Product Cost Flows and Business
Organizations
Product Cost Flows and Business
Organizations
C H A P T E R 3
Manufacturing overheadall costs incurred in the manufacturing process other than direct materials and direct labor.
Define the Three Manufacturing Product Costs
Direct laborwages paid to those who physically work on the direct materials to transform them to a finished product and are traceable to those products.
Direct materialsmaterials that become part of the product and are traceable to it.
Direct Labor Costs
Direct Labor Costs
Assignment of Product Costs
Product CostProduct Cost
Direct Materials
Costs
Direct Materials
Costs- Expenditure
and use usually match production.
- Expenditure and use usually match production.
Easily assigned to products.
Easily assigned to products.
Manufacturing Overhead
Costs
Manufacturing Overhead
Costs- Total costs not known
until the end of the period.
- Not usually assigned to specific products.
- “Lumped” costs don’t match production very well.
Difficult to assign to products.
Product Cost Systems
Why does management needs accurate product cost information?
Why does management needs accurate product cost information?
To plan for the future.
To control current operations.
To evaluate past performance.
To deliver high-quality products to customers at the lowest price and at the fastest speed.
Product Cost Systems
What does accurate information allow management to do?
What does accurate information allow management to do?
To determine the appropriate level at which to operate.
To assess the long-term profitability of various products.
To manage the costs of production activities.
Review the Time Line of Business
BUY
raw materials or goods for resale
COMPUTE
ADD
value
SELL
finished inventory
cost of goods soldending inventory
To accurately measure product costs, accountants must:
Determine which costs relate to manufacturing and which relate to administrative and selling functions.
Accurately identify and measure all costs associated with manufacturing.
Determine appropriate ways to assign costs incurred to products manufactured.
Measuring Cost
Outline the Flow of Cost in a Manufacturing Process
Raw Materials Inventory
Direct Labor
Factory Overhead
Work-In- Process
Inventory
Cost of Goods Sold
Finished Goods
Inventory
Determining Cost
Multiple products produced in same facility.
Changing prices and labor rates.
Multiple manufacturing locations (perhaps international).
Individuals performing multiple tasks.
What are some difficulties in determining costs of manufactured products?
Direct materials
Costs of Manufacturing ProductsDiscuss the Nature of Raw Materials.
Cost of raw materials used directly in the
manufacture of products.
Kept in raw materials warehouse until used.
Examples: Rubber to make tires, steel to make cars, wood to
make tables.
Example: Direct Materials Costs
Venus Vehicles purchased $2 million of steel for its new line of cars. What is the journal entry?
Raw Materials Inventory. . . . . . . . . . . 2,000,000Accounts Payable . . . . . . . . . . . . 2,000,000
Half the new steel is requested from the warehouse for production. What is the journal entry?
Work-in-Process Inventory. . . . . . . . . .1,000,000 Raw Materials Inventory . . . . . . . .1,000,000
Indirect materials ($250,000 of glue and bolts) are requisitioned from the storeroom. What is the journal entry?
Manufacturing Overhead. . . . . . . . . . . . 250,000Raw Materials Inventory . . . . . . . . 250,000
Direct labor
Costs of Manufacturing ProductsDiscuss the Nature of Direct Labor.
Wages/payroll-related expenses of factory
employees who work directly on products.
Does not include wages/benefits of those who do not work directly
on making products.
Cost of wages/benefits for assembly workers.
Direct Labor Costs and ExampleTime clocks, computer entries, time sheets—
- All allow production personnel to identify specific jobs worked on.
This information is revealed on the job cost sheet.Labor costs can be direct or indirect.Payroll records report direct labor of $50,000 and
indirect labor of $50,000. Record the direct labor.
Work-in Process Inventory. . .50,000Wages Payable. . . . . . . . 50,000
Manufacturing Overhead. . . . 50,000Wages Payable. . . . . . . . . 50,000
Record the indirect labor.
Manufacturing overhead
Costs of Manufacturing ProductsDiscuss the Nature of Factory Overhead.
All manufacturing costs not classified as
direct materials or direct labor.
Miscellaneous materials used in
production (such as glue or nails).
Costs such as utilities, depreciation,
insurance, and property taxes.
Describe Some of the Characteristics of Manufacturing Overhead Costs
Involves more complex accounting procedures and estimation problems.
Must often be estimated in advance of their occurrence.
Cannot be traced directly to individual items produced during the period.
Managers need current product cost information:
- for pricing similar jobs.
- for estimating costs for next period.
Therefore, each job is assigned a share of estimated overhead.
