours X $1.20 per machine hour ($60 000/50 000 machine hours)



Standard hours allowed for output X standard rate $67 500 (54 000 machine hours (27 000 rugs X 2 hours per rug) X $1.25 per machine hour)

Spending variance is $3 750 F Production volume variance is $3 750 F


Budgeted Fixed Overhead costs $63 750/51 000 machine hours = $1.25 per machine hour

Variable overhead spending and efficiency variances Actual results Flexible budget

Actual hours of inputs X actual rate $38 000 (50 000 machine hours x $0.76 per hour*)

Actual hours of inputs X standard rate $45 500 (50 000 machine hours x $0.91 per hour)

Standard hours allowed for output X standard rate $49 140 (54 000 machine hours (27 000 rugs X 2 hours per rug) x $0.91 per machine hour)

Spending variance is $7 500 F Efficiency variance is $3 640 F

* $38 000/50 000 machine hours = $0.76 per machine hour

$46 000/51 000 machine hours = $0.91 per machine hour

4.23 a) Predetermined overhead per machine hour

$430 000/4 570 = $94.09 per machine hour

b) Cost of new outback tent

Direct materials ($463 000/500) $ 926 per tent

Direct labour ($23 560/500) $ 47 per tent

Overheads ($94.09 X 160 hours = $15 054.40/500) $ 30 per tent

Total cost of one tent $1 003

c) Price to be charged of one new tent

$1 003 + ($1 003 X 35%)

$1 003 + 351

= $1 354

Therefore the price to charge of one new camping tent is $1 354

d) The factors that would be considered would be: o The selling price that the customer is willing to pay

o The selling price that is competitive in the marketplace

o The desired rate of return on investment, that is, what profit margin does the business wish to make. o The business’s costs, as all costs must be covered.



Cutting and Assembly Department

$460 000/7 200 machine hours = $63.89 per machine hour

Finishing Department


b) Production targets

Model Basic – 1 500 X 70% = 1 050 products

Model Luxury – 1 500 X 30% = 450 products

Cost of making Model Basic

Direct Materials: Cutting and Assembly – 890 000 X 60% = 534 000/1 050 $ 508.57

Direct Materials: Finishing – 370 000 X 60% = 222 000/1 050 $ 211.43

Direct labour

Cutting and Assembly – 1 400 hours X 50% =

700 hours X $30 per hour = 21 000/1 050 $ 20.00

Finishing – 3 500 hours X 50% =

1 750 hours X $35 per hour = 61 250/1 050 $ 58.33

Overheads

Cutting and Assembly – 7 200 X 70% =

5 040 hours X $63.89 per hour = $322 005.60/1 050 $ 306.67

Finishing – 3 500 X 50% =

1 750 hours X $71.43 per hour = $125 002.50/1 050 $ 119.05

Total cost of making the Model Basic $1 224.05

Cost of making Model Luxury

Direct Materials

Cutting and Assembly – 890 000 X 40% = 356 000/450 $ 791.11

Finishing – 370 000 X 40% = 148 000/450 $ 328.89

Direct labour

Cutting and Assembly – 1 400 hours X 50% =

700 hours X $30 per hour = 21 000/450 $ 46.67

Finishing – 3 500 hours X 50% =

1 750 hours X $35 per hour = 61 250/450 $ 136.11


Overheads

Cutting and Assembly – 7 200 X 30% =

2 160 hours X $63.89 per hour = $138 002.40/450 $ 306.67

Finishing – 3 500 X 50% =

1 750 hours X $71.43 per hour = $125 002.50/450 $ 277.78

Total cost of making the Model Basic $1 887.23

c) Price Model Basic

$1 224.05 + ($1 224.05 X 25%)

$1 224.05 + 306.01

= $1 530

Therefore the price to charge for Model Basic is $1 530

Price Model Luxury

$1 887.23 + ($1 887.23 X 30%)

