Three manufacturing costs

1
Three manufacturing costs
Direct material cost Consist of all those
material that can be identified with a specific
product. Example wood used in manufacturing of a
table. Direct labor cost Consist of all those
cost that can be specifically traced or
identified with a particular product. Example
wages of workers working on that table. Overhead
(indirect) cost overhead refers to the cost
pool used to accumulate all indirect
manufacturing costs. Indirect costs are allocated
to the cost object using of cost allocation
method. Example heat, light and power for the
factory, rent on factory building, property taxes
on factory building, and all kind of depreciation.
2
Factory Overhead
Overhead consists of many individual cost items.
These are costs that cant be measured or traced
for a specific product. Factory overhead costs
are both fixed and variable. The factory overhead
controlling account is debited when costs are
incurred and credited when factory overhead is
applied to various job orders. i.e indirect
material and labor, utility costs, depreciation
of equipment and salaries of factory
administrative personnel.
3
Plant-wide (blanket) overhead rates
The most simplistic traditional costing system
assigns indirect costs to cost objects using a
single overhead rate for the organization as a
whole. The terms blanket overhead rate or
plant-wide rate are used to describe a single
overhead rate that is established for the
organization as a whole.
4
Job Order Costing
A job is a production run for a specific product.
A relatively small number of units generally
comprise a job. Job order costing system record
actual and estimated production costs in the
formal accounting system leading to manufacturing
statements. Construction firms use a variation of
job order costing. Some overhead is applied to
each job so that the contractor can recoup its
general production costs which apply to all jobs
but which are not traceable to any specific job.
5
Benefits of job costing

• You will know on an ongoing basis which projects
  are profitable and which ones arent.
• You will be able to get paid on a timely basis as
  you complete the job.
• You can avoid committing resources to projects.
• If you manufacture products
• You will know what it cost to make each item
• You will be able to set selling prices that cover
  your costs and earn a fair profit
• You will know what product lines to expand
  because theyre profitable, and what product line
  to drop because theyre unprofitable.

6
General approach to job costing

• Identify the job that is chosen cost object
• The cost object can be chosen through the job
  cost record. Companies keep a job cost record for
  every specific job. A job cost record, also
  called a job cost sheet records and accumulates
  all the costs assigned to a specific job,
  starting when work begins.

7

• Identify the Direct costs of the job
• Robinson identified two direct manufacturing
  cost categories,
• direct material and direct manufacturing
  labour. Example can be seen for the direct costs
  for the specific job.
• Select the cost allocation bases to use for
  allocating indirect cost to the job.
• Indirect costs cant be allocated to a
  specific product. It will be impossible to
  complete a job without incurring indirect cost
  such as supervision, manufacturing engineering,
  utilities and repairs. Multiple cost allocation
  bases are used to allocate a indirect cost
  because different indirect cost have different
  cost drivers. Example depreciation or repair of
  machines is closely related to machine hours so
  machine hours can be used as a cost driver.

8

• Identify the indirect cost associated with each
  cost allocation base.
• Now that the allocation bases has been
  identified, all indirect cost are now identified
  for that allocation base. In our example from the
  Robinson company they use indirect manufacturing
  costs to machinery hours used.

• Compute the rate per unit of each cost allocation
  base used to allocate indirect costs to the job.

Actual manufacturing overhead costs
Actual manufacturing overhead rate
Actual total quantity of cost allocation base
1215000
Actual manufacturing overhead rate
27000 direct manufacturing labor hours
45 per direct manufacturing labor hour

9

• Compute the indirect costs allocated to the job.

Indirect cost allocated to a job actual quantity
of each different allocation base x indirect cost
rate of each allocation base

1. Compute the total cost of the job by adding all
   direct and indirect costs assigned to the job.

Total cost Direct cost Indirect cost
10
JOB-COST RECORD
JOB NO
CUSTOMER
WPP 298
Western Pulp and Paper
Date Started
Date Completed
Feb. 3, 2006
Feb. 28, 2006
DIRECT MATERIALS
Materials Requisition No.
Unit Cost
Date Received
Quantity Used
Total Costs
Part No.
Feb. 3, 2006
2006 198
MB 468-A
8
14
112
Feb. 3, 2006
2006 199
TB 267-F
12
63
756


4,606
Total
DIRECT MANUFACTURING LABOR
Period Covered
Labor-Time Record No.
Employee No.
Hours Used
Hourly Rate
Total Costs
Feb. 3-9, 2006
LT 232
551-87-3076
25
18
450
Feb. 3-9, 2006
LT 247
287-31-4671
5
19
95


