Chapter Two

1
Chapter Two

• Manufacturing Costs and
• Job-Order Costing Systems

2
What Does it Cost to Make Something?

• In Accounting 284, all inventory was purchased
  from another entity
• In Accounting 285, we will learn how to cost a
  product that is manufactured
• All cost associated with the production process
  are called product costs and go through inventory
  accounts

3
Product and Period Costs

• Product costs are
• Direct material
• Direct labor
• Manufacturing Overhead
• Indirect material
• Indirect labor
• Utilities
• Depreciation
• Any other manufacturing cost

• Period Costs are
• Selling cost
• Administrative cost

4
Product Costs and Period Costs
Income Statement
Balance Sheet
Product Cost
Inventory Accounts
Cost of Goods Sold
Selling General and Administrative Expense
Period Cost
5
Three Inventory Accounts

• Material inventory includes the cost of materials
  purchased but not yet put into production
• Work in Process (WIP) includes the cost of
  material, labor and manufacturing overhead of
  goods started but not yet completed
• Finished goods included the cost of good
  completed but not yet sold

6
Cost Flows Through Inventory
Raw material
Work in Process
Finished Goods
Cost of Goods Sold
Direct labor
Overhead
7
Flow Through Accounts
8
Job-order versus Process Costing
Job-order costing keeps track of the cost of
materials and labor used on each job and then
applies manufacturing overhead to each
job. Process costing keeps track of total costs
and divides by output for a period to get an
average unit cost.
9
Job Order versus Process Costing

• Use Job order costing for non-repetitive, high
  cost unique orders
• Use Process costing for large numbers of
  homogeneous products
• Which would home builder, tomato cannery, and
  automobile manufacturer use?

10
Job Order Costing

• Keep payroll records according to jobs to know
  direct labor cost of each job
• Use material requisitions for all materials to
  know the direct material cost for each job
• Put all overhead (including indirect materials
  and indirect labor) into the overhead account and
  apply it to jobs

11
Actual versus Normal Overhead

• The big problem in job order costing is relating
  overhead to production
• To solve this, overhead is applied to production
  on the basis of some activity driver
• Actual costing waits until the end of the period
  and then determines the actual overhead and the
  actual level of the driver.
• Normal costing estimates the level of the driver
  and overhead in advance and then applies it
  throughout the period.

12
Problems with Actual Costing

• If done on shorter than an annual period - say
  monthly - overhead rates can vary greatly from
  month to month.
• If done annually, must wait until end of year to
  determine costs of all units during the year
• No estimates are available for bidding, which is
  how job order costers normally obtain jobs.

13
Normal Costing

• Use a predetermined overhead rate so that
  products can be costed as the period goes along,
  not at the end
• Rate is developed by using the cost formula for
  overhead, estimating activity and developing a
  rate
• This is called NORMAL COSTING

14
Developing Overhead Rate

• Determine overhead application basis
• Estimate activity level
• Estimate overhead costs at that level
• Divide estimated costs by activity to get rate

15
Rate Example

• Activity driver is direct labor hours
• Estimated activity level is 25,000 hours
• Estimated costs at 25,000 hours is 250,000
  (based on a cost function where overhead is
  100,000 6/DLHr)
• Rate is 250,000/25,000 10/DLHr

16
Applying Overhead

• Multiply actual activity by predetermined
  overhead rate - this is applied overhead
• Compare to the actual overhead - if the applied
  is greater overhead is overapplied, if it is less
  it is under applied. Being overapplied is
  favorable.
• The amount of under or overapplied overhead is
  assigned to cost of goods sold or prorated
  between inventories

17
Applied Overhead Example

• Assume that actual hours worked were 26,000 and
  actual overhead was 257,000
• Applied overhead would be 26,000 10 or
  260,000
• Overhead would be overapplied by 3,000
• Why might this be the case?

18
Why Under or Over Applied?

• Remember, the cost function was 100,000
  6/DLHr giving us a budgeted overhead or 250,000
  at 25,000 labor hours
• Actual hours were 26,000 and the budget for that
  would have been 256,000, but the applied is
  260,000 and the actual was 257,000.
• Thus we are 3,000 overapplied even though we
  spent 1,000 more than we should. This is
  because we more than covered the fixed overhead
  by working an extra 1,000 hours.

19
Costing Individual Job

• Assume Job ANZ used 5,000 worth of material, 150
  labor hours at 15/hour what is the cost of this
  job?
• Direct material 5,000
• Direct labor 2,250
• Overhead (15010) 1,500
• Total Cost 8,750

20
Just In Time Production

• Goal is to minimize inventories to allow quicker
  response to customer needs
• Requires more frequent smaller delivers tied to
  when the input is needed in production
• Allows simpler accounting procedures as there are
  fewer inventories

21
Total Quality Management

• Continuous improvement
• Do it right the first time
• Listen to the needs of customers
• Empowering employees to make good products or
  provide good service