$1 887.23 + 566.17

= $2 453

Therefore the price to charge for Model Basic is $2 453

4.25 a) Charge our rate for a partner and an associate

Cost of overheads

Salaries of secretarial staff $ 90 000

Electricity $ 5 700

Insurance $ 3 700

Rent of office space $ 40 000

Office supplies $ 18 500

Depreciation of office equipment $ 19 500

Repairs to equipment $ 2 700

Professional requirements costs $ 10 000

Miscellaneous costs $ 15 500

Total overhead $205 600

Total hours 1 800 X 7 staff = 12 600 hours

Predetermined Overhead Rate

$205 600/12 600 hours = $16.32 per hour


Partners charge our rate

Salary costs ($270 000/1 800) $150.00 per hour

Overhead costs $ 16.32 per hour

Total cost $166.32 per hour

Associates charge out rate

Salary costs ($120 000/1 800) $ 66.67 per hour

Overhead costs $ 16.32 per hour

Total cost $ 82.99 per hour

b) Cost of preparing the three types of personal tax returns

Basic personal tax returns

Partners time 2 ½ hours X 20% = ½ hour X $166.32 per hour $ 83.16

Associates time 2 ½ hours X 80% = 2 hours X $82.99 per hour $ 165.98

Total cost $ 249.14

Standard personal tax returns

Partners time 5 hours X 40% = 2 hours X $166.32 per hour $ 332.64

Associates time 5 hours X 60% = 3 hours X $82.99 per hour $ 248.97

Total cost $ 581.61

Difficult personal tax returns

Partners time 10 hours X 60% = 6 hour s X $166.32 per hour $ 997.92

Associates time 10 hours X 40% = 4 hours X $82.99 per hour $ 331.96

Total cost $1 329.88

c) Standard hourly rate for each type of personal tax return

Basic personal tax returns

$249.14 + ($249.14 X 20%) = $298.97

$298.97/2.5 hours = $120 per hour

Standard personal tax returns

$581.61 + ($581.61 X 20%) = $697.93

$697.93/5 hours = $140 per hour

Difficult personal tax returns

$1 329.88 + ($1 329.88 X 20%) = $1 595.86

$1 595.86/10 hours = $160 per hour


Standard price for each type of personal tax return

Basic personal tax return – 2 ½ hours X $120 per hour = $300

Standard personal tax return – 5 hours X $140 per hour = $700

Difficult personal tax return – 10 hours X $160 per hour = $1 600

4.26 Costs

Predetermined overhead rate $75 per direct labour hour X 15 hours (3 workers X 5 hours each) $1 125

Direct materials $1 700

Direct labour $62 per hour X 15 hours (3 workers X 5 hours) $ 930

Total cost $3 755

Mark up

Cost $3 755 + ($3 755 X 25%)

= $4 694

Quote for repairing the vehicle is $4 694

4.27 Costs

Prefabrication Department

Direct materials $6 000

Direct labour – 4 hours X $45 per hour $ 180

Overheads – $23 per machine hour X 10 hours $ 230

Total cost $6 410

Cutting Department

Direct materials $ 300

Direct labour – 8 hours X $55 per hour $ 440


Total cost $ 884

Construction Department

Direct materials $ 500

Direct labour – 30 hours X $61 per hour $1 830


Total cost $2 420

Total overall cost $9 714


Mark up

$9 714 + ($9 714 X 28%) = $12 434

Quote for making and erecting the patio is $12 434


Manufacturing Department Air‐conditioners –

$530 000/5 000 machine hours $106 per machine hour

Manufacturing Department Other Parts –

$257 000/3 000 machine hours $ 86 per machine hour

Installation Department – $210 000/30 000 direct labour hours $ 7 per direct labour hour

Model A67 costs

Direct materials

Manufacturing Department Air‐conditioners – $1 958 000

Manufacturing Department Other Parts – $1 120 000

Total Direct materials cost $3 078 000

Direct labour


9 750 X 30% = 2 925 hours X $30 per hour $ 87 750


2 470 X 30% = 741 hours X $35 per hour $ 25 935

Total Direct labour cost $ 113 685

Overheads


5 000 X 35% = 1 750 hours X $106 per hour $ 185 500


3 000 X 35% = 1050 hours X $86 per hour $ 90 300

Total Overhead cost $ 275 800

Total cost to make Model A67 $3 467 485

Cost of making one Model A67:

Production 2 500 X 40% = 1 000 air conditioners

Therefore $3 467 485/1 000 = $3 467 each


b) Direct materials

Installation Department – $190 000

Direct labour

Installation Department –

30 000 X 30% = 9 000 hours X $35 per hour $315 000

Overheads

Installation Department –

30 000 X 30% = 9 000 hours X $7 per hour $ 63 000

Total cost of one $568 000

Cost of one Basic Installation Package:

Production 2 500 X 40% = 1 000 air conditioners

Therefore $568 000/1 000 = $568 each

c) Quote for Holly Spears

One A67 Basic Air Conditioner $3 467

One Basic Installation Package $ 568

Other parts for installation $ 250

Extra direct labour time 2 hours $35 per hour = $ 70

Total cost $4 355

Plus mark up $4 355 X 25% $1 089

Total cost to make and install $5 444

Essay The following is a skeleton outline only showing some key points.

Cost accounting is important to the accurate measuring, analysing, recording and reporting on the cost of a product or service so as to determine the selling price of an item and its profitability. Cost accounting information is therefore used to make informed decisions and to maximise profits. The business can see how profit is linked closely with costs and the level of business activity.

Costing can be used to improve the efficiency and effectiveness of business operations through identifying value‐added and non‐value‐added costs. The latter can then be eliminated to make the business more profitable.

Specifically cost accounting is important and useful as follows:

• control of costs – comparing actual product costs with planned costs and, if necessary, taking corrective action so that the predetermined targets are met in the future

• planning – using past product costs to estimate future product costs

• inventory valuation – calculating the value of products that are complete (finished goods) and products that are partially complete (work in progress) at the end of each accounting period for inclusion in the financial statements

• the setting of selling prices – often set with reference to the cost of the product or service • determining profitability – management can determine if it is worth producing or selling the product or service.


In explaining how it is useful students should give examples for each of the above relating to manufacturing, service and retail businesses.

