Part 1 Study Unit 2

Cost Accumulations Methods

Overview

Cost accounting systems record manufacturing activities using a perpetual inventory system, which continuously update records for cost of materials, goods in process and finished goods inventory.

• Cost accounting systems accumulate cost and the assign them to products and services.

• The two basic types of cost accounting systems are job order cost accounting and process cost accounting.

2.1 Job Costing

• When companies produce customized products that are separately manufactured, the production is called job order productions or job order manufacturing (also called customized production, which is the production of products in response to special orders).

• Production activities for a customized product represent a job, which can apply to manufacturing or service companies.

2.1 Job Costing

“A major aim of a job order cost accounting system is to determine the cost of producing each job or job lot, the system

also aims to compute the cost per unit”

Required: Separate records for each job to accomplish this.

2.1 Job Costing

• Steps in Job-Order Costing • Receipt of a sales order • Predict the cost to complete the job – depends on product design • Negotiate price and decide whether to pursue the job

– Cost-plus contracts – Customer pays the mfg. for cost incurred on the job plus a negotiated amount or rate of profit

– Market factor prices – Target cost

• Sales order is approved and production order is issued • Cost are recorded by classification

– Direct Material – Direct Labor – Manufacturing Overhead – Overhead costs support production of more

than one job, and include depreciation, factory supplies, supervision, maintenance, cleaning and utilities.

2.1 Job Costing

Target Costing: Many producers determine a target cost for their jobs. Target cost is determined as follows:

Expected selling price – Desired profit = Target Cost

If the projected target cost of the job as determined by job costing is too high, the producer can apply value engineering, which is a method of determining ways to reduce job cost until the target cost is met.

2.1 Job Costing

• Job Cost Sheet – General ledger accounts usually do not provide the

accounting information that managers of job order operations need to plan and control production activities.

– Subsidiary records store information about raw materials, overhead costs, jobs in process, finished goods, and other items.

– Jobs cost sheets are separate records maintained for each job. It identifies: • Customer • Job Number • Product • Key Dates

Continued

2.1 Job Costing

– Any costs incurred on the job are immediately recorded on this sheet.

– When each job is complete, the supervisor enters the date of completion and records any remarks.

– Factory overhead is also allocated (also termed applied, assigned or charged).

Factory overhead consists of cost (other than direct materials and direct labor) that ensure the production activities are carried out.

2.1 Job Costing

• As a job is being produced, its accumulated cost are kept in Good in Process Inventory.

• The summation of all cost sheets makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger.

2.1 Job Costing

• Cost Flows: During Production – While a job is being produced, its accumulated costs are kept in Goods in Processed Inventory. The collection of job cost sheets for all jobs in process makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger. Managers use job cost sheets to monitor costs incurred to date and to predict and control cost for each job.

• Cost Flow: Job completion – When a job is finished, its job cost sheet is completed and moved from the jobs in process file to the jobs file. This latter file acts as a subsidiary ledger controlled by the Finished Goods Inventory Account.

• Cost Flows: Job Delivery – When a finished job is delivered to a customer, the job cost sheet is moved to a permanent file supporting the total cost of goods sold. This permanent file contains records from both current and prior periods.

2.1 Job Costing

• Material Ledger Cards (files) are perpetual records that are updated each time units are purchased and each time units are issued for use in production.

• When materials are needed in production, a production manager prepares a material requisition and sends it to the materials manager.

2.1 Job Costing

• Labor cost from Factory Payroll account flow to the subsidiary records of the job order cost accounting system.

Factory Payroll and Factory Overhead should be considered temporary accounts, which hold various expenses until they are allocated to balance sheep or income statements accounts.

2.1 Job Costing

• Factory overhead includes all production costs other than direct materials and direct labor, such as indirect material and indirect labor.

• They are recorded to the Factory Overhead Control account, and ultimately to the job cost sheets via an allocations.

2.1 Job Costing

• Overhead Allocation Bases – Usually based on factors of productions like direct

labor or machine hours. – Correct allocation is important and affects accuracy.

• Overhead Allocation Rates – Predetermined Overhead rate or predetermined

overhead allocation (or application) rate.

The predetermined overhead rate is computed at the start of the period and is used throughout the

period to allocate overhead to jobs.

2.1 Job Costing

• Adjusting Factory Overhead

– See Exhibit 19.13 re. flow of factory overhead costs.