Describe the Two-Step Process to Apply Manufacturing Overhead to Products
Step One
Annual expected (budgeted)manufacturing overhead
Annual expected (budgeted) activity level(e.g., direct labor hours)
=Predeterminedoverhead rate
Step TwoPredeterminedoverhead rate
xActual activitylevel per job
=Allocated manufacturing
overhead assigned to job
Steel Works estimates annual variable manufacturing overhead costs of $10,000 and fixed manufacturing overhead of $20,000. What is the predetermined overhead rate if the company expects to use the machines 10,000 hours?
Example: Determining Manufacturing Overhead Rate
$30,000
10,000= $3.00 per machine
hour
Total estimated manufacturing overhead costs
Selected activity base (machine hours)=
Steel Works used 10 machine hours in the production of Job No. 12. Using the $3.00 predetermined overhead rate, what overhead costs will be applied to manufacturing overhead (MOH) for this job? What is the journal entry to apply this MOH to Job No. 12?
Work-in-Process Inventory. . . . . . . . . . . 30Manufacturing Overhead . . . . . . . . 30
OverheadRate
$3.00
Actual Activity
10 hoursx =
AppliedMOH
$30.00
Example: Determining Manufacturing Overhead Rate
Steel Works used $100 in direct materials in Job No. 12’s production as well as 10 hours of direct labor at $20 per hour. Using a job cost sheet, determine the job’s total cost. Now that the job is complete, prepare the entries for its transfer to Finished Goods and its sale.
Job Cost Sheet Job No. 12
Direct Materials $100
Direct Labor 200
MOH 30
Total $330
Example: Transferring Completed Products to Finished Goods Inventory and then Selling
the Products
Finished Goods Inventory . . 330Work-in Process. . . . . . . . . . . . 330
Cost of Goods Sold. . . . . . . 330 Finished Goods Inventory. . . 330
Actual versus Applied Manufacturing Overhead
Actual Overhead Actual annual manufacturing overhead costs. Needed for accurate determination of income. Recorded as debit to Manufacturing
Overhead.Applied Overhead
Amount of overhead applied to products using the predetermined overhead rate.
Recorded as credit to Manufacturing Overhead.
Disposition of Over- and Underapplied MOH
Overapplied Manufacturing Overhead:
The excess of applied overhead costs over actual overhead costs for a period.
Manufacturing Overhead
Actual
10
Applied
20
Underapplied Manufacturing Overhead:
The excess of actual overhead costs over applied overhead costs for a period.
(Cost of job is overstated)
Manufacturing Overhead
Actual
20
Applied
10
(Cost of job is understated)
Treating Applied Overhead
Two methods for treating over- and underapplied MOH:
- Allocate over- or underapplied manufacturing overhead to Work-in-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold on the basis of the ending balances in these three accounts.
- More accurate; any difference is allocated proportionately.
- More complicated; requires detailed calculations.
- Close over- or underapplied overhead directly to Cost of Goods Sold.
- Easier and more commonly used, especially if amount is small.
- Debit MOH, Credit COGS.
The Distribution Channel
The process of wholesalers purchasing from manufacturers and supplying retailers who sell to final customers.
A Typical Channel of Distribution
Manufacturer Brand A
Manufacturer Brand B
Manufacturer Brand C
Manufacturer Brand D
Manufacturer Brand E
Manufacturer Brand F
Wholesaler
Wholesaler
Wholesaler
Retailer
Brand A Customers
Brand B Customers
Brand C Customers
Brand D Customers
Brand E Customers
Brand F Customers
Wholesalers Receive goods in bulk
shipments; break them down for smaller shipments to retailers.
Profit—the difference between price at which they buy goods and price at which they sell goods to retailers.
Quality and timelines are also important performance measures.
To be profitable, wholesalers must be sure the right goods are received and shipped in the right manner to the right retailer for the right price at the right time.
To be profitable, wholesalers must be sure the right goods are received and shipped in the right manner to the right retailer for the right price at the right time.
Retailers – Define Risk and Stockturns
Often work with many wholesalers (and some manufacturers) to obtain inventory mix.
Risk is having money tied up in inventory that is not selling (opportunity cost).
Stockturns—the faster stock (inventory) can be turned, the sooner the money is available to purchase more inventory.
Second-tier merchants who typically purchase products from wholesalers to distribute to customers. Many will often bypass wholesalers to purchase inventory directly from the original manufacturers.
Second-tier merchants who typically purchase products from wholesalers to distribute to customers. Many will often bypass wholesalers to purchase inventory directly from the original manufacturers.
