job system cost allocation
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Traditional
Cost ManagementSystems
Rishiraj
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Cost Management Systems (2 of 2) Since the mid-1980s companies have been
adopting activity-based costing (ABC) for productand customer costing
These three systems are often portrayed as
distinct; however, all cost systems work inessentially the same way: Expense categories are developed and then expenses
are mapped to service departments, production centers,
or activities Expenses are then attached to cost objects
The way these links are made and the activitiesdefined is what differentiates these systems
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Job Order v. Process Costing Systems
Ajob order costing system estimates the costsof manufacturing products for different jobsrequired for specific customer ordersApplicable in organizations that treat each individual job
as a single unit of output Aprocess costing system is applicable when all
units produced during a specified time frame aretreated as one unit of output Every unit made during the time period is essentially
identical
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Need for Job Order Costing
Products may differ Materials content
Hours of labor required
Machine time required
Demand placed on support activity resources (i.e.,manufacturing overhead)
Special customer needs that require customizedproduction
With such variety, managers need to understandthe costs of individual products so that they canassess product and customer profitability
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The Cost Flow Model
The cost flow model essentially uses aninventory concept to track costs Raw materials inventory
Work-in-process (WIP) inventory
Raw materials are transformed by labor and supportresources
Costs of the resources for each job not yetcompleted
Finished goods inventory When the goods are sold, they are accounted for
in the expense category Cost of Goods Sold
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Bidding Using Job Order Costing
Firms are sometimes required to bid onjobs before customers decide to place anorder with them
Costs need to be estimated for each job inorder to prepare a bid
Job order costing systems provide the
means to estimate these costs A job bid sheet provides a format for
recording the estimated costs
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Job Bid Sheet (1 of 6)
Panel 1 identifies the customer, theproduct, and the number of units required
Bid Number: J4369 Date: July 6, 2009
Customer: Ashok Motors
Product: Automobile engine valves (Valve #L181)
Engineering Design Number: JDR-103
Number of Units: 1,500
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Job Bid Sheet (2 of 6)
Panel 2lists all the materials required tocomplete the job
Materials Quantity Price AmountBar steel stock 3 3,600 Kgs 11.30 40,680
Subassembly 1,500 39.00 58,500
Total direct materials 99,180
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Job Bid Sheet (3 of 6)
Panel 3lists the amount of direct laborrequired for the job
Labor Hours Rate Amount
Lathe operators 480 26.00 12,480
Assembly workers 900 18.00 16,200Total direct labor 1,380 26,680
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Job Bid Sheet (4 of 6)
Panel 4contains estimates for cost drivercosts
Support Costs Amount
600 machine-hours @ 40/hour 24,000
1,380 direct labor hours @ 36/hour 49,680Total support costs 73,680
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Job Bid Sheet (5 of 6)
Panel 5summarizes the total costsestimated for the job
Direct material 99,180
Direct labor 28,680
Support costs 73,680Total costs 201,540
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Job Bid Sheet (6 of 6)
A markup rate is applied to translate theestimated cost into a bid price
A 25% markup rate is assumed in this example
Total costs 201,540
Add 25% markup 50,385
Bid price 251,925Unit cost 134.36
Unit price 167.95
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Job Costs And Markup Most firms mark up the job costs by adding an
additional amount, or margin, to make a profit onthe job
The total job costs plus the margin equals thebid price
The markup rate depends on a variety of factors: The amount of support costs excluded from the cost
driver rate The target rate of return desired by the corporation Competitive intensity Past bidding strategies adopted by key competitors Demand conditions Overall product-market strategies
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Determination Of Cost Driver Rates
Determining realistic cost driver rates hasbecome increasingly important in recent years Support costs now comprise a large portion of the total
costs in many industries
Many firms now recognize that several differentfactors may be driving support costs rather thanone or even two factors, such as direct labor or
machine hours Firms are now taking greater care in identifying which
support costs should relate to what cost driver
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Cost Driver Rates
All costs associated with a cost driver, such assetup hours, are accumulated separately Each subset of total support costs that can be
associated with a distinct cost driver is referred to as a
cost pool Each cost pool has a separate cost driver rate
The cost driver rate is the ratio of the cost of asupport activity accumulated in the cost pool to
the level of the cost driver for the activityActivity cost driver rate =
Cost of support activity / Level of cost
driver
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Stable Cost Driver Rates (1of 2)
The cost of the support activity is the cost of theresources committed to the particular activity
The level of the activity cost driver is the long-term capacity made available by the amount of
resources committed to a support activity The cost of a support activity, therefore, excludes
fluctuations in costs caused by short-term adjustmentssuch as overtime payments
