Product Costing Measurement Decisions

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Chapter 3

• Product Costing Measurement Decisions

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Introduction
How do managerial accountants determine the cost
of the products or services being produced and
sold by a company?
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Introduction
How is the cost of the product used? Determining
the selling price Buying or making a component
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Introduction
Pause and Reflect As a reaction to decreasing
sales in its restaurants, McDonalds Corp.
proposed a radical price reduction on its Big Mac
in early 1997. The sandwich (usually priced
around 1.90) would be offered for .55 with the
purchase of fries and a drink.
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Introduction
Pause and Reflect The proposal required the
approval of a majority of franchisees. As an
owner of a local McDonalds, you estimate that
the cost of making a Big Mac is .63. Would you
vote for the proposal?
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Product Costing Systems
Job Costing
Customized Production Home, Furniture, Print
Order Customized Service Tax Return, Audit,
Patient
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Product Costing Systems
Process Costing A homogenous product being
produced on a continuous basis. Oil refineries,
Breweries, Paint and Paper Manufacturers
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Basic Job-Order Costing
Cost Sheet for Job 101
Northern Lights Custom Cabinets
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Basic Job-Order Costing
Cost Sheet for Job 101 Summary
Cost Summary
Direct Materials Direct Labor Manufacturing
Overhead Total
1883.00 453.61 373.41 2,710.02
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Basic Job-Order Costing
Measuring and Tracking Direct Material Normal
Spoilage Results from the regular operation of
the production process (include in Direct
Materials) Abnormal Spoilage Results from
improper handling, poorly trained craftspeople,
equipment that is in poor condition (include in
MOH)
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Direct Labor or Overhead?

• Idle time?
• Include in MOH
• Overtime premiums?
• Generally include in MOH
• Part of DL if caused by rush job order

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Measuring and Tracking Manufacturing Overhead
Rent Depreciation Repairs and maintenance Utilitie
s Indirect Labor Indirect Materials
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Measuring and Tracking Manufacturing Overhead
Key Concept Overhead cannot be directly tracked
to products and services but must instead be
allocated using cost drivers.
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The Role of Cost Pools and Cost Drivers
Key Concept Understanding what causes overhead
costs to be incurred (what drives them) is the
key to allocating overhead.
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Cost Pools
Instead of identifying cost drivers for each
component of overhead, companies have
traditionally lumped overhead into similar Cost
Pools to simplify the task. May have one cost
pool for the entire factory. May have separate
pools of overhead for each department. May have a
cost pool for each activity performed in making a
product.
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Which Overhead Rate Do We Use?
Define the Problem A new product requires
substantial machine time to manufacture, but
requires very little direct labor. Which is used
to allocate overhead?
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The Use of Estimates
Key Concept Accuracy in overhead application has
become much more important as overhead costs have
increased and make up a larger portion of the
total costs of products.
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Which Overhead Rate Do We Use?
Key Concept In order to provide relevant
information for decision making, overhead must
often be estimated.
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Predetermined Overhead Rates
Key Formula
Estimated Overhead for the Cost Pool Estimated
Units of the Cost Driver
Predetermined Overhead Rate (for a Cost Pool)

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Predetermined Overhead Rates
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Predetermined Overhead Rates
If a job required 24 labor hours, how much
overhead would be allocated to that job?
12 (overhead rate) x 24 (labor hours) 288
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The Problem of Over- and Underapplied Overhead
Overapplied Overhead Applied overhead is greater
than actual overhead
Underapplied Overhead Applied overhead is less
than actual overhead
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The Problem of Over- and Underapplied Overhead

• What do you do with the under- or overapplied
  overhead?
• Generally close to COGS
• If large Allocate to WIP, FG COGS

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Basic Process Costing
Direct material and direct labor costs are
tracked by department, and costs are assigned
evenly to the products that pass through each
department. Overhead is applied to each
department and assigned evenly to each product.
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Basic Process Costing
Direct materials Direct labor Manufacturing
Overhead
Process A
Process B
Process C
Finished Goods
Cost of Goods Sold
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Basic Process Costing
Equivalent Units
One Full Glass


1/2
1/2
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Basic Process Costing
Multiple WIP accounts are used one for every
process. As products are moved from one process
to another, the costs of the previous process are
transferred to the next process. Blending and
pouring paint
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End of Chapter 3
How much would the new product cost?