Describe Merchandise Cost Flows
Accounts Payable
xxx
xx
Merchandise Inventory
xxxx
x
xxCost of Goods
Sold
xx
xx x
Inventory is purchased
Inventory is sold
Costs incurred to
ship in inventory
Inventory is returned
Describe Accounting for InventoryIn merchandising, accounting is fairly straightforward:
no raw materials, inventory, manufacturing overhead, or work-in-process accounts.
Inventory costs are often expensed as a period cost, included in Selling and General Administrative Expenses.
Prepare journal entry for when $465 inventory is sold.
Jan. 1 Cost of Goods Sold. . . . . . . . . 475
Merchandise Inventory . . . . 475
Sold inventory to customers.
Define a Service Company
Important for service firms to develop useful management accounting systems that support managing costs, quality, and timeliness in creating and delivering their product.
An organization whose main economic activity involves producing a nonphysical product that provides value to a customer.
What are the Effects of Deregulation?
In service sector, deregulation has changed pricing and profitability.
Now the most efficient producers establish prices.
Service providers who don’t know their costs will: not be able to aggressively set prices. not be responsive to consumer demands. not make enough money to stay in business.
List Similarities Between Service and Manufacturing Firms
Both prepare product for sale and delivery.
Both involve direct labor and overhead.
Both create a high-quality product that must be delivered in a timely manner while keeping costs low.
Creative process requires highly paid skilled labor or expensive capital equipment and buildings.
Large overhead must be allocated to the direct product provided to the customer.
Differences Between Service and Manufacturing Firms
Distribution channel not as prevalent in service firms.
Most service firms deal directly with end-user.
More customization in service firms.
Most service firms use a job order approach rather than a process approach to cost accounting.
Raw material inventories are insignificant or nonexistent in service firms.
Difficult in service industry to store finished service in anticipation of later sale.
Work-in-Process Inventory
At period’s end, there may be situations where significant effort and resources have been invested in a service product that is not yet completed.
Revenue is not yet earned; therefore, costs should not be recognized yet as expenses. This work in process is an asset, referred to as Work-in-Process Services.
When service is completed and delivered, service costs (overhead costs and work-in-process services) are transferred to Cost of Services.
What Impact Has e-business Had on Product Costs?
1. Reduced cost of materials, since businesses can search for the best price.
2. Better management of direct labor costs.
3. In some cases, customers interact with technology instead of employees.
4. Significant changes in the structure of companies which greatly affects overhead costs.
Expanded MaterialLearning Objective 7
Use the FIFO method to do process costing.
Process Costing
Process costing is appropriate if what two general conditions are met?
The units produced as a result of passing through the process centers must be basically the same.
The activity performed in each process center must be identical for all units.
What are the 5 Steps in Process Costing?
Step 1 Identify units that went into the process and identify where those units are at the end of the processing time. Determine the amount of work done during the processing time period.
Step 2 Determine the amount of production costs that went into the process and compute the product costs per unit for the processing time period.
Step 3 Compute the total cost of units completed and transferred out during the processing time period.
Step 4 Compute the total cost of units remaining in process at the end of the processing time period.
Step 5 Prepare the production cost report.
Step 1: Compute Equivalent Units of Production
Physical Units (lbs) % Done
Equivalent Units % Done
Equivalent Units
Beginning work-in-process 4,000 0% - 80% 3,200 Started & completed 44,000 100% 44,000 100% 44,000
Ending work-in-process 2,000 100% 2,000 60% 1,200
Equivalent units of production 46,000 48,400
Transferred out 48,000
Direct Materials Costs Conversion Costs
Step 2: Compute Product Costs per Unit
Total Costs
Equivalent Units
Cost per Unit
Beginning work-in-process Direct materials costs 800$ 4,000 0.20$ Conversion costs 1,200 800 1.50
Total 2,000$ Total 1.70$ Current period Direct materials costs 9,660$ 46,000 0.21$ Conversion costs 70,180 48,400 1.45
Total 79,840$ Total 1.66$
Step 3: Compute the Costs Transferred Out
Cost per Unit
Equivalent Units
Beginning work-in-process Initial direct materials costs 800$ Initial conversions costs 1,200 Cost to complete materials 0.21$ - - Cost to complete conversion 1.45 3,200 4,640
Total 6,640$ Started and completed 1.66$ 44,000 73,040 Total costs transferred out 79,680$
Step 4: Compute Costs of Ending Work-in Process Inventory
Cost per Unit
Equivalent Units
Costs for direct materials 0.21$ 2,000 420$ Conversion costs 1.45 1,200 1,740
Cost of ending work-in-process 2,160$
Step 5: Prepare the Production Cost Report
The production cost report contains the information prepared and presented in steps 1 through 4.
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