Accounting 1-5
Transfer of Product Costs
- When direct materials are used in production, their costs are transferred from Raw Materials to Work in Process. - Direct labor and manufacturing overhead costs are added to Work in Process to convert direct materials into finished goods. - Once units of product are completed, their costs are transferred from Work in Process to Finished Goods. - When a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to Cost of Goods Sold.
Shifting of Overhead Cost - Production-Orders Cost Pool
1. Compute the number of units processed per production order for each product. 2. Compute production-order cost per unit for each product.
Other examples of manufacturing overhead include:
1. depreciation of manufacturing equipment, utility costs, property taxes, and insurance premiums incurred to operate a manufacturing facility.
Relevant Range
1. is that range of activity within which the assumptions made about cost behavior are valid.
indirect materials
1. that cannot be easily or conveniently traced to specific units of product.
Discretionary fixed costs
1. usually arise from annual decisions by management and they can be easily reduced in the short term.
Process Costing
1.A single product is produced either on a continuous basis or for long periods of time. All units of product are identical. 2.Costs are accumulated by department 3.Unit costs are computed by department.
Predetermined overhead rates that rely upon estimated data are often used because:
1.Actual overhead for the period is not known until the end of the period, thus inhibiting the ability to estimate job costs during the period. 2.Actual overhead costs can fluctuate seasonally, thus misleading decision makers.
Purposes of Cost Classification
1.Assigning costs to cost objects 2.Accounting for costs in manufacturing companies 3.Preparing financial statements 4.Predicting cost behavior in response to changes in activity 5.Making decisions
The predetermined overhead rate is computed before the period begins using a four-step process.
1.Estimate the total amount of the allocation base (the denominator) that will be required for next period's estimated level of production. 2.Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base.
Inaccurately assigning manufacturing costs to jobs adversely influences planning and decisions made by managers.
1.Job-order costing systems can accurately trace direct materials and direct labor costs to jobs. 2.Job-order costing systems often fail to accurately allocate the manufacturing overhead costs used during the production process to their respective jobs.
Job-Order Costing
1.Many different jobs are worked on during each period, with each job having unique production requirements. 2.Costs are accumulated by individual job. 3.Unit costs are computed by job on the job cost sheet.
Job-order costing systems are used when:
1.Many different products are produced each period. 2.Products are manufactured to order. Many service industries use job-order costing. 3.The unique nature of each order requires tracing and allocating costs to each job, and maintaining cost records for each job.
Today, direct labor may no longer be a satisfactory base for allocation of overhead.
1.Most companies sell a large variety of products that consume differing amounts of overhead. 2.As a percentage of total costs, direct labor has been declining and overhead has been increasing. Many of these growing overhead costs may not be correlated with direct labor. 3.Technology advancements have reduced the cost and complexity of gathering diverse sources of data. 4.A plantwide overhead allocation system may not be optimal for many companies in today's business environment.
The adjustment for underapplied overhead
1.increases cost of goods sold and decreases net operating income.
When a company applies less overhead to production
1.than it actually incurs, it creates what is known as underapplied overhead.
Activity Cost Pool
A "cost bucket" in which costs related to a particular activity are accumulated.
Mixed Costs
A cost that contains both variable and fixed elements.
variable costs
A cost that varies, in total, in direct proportion to changes in the level of activity. However, variable cost per unit is constant.
Absorption costing
A costing method that includes all manufacturing costs—direct materials, direct labor, and both variable and fixed manufacturing overhead—in the cost of a product.
Normal costing
A costing system in which overhead costs are applied to a job by multiplying a predetermined overhead rate by the actual amount of the allocation base incurred by the job.
Job-order costing
A costing system used in situations where many different products, jobs, or services are produced each period.
Job cost sheet
A form that records the direct materials, direct labor, and manufacturing overhead cost charged to a job.
Allocation base
A measure of activity such as direct labor-hours or machine-hours that is used to assign costs to cost objects.
Activity Rate
A predetermined overhead rate for each activity cost pool.
direct materials ex
A radio installed in an automobile
Predetermined overhead rate
A rate used to charge manufacturing overhead cost to jobs that is established in advance for each period. It is
Activity-Based Costing (ABC) - Definition
A technique that attempts to assign overhead costs more accurately to products. It uses multiple allocation bases for assigning costs to products. Each base represents a major activity. Activity is an event that causes consumption of overhead resources.
Transferring Finished Goods to Cost of Goods Sold:
Accounts Receivable 225,000 Sales 225,000
Activity-Based Costing (ABC) Examples of Activities
Activity An event that causes the consumption of overhead resources.
Nonmanufacturing Costs - Advertising
Advertising Expense 42,000 Other Selling and Administration Expense 8,000 Accounts Payable * 50,000
Processing Departments
Any unit in an organization where materials, labor, or overhead are added to the product. The activities performed in a processing department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous. Products in a process costing environment typically flow in a sequence from one department to another.
