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Fundamental Managerial Accounting ConceptsThomas P. Edmonds

Bor-Yi Tsay

Philip R. Olds

Copyright © Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinMcGraw-Hill/Irwin

Fifth Edition

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CHAPTER 11

Product Costing in Service and Manufacturing Entities

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Financial Accounting

Product costs are used to value inventory and

to compute cost ofgoods sold.

Managerial Accounting

Product costs are used for planning, control,

directing, and management decision

making.

Chapter Opening

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Learning Objective

LO1LO1

Describe the natureand treatment of

product cost informationfor manufacturing and

service companies.

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Cost of Purchases

Balance SheetIncome

StatementRaw

MaterialsWork-in-Process

FinishedGoods

• Materials Used• Labor• Overhead

EndingInventory

Total Mfg.Costs

Incurred

EndingInventory

Cost of Goods Mfd.

EndingInventory

Cost of GoodsSold

Cost Flow in Manufacturing Companies

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Service companies do not have

work-in-process and finished

goods inventory accounts

where costs are stored before

being transferred to a cost of

goods sold account.

Cost Flow in Service Companies

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Learning Objective

LO2LO2

Demonstrate theflow of materials and

labor costs for amanufacturing company.

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TheProduct

Manufacturing Overhead

DirectLabor

DirectMaterial

Manufacturing Cost Flow

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Cost of wages and fringebenefits for personnel who work

directly on manufactured products.

Direct Labor

Example:Wages paid to an

automobile assemblyworker.

Example:Wages paid to an

automobile assemblyworker.

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Direct Material

Example:Steel used tomanufacture

the automobile.

Example:Steel used tomanufacture

the automobile.

Raw material that is used to make,and can be conveniently

traced, to the finished product.

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All other manufacturing costs

Manufacturing Overhead

Materials used to support the production process. Examples: Lubricants and cleaning

supplies used in an automobile assembly plant.

IndirectLabor

IndirectMaterial

OtherCosts

Cost of personnel who do not work directly on the product. Examples: Maintenance workers,

janitors and security guards.

Examples: Depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time.

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Let’s examine the cost flows in a manufacturing

company. We will use T-accounts and start with

materials.

Manufacturing Cost Flow

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Work-in-ProcessRaw Materials

Mfg. Overhead

•MaterialPurchases

•Direct Material

•Direct Material

•Indirect Material

•Indirect Material

Manufacturing Cost Flow

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Next let’s add labor costs and

applied manufacturing overhead to the job-order cost flows. Are you

with me?

Manufacturing Cost Flow

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•Direct Labor

•Indirect Material

•OverheadApplied to

Work inProcess

If actual and applied manufacturing overhead are

not equal, a year-end adjustment is required. We will look at the procedure to

accomplish this later.

•IndirectLabor

•Direct Labor

•Overhead Applied

•IndirectLabor

Wages Payable Work-in-Process

Mfg. Overhead

•Direct Material

Manufacturing Cost Flow

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Now let’s complete the

goods and sell them. Still with

me?

Manufacturing Cost Flow

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•Cost ofGoodsMfd.

Finished Goods

•Cost ofGoodsSold

•Cost ofGoodsMfd.

Cost of Goods Sold

•Cost ofGoodsSold

Work-in-Process•Direct

Material•Direct Labor

•Overhead Applied

Manufacturing Cost Flow

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Let’s look atthe January

transactions of Ventra

Manufacturing Company.

Manufacturing Cost Flow

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Manufacturing Cost Flow

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Ventra pays $26,500 cash to purchase raw materials.

26,500

CashBal. 64,500

26,500

Raw MaterialsBal. 500

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Cash + Materials + Equity

(26,500) + 26,500 = NA + NA NA – NA = NA (26,500) OA

Assets

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Ventra places $1,100 of raw materials into production in the process of making jewelry boxes.

1,100

Work-in-ProcessBal. 0

Raw Materials

26,500

Bal. 500 1,100

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Materials + WIP + Equity

(1,100) + 1,100 = NA + NA NA – NA = NA

Assets

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Ventra pays $2,000 cash to purchase production supplies.

Production SuppliesCash

26,500Bal. 64,500 2,000 2,000

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Cash + Production

Supplies + Equity

(2,000) + 2,000 = NA + NA NA – NA = NA

Assets

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Ventra pays production workers $1,400 cash.

26,500

CashBal. 64,500

2,000 1,100

Work-in-ProcessBal. 0

1,400 1,400

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Cash + WIP + Equity

(1,400) + 1,400 = NA + NA NA – NA = NA

Assets

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Learning Objective

LO3LO3

Assign estimatedoverhead costs to

inventory andcost of goods sold.

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Using a predetermined rate makes itpossible to estimate total job costs sooner.

Actual overhead for the period is notknown until the end of the period.

$$

Flow of Overhead Costs

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Estimated total manufacturingoverhead cost for the period

Estimated total units in theallocation base for the period

POHR =

A predetermined overhead rate (POHR), used to apply overhead to products, is determined before the period begins.

