Module 18 - Lecture notes 18 PDF

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Lecture 18 with notes...

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Module 18: Product Costing: Job and Process Operations  Objectives: - Discuss flow of costs through the inventories. - Learn about allocating indirect costs: why it is done and how it is done. - Understand job order costing vs. process costing. - Explain why profits under absorption and variable costing may not always be the same.

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1. Inventory Costs in Various Organizations As inventories are sold or used, they are matched against expenses.

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2. Cost Classifications Manufacturing costs

Out-of-pocket costs that relate Direct materials (DM) to a firm’s production Direct labor (DL) operations; all costs incurred in Overhead (OH) the factory to manufacture the Indirect materials product. Indirect labor Other

Nonmanufacturing costs

All out-of-pocket costs of the company that are not manufacturing costs.

Selling or marketing costs Administrative costs R&D Costs

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Manufacturing cost (=Product cost = Inventoriable cost) Costs of a product Direct Materials (DM)

A measurement, in monetary terms, of the amount of resources used to manufacture a product. Materials: that become physically embodied in the products being manufactured; - whose cost is sufficiently large to justify the record-keeping expenses necessary to trace the costs to each different product line. -

Indirect Materials (IM)

Materials used in the manufacturing process that are not direct materials.

Direct Labor (DL)

Employee time that - is physically traceable to the products being manufactured; - whose cost is sufficiently large to justify the record-keeping expenses necessary to trace the costs to each different product line.

Indirect Labor (IL)

Employee time used in the manufacturing process that is not direct labor.

Overhead (OH)

All of the manufacturing costs other than direct labor and direct materials; thus it includes indirect materials, indirect labor, and other overhead.

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Direct Costs (Prime costs) Conversion Costs (CC)

Direct Labor + Direct Materials Direct Labor + Manufacturing Overhead Non-manufacturing costs

Marketing Costs (or Selling Costs)

Costs incurred in getting orders from customers and providing customers with the finished product

Administration Costs

Executive, organizational, and clerical that cannot logically be considered manufacturing or marketing costs

R&D Costs

Costs of developing new products and services

Product Costs vs. Period Costs Product costs (=Inventoriable costs)

Costs assigned to products, which were either purchased for resale or manufactured for sale.

Inventory on Balance Sheet; Cost of Goods Sold to be recognized only when the goods are sold

Period costs

Costs associated with the period in which they occur (not a particular product manufactured or acquired for resale during that period)

The expense is recognized immediately or in the same period as the cost.

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3. Flow of Costs through the Inventories  Purchase raw materials and store them in Raw or Direct Materials Inventory.  Requisition the raw materials from the inventory and move to production area. Combine raw materials with other inputs (e.g. labor, machinery) in the production area to manufacture the product.  The costs of all inputs used in the production are recorded in the Work In Process (WIP) Inventory.  Take the finished products and move it to the Finished Goods (FG) Inventory.

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Three Product Cost Components Product costs  Related to production activities

Assigned to Inventory (Asset)

Expensed when Sold

Absorption Cost: Assigning all Production Costs to Inventory Module 18 – page 7

Direct Materials Inventory Beginning balance

Ending balance Work In Process (WIP) Inventory Beginning balance

Ending balance Finished Goods (FG) Inventory Beginning balance

Ending balance Module 18 – page 8

Basic inventory equation: Beginning Inventory + Additions = Ending Inventory + Items Removed

Total Manufacturing Costs (of the Period)

Costs of Goods Manufactured

Cost of Goods Sold

BB of materials + Materials purchased Materials available for use - EB of materials Materials used in production + DL + OH Total manufacturing costs

BB of WIP + Total manufacturing costs Total Costs in WIP - EB of WIP COGM

BB of FG + COGM Costs of goods available sale - EB of FG COGS

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Flow of Costs: A Conceptual Overview (Garrison et al, 16th edition)

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Mini-Example: Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? a. $276,000 b. $272,000 c. $280,000 d. $2,000

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Mini-Example: Direct materials used in production totaled $280,000. Direct labor was $375,000, and $180,000 of manufacturing overhead was added to production for the month. What were total manufacturing costs incurred for the month? a. $555,000 b. $835,000 c. $655,000 d. Cannot be determined.

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Min-Example: Beginning work in process was $125,000. Manufacturing costs added to production for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? a. $1,160,000 b. $ 910,000 c. $ 760,000 d. Cannot be determined.