Cost object
Anything for which cost data are desired including products, customers, jobs, organizational subunits, etc. For purposes of assigning costs to cost objects costs are classified two ways:
◦Cost of goods available for sale
Beginning finished goods inventory + Cost of goods manufactured
Raw materials available for use in production=
Beginning raw materials inventory + Raw materials purchased
Total work in process for the period=
Beginning work in process inventory + Total manufacturing costs
Finished goods
Consists of completed units of product that have not yet been sold to customers.
work in process
Consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer.
Activity-Based Costing (ABC) Process
Cost Objects (e.g., products and customers), Activities, Activities Consume Resources, Consumption of Resources Incur Cost
Transferring Finished Goods to Cost of Goods Sold:
Cost of Goods Sold 118,500 Finished Goods 118,500
cost per equivalent unit formula
Cost of beginning work in process inventory + Cost added during the period = Total. Then divide by equivalent units of production.
Cost of goods sold
Cost of goods available for sale - Ending finished goods inventory
Direct costs
Costs that can be easily and conveniently traced to a specified cost object
Indirect costs
Costs that cannot be easily and conveniently traced to a unit of product or other cost object.
Purchase of Raw Materials Journal Entry
Debit: Raw Materials Credit: Accounts Payable
Nonmanufacturing Costs - S G&A Depreciation on office equipment during April was $7,000. The entry is as follows:
Depreciation Expense 7,000 Accumulated Depreciation 7,000
Classifications of Manufacturing Costs
Direct Labor, Direct Materials, Manufacturing Overhead
Both Process and Job-Order Costing include:
Direct Materials Direct Labor Manufacturing Overhead
Processing Department includes:
Direct Materials Direct Labor Manufacturing Overhead
Job-Order Costing - Cost Flow 1
Direct costs ◦Direct materials Job No. 1 Job No. 2 Job No. 3 ◦Direct labor Job No. 1 Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed.
Job-Order Costing - Cost Flow 2
Direct costs ◦Direct materials ◦Direct labor Indirect costs ◦Manufacturing overhead Job No. 1 Job No. 2 Job No. 3 Manufacturing overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job
Product Cost Flows - Part 2: Total Manufacturing Costs
Direct labor used in production and manufacturing overhead applied to production are added to direct materials to arrive at total manufacturing costs. Raw Materials ◦Beginning raw materials inventory + Raw materials purchased = Raw materials available for use in production ◦Raw materials available for use in production - Ending raw materials inventory = Raw materials used in production
Predetermined overhead rate =
Estimated total manufacturing overhead cost ÷ Estimated total amount of the allocation base
Activity Measure
Expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs.
Transferring Completed Jobs from Work in Process to Finished Goods:
Finished Goods 158,000 Work in Process 158,000
Both Process and Job-Order Costing transfer Work in Process when completed to:
Finished Goods Cost of Goods Sold
Administrative costs
Includes all costs associated with the general management of an organization. Administrative costs can be either direct or indirect costs.
Selling costs
Includes all costs necessary to secure customer orders and get the finished product to the customer. Selling costs can be either direct or indirect costs.
Manufacturing Overhead
Includes all manufacturing costs except direct materials and direct labor. These costs cannot be readily traced to finished products (also called indirect manufacturing cost, factory overhead, and factory burden), indirect materials, indirect labor
Common costs
Indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.
Disposition of Overapplied and Underapplied Overhead - Part 6
Manufacturing Overhead 30,000 Work in Process Inventory 3,000 Finished Goods Inventory 9,000 Cost of Goods Sold 18,000
Applied Overhead
POHR × Actual Direct Labor-Hours
The predetermined overhead rate
POHR) used to apply overhead to jobs is determined before the period begins.
Overhead applied to a particular job =
Predetermined overhead rate × Amount of allocation base incurred by the job
Product Cost Flows - Part 1: Raw Materials
Raw material purchases made during the period are added to beginning raw materials inventory. The ending raw materials inventory is deducted to arrive at the raw materials used in production. As items are removed from raw materials inventory and placed into the production process, they are called direct materials. Raw Materials ◦Beginning raw materials inventory + Raw materials purchased = Raw materials available for use in production
Raw materials used in production=
Raw materials available for use in production - Ending raw materials inventory
Product Cost Flows - Part 1: Direct Materials
Raw materials available for use in production - Ending raw materials inventory = Raw materials used in production Manufacturing Costs ◦Raw materials used in production à Direct materials Work In Process
Classifications of non-manufacturing costs
Selling costs, Administrative costs
Examples of Activities
Setting up machines, Admitting hospital patients, Billing customers, Opening a bank account
Mixed Costs equation
The equation is Y = a + bX a. Y = The total mixed cost. b. a = The total fixed cost (the vertical intercept of the line). c.b = The variable cost per unit of activity (the slope of the line).
opportunity cost
The potential benefit that is given up when one alternative is selected over another.