Flow of Overhead Costs

$40,320

12,000 jewelry boxesPOHR = = $3.36

per box

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Overhead applied = POHR × Actual activity

Actual amount of theallocation base such as

units produced, direct labor hours, or machine hours.

Based on estimates, and determined before

the period begins.

Flow of Overhead Costs

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Ventra applies $1,680 of estimated manufacturing overhead costs at the end of January.

Applied

Manufacturing Overhead

Actual

1,680

1,680

1,100

Work-in-Process

1,400

Bal. 0

Applied overhead = 500 boxes × $3.36 per box = $1,680

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Mfg. OH + WIP + Equity

(1,680) + 1,680 = NA + NA NA – NA = NA

Assets

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Learning Objective

LO4LO4

Account forcompletion and

sale of products.

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Ventra transfers the total cost of 500 jewelry boxes from work-in-process to finished goods.

1,100

Work-in-Process

1,400 1,680

Bal. 0

4,180

4,180

Finished GoodsBal. 836

100 boxes @ $8.36

Unit cost = $4,180 ÷ 500 boxes = $8.36 per box

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

WIP + Fin. Goods + Equity

(4,180) + 4,180 = NA + NA NA – NA = NA

Assets

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Ventra recognizes cost of goods sold for 400 jewelry boxes sold to customers.

Finished Goods

4,180

Bal. 836

Cost of Goods Sold 3,344 3,344

400 boxes @ $8.36 per box = $3,344

Manufacturing Cost Flow

Assets = Liabilities + Equity Rev. – Exp. = Net Inc.

Fin. Goods + Ret. Earnings

(3,344) = NA + (3,344) NA – 3,344 = (3,344)

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Ventra recognizes $5,600 of sales revenue for the cash sale of 400 boxes.

Revenue 5,600

400 boxes @ $14.00 per box = $5,600

26,500

CashBal. 64,500

2,000 1,400

5,600

Manufacturing Cost Flow

Assets = Liab. + Equity Rev. – Exp. = Net Inc.

5,600 = NA + 5,600 5,600 – NA = 5,600

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Ventra pays $1,200 cash for actual manufacturing overhead costs including indirect labor, utilities, rent, etc.

Cash26,500Bal. 64,500 2,000 1,400

5,600

Applied

Manufacturing Overhead

Actual

1,680 1,200

1,200

Manufacturing Cost Flow

= Liabilities + Equity Rev. – Exp. = Net Inc.

Cash + Mfg. OH + Equity

(1,200) + 1,200 = NA + NA NA – NA = NA

Assets

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Ventra pays $1,200 cash for actual manufacturing overhead costs including indirect labor, utilities, rent, etc.

Manufacturing overhead is $480 overapplied at the end of

January. Any difference between actual and applied overhead remaining at year end will be closed to cost of

goods sold.

Manufacturing overhead is $480 overapplied at the end of

January. Any difference between actual and applied overhead remaining at year end will be closed to cost of

goods sold.

Applied

Manufacturing Overhead

Actual

1,680 1,200

Manufacturing Cost Flow

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Manufacturing Cost Flow

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Supplies: $2,000 purchased, $1,700 used.

See Cost of GoodsManufactured and

Sold Schedule

Manufacturing Cost Flow

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Explanation of Manufacturing

Overhead balance follows.

Manufacturing Cost Flow

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Applied

Manufacturing Overhead

Actual39,64843,400

3,752

Manufacturing overhead is $3,752 underapplied.

11,800 boxes manufactured × $3.36 POHR

Analyzing Underapplied Overhead

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Applied

Manufacturing Overhead

Actual39,64843,400

3,752

Manufacturing overhead is $3,752 underapplied.

Cost of Goods Sold 83,600

10,000 boxes @ $8.36

3,752 3,752

Underapplied overhead is closed to Cost of Goods Sold leaving a zero balance in the

overhead account.

87,352

Analyzing Underapplied Overhead

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Spending variance$3,080 unfavorable

Volume variance$672 unfavorable

$43,400 $40,320 $39,648

Actual Overhead Overhead Overhead Incurred Budget Applied

Total variance is $3,752 unfavorable, theamount of underapplied overhead.

Analyzing Underapplied Overhead

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Learning Objective

LO5LO5

Prepare aschedule of cost of

goods manufacturedand sold.