Job order costing is the process of recording all the costs of a distinct product or service. A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements.

Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client. In each case the job uses its own specific resources. A batch may be a variety of wine, a type of shirt made for a particular market or a small quantity of invitations printed for an expo. The business may manufacture a number of different unique products in small or large quantities or provide a number of different services to meet client requests. The product being manufactured or service provided is unique and different to the other products being made by the business.

Job order costing is used in both manufacturing and service industries but is rarely used in merchandising firms as the cost of the product is already known.

Many firms are not purely manufacturing, merchandising or service firms, but a bit of each, as they may make and/or sell a product and also provide a service to the customer. For example, a firm may manufacture, sell and install swimming pools or a café may make sandwiches, sell pre‐purchased cakes and provide customers with an agreeable venue to eat them in. Job order costing is used in such service industries as accounting firms, legal firms and repair shops.

Job order costing records all the costs for each finished job whereby all costs are traced and allocated to the job and the quantity noted. It is possible then to calculate the average cost per unit of the item being made or service provided.

A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements.

Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client. In each case the job uses its own specific resources. A batch may be a variety of wine, a type of shirt made for a particular market or a small quantity of invitations printed for an expo. The business may manufacture a number of different unique products in small or large quantities or provide a number of different services to meet client requests. The product being manufactured or service provided is unique and different to the other products being made by the business.

Job order costing is used in both manufacturing and service industries but is rarely used in merchandising firms as the cost of the product is already known. Job order costing is used in such service industries as accounting firms, legal firms and repair shops.

Job order costing records all the costs for each finished job whereby all costs are traced and allocated to the job and the quantity noted. It is possible then to calculate the average cost per unit of the item being made or service provided.

Actual costing calculates the cost of a product or service using the actual direct materials, actual direct labour and actual overheads costs. All costs are applied to the actual quantity. In the case of the actual overhead costs, an actual overhead rate is applied at the end of each accounting period to the product or service to determine the total unit cost.

Normal costing determines the cost of a product or service with job order costing using actual direct materials, actual direct labour and a predetermined overhead rate. These figures are applied to the actual quantity related to a job. The predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced.

Absorption costing is the method whereby all fixed manufacturing costs and variable manufacturing costs are included in the product cost.

Standard costing is a system of product costing where the cost of a product is based on standard costs for direct materials, direct labour and manufacturing overheads. A standard cost is a predetermined cost and based on some preconceived benchmark of what is considered appropriate to the making of a product.


A direct cost is able to be traced to a product or service with a high degree of accuracy. Directly traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product. Direct materials and direct labour are the two most common direct costs for a business. Indirect costs are not so easily traced to a product or service. These are items that are not actually incorporated in the product or are too insignificant to make it worth tracing the cost to the finished product

Fixed costs are those that do not change in total when the level of activity changes. For example, the rent of a factory building will be the same in total no matter how many units are produced. A variable cost is one that changes in total as the level of activity changes. For example, the cost of raw materials in total will increase as the level of units produced increases

A product cost includes all those costs that are attributable to a product and are those costs to do with merchandise acquired or manufactured or a service provided. It is recorded as an expense in the period in which the product is sold and this will be recorded as the cost of goods. The product is an asset because it has future economic benefit to the business. Costs that are not product costs are period costs. Period costs are an expense and therefore shown in the business income statement in the period in which they are incurred. A period cost is a cost that relates to the current accounting period and which does not have a future economic benefit to the business. Period costs are not carried forward with the product until the time of sale.

Ethics case study The General Manager may have chosen direct labour hours for the allocation of overheads instead of the machine hours recommended by the Financial Controller so as to ensure that more or less cost is charged to the contract. The selection of the inappropriate cost allocation base could see more or less cost charged to the contract than would otherwise be the case if machine hours had been chosen.

The first ethical issue relates to the over‐charging or under‐charging of cost to the Sarich contract. The question here is why? Is it to make extra profit out of the Sarich contract or is under‐charge them so as to ensure further business in the future. The other question related to this is ethical issue is: what is the relationship of the General Manager to the Sarich contract? Is there a conflict of interest?

A further ethical issue relates to the perceived technical competence of the financial controller. This decision of the General Manager could reflect poorly, although not correctly so, on the Financial Controller. If a problem was to occur in the future with the Sarich business and this contract, and the Board of Directors was to investigate all aspects of the contract, it could perhaps incorrectly attribute some of the problem to financial controller for not selecting the appropriate allocation base. This business may have under‐charged or over‐charge Sarich and may blame this on the Financial Controller.

The Financial Controller has a number of possible options. He/she could contact the Board of Directors of Digital Electronics Ltd and explain his/her concerns to them. He/she could write a memo to the General Manager outlining his/her concerns and in this way place it on the records. He/she could contact the Sarich business, although this may be seen by Digital as breaking confidentiality. A further possible course of action is for the Financial Controller to resign.

Chapter 4: INTRODUCTION TO COST ACCOUNTING · Chapter 4: INTRODUCTION TO COST ACCOUNTING ... 4....

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