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Example: Analyzing Activity in Inventory Accounts (E18-21 modified) Selected data concerning operations of Cascade Manufacturing Company for the past fiscal year follow: Raw materials used

$600,000

Total manufacturing costs charged to production during the year (includes raw materials, direct labor, and manufacturing overhead applied at a rate of 60 percent of direct labor costs)

1,362,000

Cost of goods available for sale

1,507,000

Selling and general expenses

Raw materials

60,000

BI

EI

$70,000

$80,000

Work-in-process

85,000

30,000

Finished goods

90,000

110,000

Determine each of the following: (a) Cost of raw materials purchased (b) Direct labor costs charged to production (c) Cost of goods manufactured (d) Cost of goods sold Module 18 – page 14

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3. Product Costing Systems  Full cost: All the resources used for a product = direct costs + fair share of indirect costs. The accounting method or system that assigns a firm’s production/ manufacturing costs to the different products (services) produced. In cost allocation process, we make several decisions: 1. How many costs pools should be used for indirect costs? Single overhead rate Overhead rate for each department Many overhead rates or Activity-based Costing 2. How should costs be measured? Actual costs, Estimated costs (Normal vs. Standard costs) 3. What costs should be assigned to a product? All manufacturing costs vs. all manufacturing costs plus some selling costs 4. Is production continuous or in batches? Job order costing vs. Process costing

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Job (Job-order) vs. Process Costing Job costing system A product costing system in which costs are assigned to batches, lots, job orders, or single units of production.

Process costing system A product costing system in which production costs are averaged over a large number of identical product units. Costs must be averaged over all production for the period where some units are finished and others only partially completed.

Used for custom, heterogeneous products produced in small numbers. e.g.) Custom construction, Custom print orders, ads for advertising firms

Used for homogeneous products in large numbers. e.g.) Chemicals, beverages like Coke or Pepsi, retail banking, postal delivery

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Example: Job vs. Process Costing (Garrison et al. 14th edition): Some companies use process costing and some use job-order costing. A number of companies in different industries are listed below: 1. Contract water drilling company 2. Commercial photographer 3. Tortilla manufacturer 4. Electric utility 5. Mushroom farm that produces the standard button mushroom in caves Required: For each company, indicate whether the company is most likely to use job-order costing or process costing.

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3.1 Job (Job-Order) Costing Two Stage Allocation Process Step 1:

Divide the total indirect (OH) costs into different categories or cost pools.

Step 2:

Use an allocation base for each pool to assign the costs: a. Compute an allocation rate for each pool. b. Assign costs in a pool to each product according to the product’s usage of the allocation base for that pool.

Cost driver (= allocation base)

Some item which can be used to assign the overhead to different products. Products are assigned overhead in proportion to the amount of the allocation base they use. A good allocation base is easily measured and highly correlated with the generation of overhead.

Overhead rate =

Costs to be allocated Total amount of allocation base

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Example: The Caterpillar During the month of May, Caterpillar, Inc. manufactured earthmovers, medium sized tractors, and bobcats. The direct materials and labor spent on each product is known. Caterpillar also knows that it spent $30,000,000 in indirect costs during the month. Caterpillar, Inc. Costs per unit Earthmovers

Tractors

Bobcats

(5 units)

(10 units)

(100 units)

Direct materials

$10,000,000

$1,000,000

$ 100,000

Direct labor

$ 5,000,000

$ 300,000

$ 20,000

?

?

?

Overhead

How should the $30,000,000 in overhead be divided among the different products?

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• How much of the $30,000,000 in overhead costs is assigned to each product (earth mover, tractor, or bobcat) made by Caterpillar?

• Any problems whit this method of dividing the overhead costs?

• Are there better ways of dividing up the overhead costs?

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Caterpillar’s management knows earth movers and bobcats use different amounts of overhead. It requires significantly more time (both labor and machine time) to manufacture earthmovers than bobcats. Caterpillar, Inc.

Machine hours per unit

Earthmovers (5 units)

Tractors (10 units)

Bobcats (100 units)

1,620 MH/unit

90 MH/unit

10 MH/unit

a. Compute an allocation rate. What is the overhead cost per machine hour?

b. Assign costs to each product according to the product’s usage of the allocation base.

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Using multiple allocation bases: Step 1: Divide total indirect costs into pools, (i) materials ordering and handling costs, (ii) engineering support, and (iii) all other overhead costs. Caterpillar Overhead Costs Salaries for staff purchasing supplies Engineers’ salaries

$

Electricity Depreciation on factory and support building Other Total

325,000 7,000,000 21,952,000 $ 30,000,000

240,000 483,000

After much analysis, Caterpillar has divided the overhead into the following pools: Material handling and ordering costs Engineering costs

480,000 960,000

All other overhead costs Total

28,560,000 $ 30,000,000

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Step 2: Use an allocation base for each pool to assign the costs in the pools to each product type. The following allocation bases can be used for each cost pool: Cost pool

Cost driver/Allocation base

Materials handling and ordering Engineering All other overhead

Number of requisitions Number of engineering hours Machine hours

The information about the amount of each allocation base used by each product: Amount of base Number of requisitions for the product line

Earthmovers (5 units) 5,430

Tractors (10 units) 530

Bobcats (100 units)