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Schedule of Cost of Goods Manufactured and Sold

Ventra Manufacturing Company

Schedule of Cost of Goods Manufactured and Sold

Direct Raw Material Used 25,960$

Direct Labor 33,040

Actual Manufacturing Overhead 43,400

Total Manufacturing Costs 102,400

Plus Beginning Work-in-Process Inventory 0

Total Work-in-Process Inventory 102,400

Less Ending Work-in-Process Inventory 8,360

Cost of Goods Manufactured 94,040

Plus Beginning Finished Goods Inventory 836

Cost of Goods Available for Sale 94,876

Less Ending Finished Goods Inventory 7,524

Cost of Goods Sold 87,352$

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Ventra Manufacturing Company

Schedule of Cost of Goods Manufactured and Sold

Direct Raw Material Used 25,960$

Direct Labor 33,040

Actual Manufacturing Overhead 43,400

Total Manufacturing Costs 102,400

Plus Beginning Work-in-Process Inventory 0

Total Work-in-Process Inventory 102,400

Less Ending Work-in-Process Inventory 8,360

Cost of Goods Manufactured 94,040

Plus Beginning Finished Goods Inventory 836

Cost of Goods Available for Sale 94,876

Less Ending Finished Goods Inventory 7,524

Cost of Goods Sold 87,352$

Schedule of Cost of Goods Manufactured and Sold

Computation of Direct Raw Materials Used

Beginning Raw Materials Inventory 500$

Plus Purchases 26,500

Raw Materials Available for Use 27,000

Less Ending Raw Materials Inventory 1,040

Direct Raw Materials Used 25,960$

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Ventra Manufacturing Company

Schedule of Cost of Goods Manufactured and Sold

Direct Raw Material Used 25,960$

Direct Labor 33,040

Actual Manufacturing Overhead 43,400

Total Manufacturing Costs 102,400

Plus Beginning Work-in-Process Inventory 0

Total Work-in-Process Inventory 102,400

Less Ending Work-in-Process Inventory 8,360

Cost of Goods Manufactured 94,040

Plus Beginning Finished Goods Inventory 836

Cost of Goods Available for Sale 94,876

Less Ending Finished Goods Inventory 7,524

Cost of Goods Sold 87,352$

Schedule of Cost of Goods Manufactured and Sold

Computation of Actual Manufacturing Overhead

Indirect Labor, Rent, and Utilities 31,700$

Supplies 1,700

Depreciation of Manufacturing Equipment 10,000

Actual Manufacturing Overhead 43,400$

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Ventra Manufacturing Company

Schedule of Cost of Goods Manufactured and Sold

Direct Raw Material Used 25,960$

Direct Labor 33,040

Actual Manufacturing Overhead 43,400

Total Manufacturing Costs 102,400

Plus Beginning Work-in-Process Inventory 0

Total Work-in-Process Inventory 102,400

Less Ending Work-in-Process Inventory 8,360

Cost of Goods Manufactured 94,040

Plus Beginning Finished Goods Inventory 836

Cost of Goods Available for Sale 94,876

Less Ending Finished Goods Inventory 7,524

Cost of Goods Sold 87,352$

Schedule of Cost of Goods Manufactured and Sold

Reported in the current assets section of the balance sheet.

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Learning Objective

LO6LO6

Prepare financialstatements for a

manufacturing company.

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Ventra Manufacturing Company

Income Statement

For the Year Ended December 31, 2010

Sales revenue (10,000 boxes @$14.00) 140,000$

Cost of Goods Sold 87,352

Gross margin 52,648

Selling and Administrative Expenses 31,400

Net income 21,248$

Financial Statements

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Assets Cash 79,860$ Raw Materials Inventory 1,040 Work-inProcess Inventory 8,360 Finished Goods Inventory 7,524 Production Supplies 300 Manufacturing Equipment 40,000$ Less Accumulated Depreciation 20,000 Book Value Manufacturing Equipment 20,000 Total Assets 117,084$

Stockholder's Equity Common Stock 76,000 Retained Earnings 41,084 Total Stockholders' Equity 117,084$

Ventra Manufacturing CompanyBalance Sheet

As of December 31, 2010

Financial Statements

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Learning Objective

LO7LO7

Distinguishbetween absorptionand variable costing.

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Hokai Company incurs the followingcosts to produce 2,000 units of inventory:

Hokai Company incurs the followingcosts to produce 2,000 units of inventory:

Let’s see what happens to costsif Hokai increases production.

Let’s see what happens to costsif Hokai increases production.

Motive to OverproduceAbsorption Costing

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Now let’s compute income at the three levelsof production if Hokai sells 2,000 units.

Now let’s compute income at the three levelsof production if Hokai sells 2,000 units.

Motive to OverproduceAbsorption Costing

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Level of Production 2,000 3,000 4,000Sales @ $20 per unit × 2,000 units 40,000$ 40,000$ 40,000$ Cost of Goods Sold $15 per unit × 2,000 units 30,000 $13 per unit × 2,000 units 26,000 $12 per unit × 2,000 units 24,000 Gross Margin 10,000$ 14,000$ 16,000$

Internally, many companies use variable costingto motivate managers to increase profitability

without motivating them to overproduce.

Internally, many companies use variable costingto motivate managers to increase profitability

without motivating them to overproduce.

Motive to OverproduceAbsorption Costing

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Variable Costing

Net income is not affected by production increases.Net income is not affected by production increases.

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End of Chapter 11