C H A P T E R

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• C H A P T E R

Product Cost Flows and Business Organizations
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Learning Objective 1

• Understand the difficulty, yet importance, of
  having accurate product cost information.

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Assignment of Product Costs
Product Cost
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Product Cost Systems
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.
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Product Cost Systems
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.
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Learning Objective 2

• Explain the flow of goods and services in a
  manufacturing organization and follow the
  accumulation of product costs in its accounting
  system.

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Review the Time Line of Business
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Measuring Cost
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.
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Outline the Flow of Cost in a Manufacturing
Process
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Determining Cost

• What are some difficulties in determining costs
  of manufactured products?

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Costs of Manufacturing ProductsDiscuss the
Nature of Raw Materials.
Direct materials
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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. . . . . . . . . . .
2,000,000 Accounts 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. . . . . . . . . . . .
250,000 Raw Materials Inventory . . . . . . .
. 250,000
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Costs of Manufacturing ProductsDiscuss the
Nature of Direct Labor.
Direct labor
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Direct Labor Costs and Example

• Time 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. . . . . . .
50,000 Wages Payable. . . . . . . .
50,000
Record the indirect labor.
Manufacturing Overhead. . . . 50,000 Wages
Payable. . . . . . . . . 50,000
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Costs of Manufacturing ProductsDiscuss the
Nature of Factory Overhead.
Manufacturing overhead
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Describe 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
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Describe the Two-Step Process to Apply
Manufacturing Overhead to Products
Step One
Step Two
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Determining Manufacturing Overhead Rate
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?
3.00 per machine hour
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Determining Manufacturing Overhead Rate
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. . . . . . . . . .
. 30 Manufacturing Overhead . . . . . . . . 30
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Transferring Completed Products to Finished Goods
Inventory then Selling the Products
Steel Works used 100 in direct materials in Job
No. 12s production as well as 10 hours of direct
labor at 20 per hour. Using a job cost sheet,
determine the jobs total cost. Now that the job
is complete, prepare the entries for its transfer
to Finished Goods and its sale.
Finished Goods Inventory . . 330 Work-in
Process. . . . . . . . . . . . 330
Cost of Goods Sold. . . . . . . 330 Finished
Goods Inventory. . . 330
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Learning Objective 3

• Understand the process of accounting for overhead.

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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.

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Disposition of Over- and Underapplied MOH
(Cost of job is overstated)
(Cost of job is understated)
Underapplied Manufacturing Overhead The excess
of actual overhead costs over applied overhead
costs for a period.

• Overapplied Manufacturing Overhead
• The excess of applied overhead costs over actual
  overhead costs for a period.

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Treating Applied Overhead
Two methods for treating over- and underapplied
MOH
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Learning Objective 4

• Create a Cost of Goods Manufactured schedule and
  understand how it is used to calculate cost of
  goods sold.

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Discuss the Cost of Goods Manufactured Schedule

• Summarizes cost flows in a manufacturing firm for
  a period
• Supports the Cost of goods sold calculation on
  the Income statement
• Provides the number for amount transferred out of
  work-in-process for the period
• Reports the total costs incurred to manufacture
  goods for the period
• Useful for planning, controlling and evaluating
  costs

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Example Cost of Goods Manufactured Schedule

• Satchel Manufacturing, Inc.
• Cost of Goods Manufactured Schedule
• For the Year Ended December 31, 2006
• Raw Materials
• Beginning raw materials inv. 30,000
• Add Raw materials purchased 150,000
• Total raw materials available 180,000
• Less Ending raw materials inv. 20,000
• Raw materials used in production
  160,000
• Direct labor 220,000
• Applied manufacturing overhead 330,000
• Total manufacturing costs 710,000

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Example Cost of Goods Manufactured Schedule

• We will begin with the bottom line from the
  previous slide.
• Total manufacturing cost 710,000
• Add Beginning work-in-process 25,000
• Less Ending work-in-process 35,000
• Cost of goods manufactured 700,000

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Learning Objective 5

• Explain the flow of goods and services in a
  merchandising organization and follow the
  accumulation of product costs in its accounting
  system.

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The Distribution Channel

• The process of wholesalers purchasing from
  manufacturers and supplying retailers who sell to
  final customers.

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A Typical Channel of Distribution
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Describe What Wholesalers Do

• Receive goods in bulk shipments break them down
  for smaller shipments to retailers.
• Profitthe 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.
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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).
• Stockturnsthe 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.
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Describe Merchandise Cost Flows
Accounts Payable
xxx
Merchandise Inventory
xx
xxx
xx
xx
Cost of Goods Sold
xx
xx x
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Describe Accounting for Inventory

• In 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.

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Learning Objective 6
Explain the flow of goods and services in a
service organization and follow the accumulation
of product costs in its accounting system
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Define a Service Company

• An organization whose main economic activity
  involves producing a nonphysical product that
  provides value to a customer.

• Important for service firms to develop useful
  management accounting systems that support
  managing costs, quality, and timeliness in
  creating and delivering their product.

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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 dont 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.

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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.

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List 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.

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Work-in-Process Inventory

• At periods 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.

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Learning Objective 7

• Understand the impact of e-business on product
  costing.

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What Impact Has e-business Had on Product Costs?

• Reduced cost of materials, since businesses can
  search for the best price.
• Better management of direct labor costs.
• In some cases, customers interact with technology
  instead of employees.
• Significant changes in the structure of companies
  which greatly affects overhead costs.

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Expanded MaterialLearning Objective 7

• Use the FIFO method to do process costing.

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Process Costing
Process costing is appropriate if what two
general conditions are met?
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What are the 5 Steps in Process Costing?

• 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.
• 2 Determine the amount of production costs that
  went into the process and compute the product
  costs per unit for the processing time period.
• 3 Compute the total cost of units completed and
  transferred out during the processing time
  period.
• 4 Compute the total cost of units remaining in
  process at the end of the processing time period.
• 5 Prepare the production cost report.

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Step 1 Compute Equivalent Units of Production
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Step 2 Compute Product Costs per Unit
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Step 3 Compute the Costs Transferred Out
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Step 4 Compute Costs of Ending Work-in Process
Inventory
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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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This Completes Managerial Chapter 3
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