Total

40

Number of engineering hours for the product line

19,650

250

100

Machine hours (per unit)

1,620 MH

90 MH

10 MH

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a. Compute an allocation rate for each pool. Allocation rate

Name of cost pool

Costs in pool

Total amount of allocation base used

Materials handling and ordering

$480,000

6,000 requisitions

Engineering

$960,000

20,000 engineering hours

$960,000/20,000 =$48/engineering hour

All other overhead

$28,560,000

10,000 MH

$28,560,000/10,000MH =$2,856/MH

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b. Assign costs in a pool to each product according to the product’s usage of the allocation base for that pool. Find the overhead per unit. Caterpillar, Inc. Overhead costs per unit Materials

Engineering

handling and

All other

Total

overhead

ordering Earthmovers

Tractors

Bobcats

($48*19,650)/5

$2,856*1,620

=$188,640

=$4,626,720

($48*250)/10

$2,856*90

=$1,200

=$257,040

($48*100)/100

$2,856*10

=$48

=$28,560

$4,902,240

$262,480

$28,640

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Caterpillar Inc. Total per unit cost (=DM+DL+OH) Method Earthmovers Tractors 1. Same costs for each product – DM $ 10,000,000 $ 1,000,000 equal share DL 5,000,000 300,000 OH

2. Single allocation rate – per machine hour

200,000

260,870

260,870

260,870

Total

$15,260,870

$1,560,870

$380,870

DM

$ 10,000,000

$ 1,000,000

$100,000

DL

5,000,000

300,000

200,000

OH

4,860,000

270,000

30,000

19,860,000

$1,570,000

$150,000

DM

$ 10,000,000

$ 1,000,000

$100,000

DL OH

5,000,000 4,902,240

300,000 262,480

200,000 28,640

$19,902,240

$1,562,480

$148,640

Total 3. Several allocation rates – Per number of requisitions, number of engineering hours, and machine hours.

Bobcats $100,000

Total

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Question 1: Do any of the methods tell us the “actual or “true” costs for each product?

Question 2: What are the problems with actual costing?

Question 3: Is there a solution to the problems with actual costing?

Question 4: What is normal costing?

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Two stage allocation process for JOB COSTING Step 1.

Divide the total estimated indirect costs into different categories or cost pools.

Step 2.

Use an allocation base for each pool to assign the costs: a. Compute a predetermined overhead rate for each pool. b. Assign costs in a pool to each product according to the product’s actual usage of the allocation base for that pool.

Estimated total amount of overhead in cost pool Predetermined Overhead rate = Estimated total amount of allocation base

Overhead applied or added to each product in WIP = Actual amount of base used by each product x Predetermined overhead rate

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Example: Plantwide and Departmental Predetermined Overhead Rates (Garrison et al. 16th edition) Delph Company uses a job-order costing system and has two manufacturing departments—Molding and Fabrication. The company provided the following estimates at the beginning of the year:

During the year, the company had no beginning or ending inventories and it started, completed, and sold only two jobs—Job D-70 and Job C-200. It provided the following information related to those two jobs:

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Delph had no underapplied or overapplied manufacturing overhead during the year. Required: 1. Assume Delph uses a plantwide predetermined overhead rate based on machinehours. a. Compute the plantwide predetermined overhead rate. b. Compute the total manufacturing cost assigned to Job D-70 and Job C-200. c. If Delph establishes bid prices that are 150% of total manufacturing cost, what bid prices would it have established for Job D-70 and Job C-200? d. What is Delph’s cost of goods sold for the year? 2.Assume Delph uses departmental predetermined overhead rates based on machinehours. a. Compute the departmental predetermined overhead rates. b. Compute the total manufacturing cost assigned to Job D-70 and Job C-200. c. If Delph establishes bid prices that are 150% of total manufacturing costs, what bid prices would it have established for Job D-70 and Job C-200? d. What is Delph’s cost of goods sold for the year?

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2d. Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufacturing costs assigned to both jobs of $3,010,000 (=$1,640,000 + $1,370,000). 3. The plantwide and departmental approaches for applying manufacturing overhead costs to products produce identical cost of goods sold figures. However, these two approaches lead to different bid prices for Jobs D-70 and C-200. The bid price for Job D-70 using the departmental approach is $270,000 (=$2,460,000 ‒ $2,190,000) higher than the bid price using the plantwide approach. This is because the departmental cost pools reflect the fact that Job D-70 is an intensive user of Molding machine-hours. The overhead rate in Molding ($38) is much higher than the overhead rate in Fabrication ($8). Conversely, Job C-200 is an intensive user of the less-expensive Fabrication machine-hours, so its departmental bid price is $270,000 lower than the plantwide bid price.

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Time line: Beginning of period

Throughout the period

End of period

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Mini-Example:

Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. ...