1,579
Total
MANUFACTURING OVERHEAD
Allocation-Base Units Used
Cost pool Category
Allocation- Base Rate
Total Costs
Date
Allocation-Base
Dec. 31, 2006
Manufacturing
Direct Manufacturing
88 hours
45
3,960
Labor-Hours
3,960
Total
10,145
TOTAL MANUFACTURING COST OF JOB
11
MATERIALS-REQUISITION RECORD
Materials-Requisition Record No
2006 198 Feb. 3, 2006 Unit Total Cost
Cost
Date Quantity 8
Job No. Part No. MB 468-A
WPP 298 Part Description Metal Brackets
14 112
Issued ByB. Clyde Received By L. Daley
Date Date
Feb. 3, 2006 Feb. 3, 2006
12
Panel 1Job Number J4369 Date
July 6, 2000Customer Michigan MotorsProduct
Automobile engine valves (Valve
L181)Engineering Design Number JDR-103Number
of Units 1,500
Panel 2Material Requisition Number
Description Quantity Rate Amount
47624 Bar steel 720 lbs
11.50 8,280.00 Stock
3 A35161 Subassemblies 290 units
38.00 11,020.00 Total direct materials cost
19,300.00
13
Panel 3Dates Number Hours
Rate Amount 8/2, 8/3, 8/4, 8/5
M16 24
28.00 672.00 8/2, 8/3, 8/4, 8/5
M18, M19, M20 64
26.00 1,664.00 8/6, 8/7, 8/8, 8/9, 8/10
A25, A26, A27 120 18.00
2,160.00 8/6, 8/7, 8/8, 8/9, 8/10
A32, A34, A35 60 17.00
1,020.00 Total direct labor cost
268
5,516.00
Panel 4 Support Cost
Amount 117 Machine hours _at_ 40
per hour 4,680.00 268 Direct
labor hours _at_ 36 per hour
9,648.00 Total overhead cost
14,328.00
14
Concept of Costing System
Cost Assignment
Direct costs
Cost Object
Cost Tracing
Indirect costs
Cost Allocation
15
Assigning direct and indirect costs
A cost allocation is the process of assigning
costs when a direct measure does not exist for
the quantity of resources consumed by a
particular cost object. Example consider an
activity such as receiving incoming materials.
Assuming that the depreciation of the machine is
strongly related to the number of hours machine
was used. The basis that is used to allocate
costs to cost objects is called an allocation
base or cost driver. Two types of systems can be
used to assign indirect costs to cost objects.
They are traditional costing system and
activity-based-costing(ABC) systems.
16
Cost Allocations and Cost Tracing
Direct costs
Cost tracing
Traditional costing systems
Cost objects
Indirect costs
Cost allocations
ABC systems
17
Traditional Costing Systems
Overhead cost accounts (for each individual
category of expenses)
First stage allocations
Cost center 1 (Normally departments)
Cost center 2 (Normally departments)
Cost center N (Normally departments)
Second stage allocations (Direct labour
or machine hour)
Cost objects (Products, services and customers)
Direct cost
18
An illustration of the three-stage process for a
traditional costing system

• Applying the three-stage allocation process
  requires the following four steps
• Assigning all manufacturing overheads to
  production and service cost centres
• Reallocating the cost assigned to service cost
  centres to production cost centres
• Computing separate overhead rates for each
  production cost centre
• Assigning cost centre overheads to products or
  other chosen cost objects.

19
Traditional Costing System Levels of
Sophistication
Simplistic systems

• Inexpensive to operate
• Extensive use of arbitrary cost allocations
• Low levels of accuracy
• High cost of errors

20
Service dept
S1
S4
S2
S3
Conceptual view of the separate department
overhead rates
Producing dept
DM DL FO
DM DL FO
DM DL FO
Cost objects
Cost objects
Cost objects
Cost objects
Cost objects
Cost objects
21
Stage 1 Assigning all manufacturing overhead to
production and service departments.
Common cost are allocated to all the departments.
Some cost can be directly related such as salary
of the engineer working in the service quality
department, however other need to be allocated
using an allocation base.
Basis of allocation
Cost
Area Number of employees Value of items of plant
and machinery
Property taxes, lighting and heating
Employee-related expenditure works
management, works canteen, payroll
office Depreciation and insurance of plant and
machinery
22
Stage 2 Reallocating the cost assigned to
service cost centers to production cost centers.