The level of the support activity cost driver alsoexcludes short-term variations in demand as reflectedin overtime or idle time
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Stable Cost Driver Rates (2of 2)
The ratio shown in the previous equationis based on costs and cost driver levels,the rate remains stable over time:
It does not fluctuate as activity levels changein the short run
It does not change simply because of short-run changes in external factors that do not
affect the efficiency or price of the activityresources
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Fluctuating Rates
For example, if the rate for machine costs isbased on quarterly cost driver levels instead ofthe normal levels: The rate increases as the demand for the machine
activity falls The rate decreases as the demand increases
In contrast, the cost driver rate based on costsand activity levels remains fixed throughout the
year Costs depend on the machine capacity made available
and not on the season
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Problems With Fluctuating Rates Determination of cost driver rates based on
short-term usage results in higher rates duringperiods of lower demand Job costs appearto be higher during time periods
when demand is lower
Bid prices based on estimated job costs are likely to behigher during periods of low demand when theyprobably should be lower
The higher bid price can further decrease demand,which in turn leads to higher cost driver rates and even
higher prices Conversely, in periods when demand is high and
capacity is short, job costs will appear to belower, and bid prices will also be low
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Number of Cost Pools The number of cost pools can vary
Some German firms use over 1,000 The general principle is to use separate cost
pools if the cost or productivity of resources isdifferent and if the pattern of demand varies
across resources The increase in measurement costs required by
a more detailed cost system must be traded offagainst the benefit of increased accuracy in
estimating product costs If cost and productivity differences between resources
are small, having more cost pools will make littledifference in the accuracy of product cost estimates
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Recording Actual Job Costs Job order cost accounting systems record costs
actually incurred on individual jobs as they areproduced This process allows comparison of actual costs with
the estimated costs
Copies of all materials requisition notes and
worker time cards are forwarded to theaccounting department, which then posts themon a job cost sheet
The system calculates total costs for the portionof the job completed
The structure of the job cost sheet is similar tothat of the job bid sheet The direct materials and direct labor costs on the job
cost sheet represent the jobs actual costs incurred
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Multistage Process Costing For many plants engaged in continuous processing
production flows continuously, semi-continuously,or in large batches from one process stage to thenext
At each successive process stage, there is further
progress toward converting the raw materials intothe finished product
In continuous processing it is necessary first todetermine costs for each stage of the process and
then to assign their costs to individual products
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Multistage Process Costing Systems
The design of product costing systems in such
process-oriented plants allows measurement ofthe costs of converting the raw materials duringa time period to be made separately for eachprocess stage
The conversion costs are applied to products asthey pass through successive process stages
This system for determining product costs,
known as a multistage process costing system,is common in process-oriented industries
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Process-Oriented Industries Multistage process costing systems are found in plants
engaged in continuous processing, such as those in thechemicals, basic metals, pharmaceuticals, grain millingand processing, and electric utilities industries
We also find multistage process costing systems in some
discrete-parts manufacturing plants such as thoseproducing automobile components, small appliances, andelectronic instruments and computers
The common feature in these settings is that the productsmanufactured are relatively homogeneous
Few and relatively small differences occur in theproduction requirements for batches of differentproducts
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Comparison With Job Order Costing
Both systems have the same objective:Assign material, labor, and manufacturingsupport activity costs to product
Process costing systems differ in thatthey:
Do not maintain separate cost records forindividual jobs
Measure costs only for process stages Determine cost variances only at the level of
the process stages instead of at the level of
individual jobs
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Job Order and MultistageProcess Costing (1 of 3)
In job order costingproduction is carriedout in different jobs
In multistage process costing,productionis carried out continuously, semi-continuously, or in large batches
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Job Order and MultistageProcess Costing (2 of 3)
In job order costing,productionrequirements are different for eachindividual job
In multistage process costing,productionrequirements are homogeneous acrossproducts or jobs
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Job Order and MultistageProcess Costing (3 of 3)
In job order costing, variances betweenactual and estimated direct material anddirect labor costs are determined for each
individual jobs In multistage process costing, variances
between actual and estimated costs are
determined for individual process stages