– Actual overhead < applied = Underapplied overhead

– Actual overhead > applied = Overapplied

– The closer a estimate is to actuals in absolute terms the better the estimates was

Understand the effects on the Financials statements when this occurs

2.1 Job Costing

• Spoilage

– Output that does not meet the quality standards for salability is considered spoilage.

• That amount that is expected is considered normal spoilage in which case it is included as product costs.

• Spoilage that is over or above normal is considered abnormal and treated as period cost.

2.1 Job Costing

See Job Order Demonstration Problem

2.3 Process Costing

Process costing is used in Process Operations, also called process manufacturing or process

production, is the mass production of products in a continuous flow of steps.

“Products pass through a series of sequential processes”

Can you think of any examples?

2.3 Process Costing

• Process operations can also extend to services, i.e. mail sorting.

• Common feature of Process Operations is that it is sequential using a series of standardized processes.

• Series of processes = series of steps

2.3 Process Costing

• Understanding processes for companies with process operations is crucial for measuring their costs.

• Job order costing system the focus is on the individual job or batch.

• In process costing system focus is on the process itself and the standardized units produced.

2.3 Process Costing

• In process operations, each process is identified as a separate production department, workstation, or work center.

• Every subsequent department, workstation, etc. receives the output of the previous “step” (and is cumulative of all preceding)

2.3 Process Costing

• Additional cost added at each “step” can be – Direct Material

– Direct Labor

– Overhead (labor, material and other)

– The last “step” produces the finished goods

– Output of one department becomes the input of another department, as is the case with sequential processing – costs transfer with those units from the prior “step”

2.3 Process Costing

Remember!

Job order cost accounting systems assign direct material, direct labor, and overhead to jobs. The total job is then divided by the number of units to compute a cost pre unit for that job. Process cost accounting systems assign direct material, direct labor, and overhead to specific processes (or departments). The total costs associated with each process are the divided by the number of units passing through that process to determine the cost per equivalent unit (EU) for that process.

2.3 Process Costing

In a process operation, the direct labor of a production department includes all labor used exclusively by that department. This is the case if the labor is not applied to the product itself. If a production department in a process operations, for instance, has a full-time manager and a full-time maintenance work, their salaries are direct labor costs of that process and are not factory overhead.

A department's indirect labor cost might include an allocated portion of the salary of a manager who supervises two or more departments.

2.3 Process Costing

• Process Cost Factory Overhead Cost

– The time it takes to process (cycle) products through a process is sometimes used to allocate costs.

– With increasing automation, companies with process operations are more likely to use machine hours to allocate overhead.

2.3 Process Costing

• Consider the Ethics – You are working to identify the direct and indirect

costs of a new processing department that has several machines. This department's manager instructs you to classify a majority of the costs as indirect to take advantage of the direct labor-based overhead allocation so it will be charged a lower amount of overhead (because of its small labor cost). This would penalize other departments with higher allocations. It also will cause the performance ratings of managers in these other departments to suffer. What actions would you take?

2.3 Process Costing

Equivalent Units!

If a process has no beginning and no ending goods in process inventory, then the unit cost of goods transferred out of a process is:

Total cost assigned to the process (direct material, direct labor, and overhead)

Total number of units started and finished in the period

2.3 Process Costing

• If a process has a beginning or ending inventory of partially processed units (or both), then the total cost assigned to the process must be allocated to all completed and incomplete units worked on during the period. Therefore, the denominator must measure the entire production activity of the process for the period, called equivalent units of production (or EUP).

• EUP = the number of units that could have started and completed given the cost incurred during a period.

2.3 Process Costing

The goal is to compute the cost per equivalent unit and to assign costs to finished goods and goods in

process inventory.

• What complicates calculations is that material, labor and overhead sometimes are added in unequal increments over the process “steps”.

• Remember: – First equivalent units are determined and then per-

unit cost are calculated.

2.3 Process Costing

• Two methods of calculating EUP (both are tested on the exam!)

– Weighted-average method – units in beginning work-in-process inventory are treated as if they were started and completed during the current period.

– First-in, first-out method – units in beginning work-in-process inventory are part of the EUP calculation. The calculation is thus more complex than weighted-average but tends to be more accurate.

2.3 Process Costing

See Process Costing Demonstration Problem