• the next step is to reallocate the costs that
  have been assigned to service cost centres to
  production cost centres. Service departments or
  support department are those departments that
  exist to provide services of various kinds of
  other units within the organization. For example,
  the costs of the cafeteria can be reallocated to
  the production cost center by using number of
  workers in the factory as the allocation base.
• There are three methods in reallocating the cost
  from service to production departments.
• DIRECT METHOD
• STEP METHOD
• ALGEBRIC METHOD

23
Producing department
Service department
Diagram of 3 diff, allocation methods
X
A
Part 1 Direct method
B
Y
X
A
Part 2 Step method
B
Y
X
A
Part 3 Algebraic method
B
Y
24
Stage 3 Assigning cost center overheads to
products or other chosen cost objects.
In the final step is to allocated the overheads
to products passing through the production
centers. Volume base allocation is used to assign
the overhead costs to the products. Example,
number of units produced, number of machine hours
used.
25
The annual costs for the Enterprise Company which
has three production centres (two machine centres
and one assembly centre) and two service centres
(materials procurement and general factory
support) are as follows
()
()
Indirect wages and supervision Machine cenres
X Y Assembly
Materials procurement General factory
support Indirect materials Machine centres X
Y Assembly
Materials procurement General factory
support Lighting and heating Property
taxes Insurance of machinery Depreciation of
machinery Insurance of buildings Salaries of
works management
1 000 000 1 000 000 1 500 000 1 100 000 1 480 000
6 080 000
500 000 805 000 105 000 0 10 000
1 420 000
500 000 1 000 000 150 000 1 500 000 250
000 800 000
4 200 000
11 700 000
26
The following information is also available
Area Occupied (sq. metres)
Number Of employees
Direct Labour hours
Book Value of Machinery ()
Machine hours
Machine shop X
Y Assembly Stores Maintenance
8 000 000 5 000 000 1 000 000 500 000 500
000
10 000 5 000 15 000 15 000 5 000
300 200 300 100 100
1 000 000 1 000 000 2 000 000
2 000 000 1 000 000
1000
15 000 000
50 000
Details of total material issues to the
production centres are as follows
()
4 000 000 3 000 000 1 000 000
Machine shop X Machine shop Y Assembly
8 000 000
27
OVERHEAD ANALYSIS SHEET
Production centres
Service centres
Machine centre Y ()
Materials procurement ()
General factory support ()
Machine centre X ()
Item of expenditure
Total ()
Basis of allocation
Assembly ()
Indirect wage and supervision Indirect
materials Lighting and heating Property
taxes Insurance of machinery Depreciation of
machinery Insurance of buildings Salaries
of works management Reallocation of
service centre costs Materials
procurement General factory
support Machine hours and direct labour
hours Machine hour overhead rate Direct labour
hour overhead rate
Direct Direct Area Area Book value of
machinery Book value of machinery Area Numbe
r of employees (1) Value of materials
issued Direct labour hours (2)
6 080 000 1 420 000 500 000 1 000 000
150 000 1 500 000 250 000 800 000
1 000 000 500 000 100 000 200 000
80 000 800 000 50 000 240 000
1 000 000 805 000 50 000 100 000
50 000 500 000 25 000 160 000
1 500 000 105 000 150 000 300 000
10 000 100 000 75 000 240 000
1 100 000 150 000 300 000 5
000 50 000 75 000 80 000
1 480 000 10 000 50 000 100 000
5 000 50 000 25 000 80
000
11 700 000
2 970 000
2 690 000
2 480 000
1 760 000
1 800 000
880 000 450 000
660 000 450 000
220 000 900 000
1 760 000
1 800 000
11 700 000
4 300 000
3 800 000
3 600 000
2 000 000
1 000 000
2 000 000
2.15
3.80
1.80
28
Reallocation of Service centre costs
Materials procurement General
factory support Machine hours and
direct labour hours Machine hour overhead
rate Direct labour hour overhead rate
Value of materials issued Direct labour
hours (2)
880 000 450 000
660 000 450 000
220 000 900 000
1 760 000
1 800 000
11 700 000
4 300 000
3 800 000
3 600 000
2 000 000
1 000 000
2 000 000
2.15
3.80
1.80
29
cost centre overheads
cost centre direct labour hours or machine hours
4 300 000
Machine centre X
2.15 per machine hour
2 000 000 machine hours
3 800 000
Machine centre Y
3.80 per machine hour
1 000 000 machine hours
3 600 000
Assembly department
1.80 per direct labour hour
2 000 000 direct labour hours
30
Product A

Direct costs (100 units x 100) Overhead
allocations Machine center A (100 units x 5
machine hours x 2.15) Machine center B (100
units x 10 machine hours x 3.80) Assembly (100
units x 10 direct labour hours x 1.80) Total
cost Cost per unit (16 675/100 units) 166.75
10 000 1 075 3 800 1 800
16 675

Product B
Direct costs (200 units x 200) Overhead
allocations Machine center A (200 units x 10
machine hours x 2.15) Machine center B (200
units x 20 machine hours x 3.80) Assembly (200
units x 20 direct labour hours x 1.80) Total
cost Cost per unit (66 700/200 units) 333.50
40 000 4 300 15 200 7 200
66 700