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Service Department
Cost AllocationsAppendix
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Operating Expense Allocations
Traditional cost accounting systemsassign operating expenses to productswith a two-stage procedure:
1. Expenses are assigned to productiondepartments
2. Production department expenses are
assigned to the products Departmental structure influences the
first-stage allocation process
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Effect Of Departmental Structure Many plants are organized into departments that are
responsible for performing designated activities Departments that have direct responsibility for
converting raw materials into finished products arecalledproduction departments
Service departments perform activities that supportproduction, such as:
Machine setup
Production engineering
Production scheduling
All service department costs are indirect supportactivity costs because they do not arise from directproduction activities
Machine maintenance
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Two-Stage Cost Allocation (1 of 2) Conventional product costing systems assign
indirect costs to jobs or products in two stages1. In the first stage:
System identifies indirect costs with variousproduction and service departments
Service department costs are then allocated toproduction departments
1. The system assigns the accumulated indirect
costs for the production departments toindividual jobs or products based onpredetermined departmental cost driver rates
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Two-Stage Cost Allocation (2 of 2)
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Allocating Service DepartmentCosts To Production Departments
There are three ways that companies allocateservice department costs to productiondepartments:
Direct allocation Sequential allocation
Reciprocal allocation
The last two are used when service departments
consume services provided by other departments(Examples based on PATIENTAID information in text)
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PATIENTAID EXAMPLEStep 1 of Stage 1 cost allocations (given)
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Direct Allocation Method The direct allocation method is a simple
method that allocates the servicedepartment costs directly to the productiondepartments
Allocations to production departments arebased on each production departmentsrelative use of the applicable cost driver
It ignores the possibility that some of the
activities of a service department may benefitother service departments as well asproduction departments
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Allocation Bases Values
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Allocation Ratios
300,000 / 1,200,000 = 0.250
Based on relative allocation basis value
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Allocation ofService Department Costs
Multiply service department cost by the allocation ratios
$160,000 x 0.250 = $40,000
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Stage 2 Cost Allocations Stage 2 allocations
Require the identification of appropriate cost drivers foreach production department
Assign production department costs to jobs andproducts while they are worked on in the departments
Conventional cost accounting systems use unit-related cost drivers, such as the number of unitsmade, the number of direct labor hours (or cost),and the number of machine hours
Dividing the indirect costs accumulated in eachproduction department by the total number ofunits of the corresponding cost driver results incost driver rates for each department
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PATIENTAID Stage 2 (1 of 2) The Casting Department allocates its indirect
costs to jobs based on machine hours, with totalcapacity for Casting equaling 6,000 machinehours
Total indirect costs for Casting, after theallocation from service departments in Step 2 ofStage 1 was $216,000
As a result, Casting allocates indirect costs to
jobs at a rate of $36.00 per machine hour= $216,000/6,000 hours
Each department will make a similar calculation
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PATIENTAID Stage 2 (2 of 2) If Job J189-4 uses 40 machine hours while in the
Casting Department, Casting will allocate $1,440of its indirect costs to Job J189-4= 40 hours x $36.00 per hour
Each department will allocate indirect costs to
Job J189-4 in a similar manner, and Casting willallocate some costs to all jobs in a similar manner To determine the total cost of Job J198-4, add the
Direct Material and Direct Labor cost assigned ineach department and the indirect cost allocated
from each department To determine the cost per unit, divide the total
cost by the number of units in Job J189-4
C t Di t ti i
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Cost Distortions inA Two-Stage Allocation (1 of 2)
The two-stage allocation can cause someproducts to be overcosted and othersundercosted if allocations are based on unitmeasures but the units of different products
have different relative consumption ratios In the Minnetka example in the textbook,
Products A and B use the same number ofmachine hours, resulting in an equal allocation of
indirect, including setup, costs per unit Product A, however, runs in larger batches, so
one units relative consumption of setupresources is lower for A than for B
C t Di t ti i
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Cost Distortions inA Two-Stage Allocation (2 of 2)
Cost distortions are greater when the differencebetween the relative proportion of the cost driverfor the activity (e.g., setup hours) and therelative proportion of the basis for second-stageassignment of support costs (e.g., machine
hours) is greater Such distortions could be eliminated if the
costing system used the actual cost driver foreach support activity to assign costs directly to
the products This logic underlies the development of activity-based costing systems discussed in thefollowing chapter
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Sequential and ReciprocalAllocation Methods
Sequential and reciprocal allocationmethods are used when servicedepartments consume services provided
by other service departments The sequential allocation method allocatesservice department costs to one servicedepartment at a time in sequential order
The reciprocal allocation method determinesservice department cost allocationssimultaneously
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Sequential Allocation Method (1 of 5)
The sequential method is appropriatewhen there is not a pair of servicedepartments in which each department inthat pair consumes a significant proportionof the services produced by the otherdepartment in that pair
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Sequential Allocation Method (2 of 5)
The sequential allocation method requires
that the service departments first bearranged in order
A service department can receive costs
allocated from another service departmentonly before its own costs have been allocatedto other departments
Once a service departments costs havebeen allocated, no costs can be allocatedback to it from other departments
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Sequential Allocation Method (3 of 5)Service
DepartmentsProduction
Departments
Item Power Engineering Machining Assembly Totals
Services Used:
Kilowatt hours
Engring hours
0
0
100,000
0
480,000
2,000
220,000
2,000
800,000
4,000
Allocation ratios:
Power
Engineering
0
0
0.125
0
0.600
0.500
0.275
0.500
1.000
1.000
Directly identifiedcosts
$320,000 $180,000 $120,000 $80,000 $700,000
480,000/800,000 = 0.600
2,000/4,000 = 0.500
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Sequential Allocation Method (4 of 5)Service Departments Production
DepartmentsItem Power Engineering Machining Assembly Totals
Directly identifiedcosts $320,000 $180,000 $120,000 $80,000 $700,000
Cost Allocations:Power
Engineering
(320,000)
0
40,000
(220,000)
192,000
110,000
88,000
110,000
Totals $ 0 $ 0 $ 422,000 $ 278,000 $ 700,000
$320,000 * 0.600 = $ 192,000
($180,000 + 40,000) * 0.500 = $ 110,000
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Sequential Allocation Method (5 of 5)
In this example, the power department does notreceive engineering services, but theengineering department uses power
Therefore, in the sequential method:
The power department costs are allocated first Then the engineering department costs are allocated
The total cost of a service department allocatedto other departments equals the amount directly
identified with the service department plus theamount allocated earlier to the servicedepartment from other service departments
R i l All i M h d
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Reciprocal Allocation Method (1 of 6) If both service departments in this
example consume each others services,the reciprocal allocation method isappropriate
The sequential method ignores orsuppresses such reciprocal relations
The reciprocal allocation methodrecognizes reciprocal interactions between
different service departments The example changes only to recognize
Powers use of Engineerings services
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Reciprocal Allocation Method (2 of 6)Service
DepartmentsProduction
Departments
Item Power Engineering Machining Assembly Totals
Services Used:
Kilowatt hours
Engring hours
0
1,000
100,000
0
480,000
2,000
220,000
2,000
800,000
5,000
Allocation ratios:
Power
Engineering
0
0.200
0.125
0
0.600
0.400
0.275
0.400
1.000
1.000
Directly identifiedcosts
$320,000 $180,000 $120,000 $80,000 $700,000
480,000/800,000 = 0.600
2,000/5,000 = 0.400
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Reciprocal Allocation Method (3 of 6)
Before allocating any costs to the production
departments, determine the reciprocalallocation between service departments:
Powers total cost is $320,000 + 20% of the total
cost of Engineering (P=320,000+.20E) Engineerings total cost is $180,000 + 12.5% of
the total cost of Power (E=180,000+.125P)
Solve the simultaneous equations bysubstitution
R i l All ti M th d
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Reciprocal Allocation Method (4 of 6)
P=320,000+.20E, with E=180,000+.125P
P=320,000+.20(180,000+.125P)
P=320,000 + 36,000 + .025P
.975P=320,000 + 36,000
P= $ 365,128
E=180,000+.125P
E=180,000+.125(365,128)
E=180,000+45,641
E= $ 225,641
These costs will beallocated to theproductiondepartments using
the allocation ratiosshown previously
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Reciprocal Allocation Method (5 of 6)Service Departments Production
DepartmentsItem Power Engineering Machining Assembly Totals
Directly identifiedcosts $320,000 $180,000 $120,000 $80,000 $700,000
Cost Allocations:Power
Engineering
(365,128)
45,128
45,641
(225,641)
219,077
90,256
100,410
90,257
Totals $ 0 $ 0 $ 429,333 $ 270,667 $ 700,000
($320,000 + 45,128) * 0.600 = $ 192,000
($180,000 + 45,641) * 0.400 = $ 110,000
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Fi l W d T St All ti
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Final Word on Two-Stage Allocation The fundamental assumption of the two-stage allocation
method is the absence of a strong direct link between the
support activities and the products manufactured For this reason, service department costs are first
allocated to production departments using one of theconventional two-stage allocation methods previouslydescribed
Activity-based costing rejects this assumption and insteaddevelops the idea of cost drivers that directly link theactivities performed to the products manufactured andmeasure the average demand placed on each activity by thevarious products
Activity costs are assigned to products in proportion to theaverage demand that the products place on the activities,usually eliminating the need for the second step in Stage1 allocations
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