Schedules of Cost of Goods Manufactured and Cost of Goods Sold
The schedules contains three types of costs: 1.Direct materials 2.Direct labor 3.Manufacturing overhead The schedules calculate: 1.The cost of raw material and direct labor used in production and the amount of manufacturing overhead applied to production. 2.The manufacturing costs associated with goods that were finished during the period.
total work in process
Total manufacturing costs are added to the beginning work in process to arrive at
Cost of Goods Manufactured
Total work in process for the period - Ending work in process inventory
direct labor ex
Wages paid to automobile assembly workers
Processing Department:
Work in process - separate account for each department. Transferred-in costs - process account to another department. Finished Goods Cost of Goods Sold
3.Use the following equation to estimate the total amount of manufacturing overhead: Y = a + bX
Y = The estimated total manufacturing overhead cost a = The estimated total fixed manufacturing overhead cost b = The estimated variable manufacturing overhead cost per unit of the allocation base X = The estimated total amount of the allocation base
Raw materials
a. Includes any materials that go into the final product.
We use an allocation base because:
a.It is impossible or difficult to trace overhead costs to particular jobs. b.Manufacturing overhead consists of many different items ranging from the grease used in machines to the production manager's salary. c.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.
cost driver
anything that has a cause-and-effect relationship to costs
Direct materials
are raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Equivalent units
are the product of the number of partially completed units and the percentage completion of those units.
finished goods
consist of completed units of product that have not been sold to customers
Direct labor
consists of labor costs that can be easily traced to individual units of product.
Nonmanufacturing Costs - S G&A Ruger Corporation incurred $30,000 in selling and administrative salary costs during April. The following entry summarizes the accrual of those salaries:
debit Salaries Expense 30,000 credit Salaries and Wages Payable 30,000
Transfers from Finished Goods to Cost of Goods Sold: Journal Entry Form
debit cogs, credit finished goods
Transfers from Work In Process-Dept. B to Finished Goods: Journal Entry Form, After processing has been finished in Department B, the costs of the completed units are transferred to the Finished Goods inventory account:
debit finished goods, credit wip dept b
Recording actual manufacturing overhead costs
debit manufacturing oh, credit accounts payable
The following journal entry records the labor costs recorded to Department A and Department B.
debit wip dept. a and b credit salaries and wages payable
Here is the journal entry to issue raw materials to Processing Department A and Department B.
debit wip dept.a and b credit raw materials
. The following journal entry records the overhead cost applied to Department A and Department B.
debit wip dept.a and dept.b credit manufacturing oh
Transfers from Work In Process - Dept. A to Work In Process - Dept. B: Journal Entry Form
debit wip dept.b credit wip dept. a
Recording Labor cost journal entry
debit wip, manufacturing oh, credit salaries and wages payable
Issue of Direct and Indirect Materials
debit work in process, manufacturing oh, credit raw materials
manufacturing overhead costs to wip
debit: wip, credit moh
Conversion cost
direct labor and manufacturing overhead
Conversion Cost Formula
direct labor cost plus manufacturing overhead cost
Total Manufacturing Costs
direct materials + direct labor + manufacturing overhead
Prime cost
direct materials and direct labor
direct material ex.
direct materials and direct labor
Prime Cost Formula
direct materials cost plus direct labor cost
Predetermined Overhead Rate
estimated total manufacturing overhead cost/estimated total amount of the allocation base
Overapplied overhead
exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.
Underapplied overhead
exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period.
Activity-based management
focuses on managing activities to eliminate waste and reduce processing time and defects.
Sunk cost
i. A cost that has already been incurred and that cannot be changed now or in the future.
Fixed cost
i. A cost that remains constant, in total, regardless of changes in the level of the activity. However, if expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity.
Differential costs (or incremental costs)
i. A difference in cost between any two alternatives; a difference in revenue between two alternatives is called differential revenue. Both are always relevant to decisions.
The linearity assumption and the relevant range
i. Accountants usually assume that costs are strictly linear, and can be represented by a straight line within a narrow band of activity known as the relevant range, which can be satisfactorily approximated by a straight line.
A. The traditional and contribution formats differ as follows:
i. The traditional approach separates product costs as required for external reporting purposes from selling and administrative expenses. It does not focus on cost behavior. ii. The contribution approach separates costs into fixed and variable categories. Sales - variable costs = contribution margin. The contribution margin - fixed costs = net operating income. The contribution approach is used as an internal planning, control, and decision-making tool
Period costs
i. include all selling costs and administrative costs. These costs are expensed in the income statement in the period incurred.
Product costs
include direct materials, direct labor, and manufacturing overhead. i. Includes all the costs that are involved in acquiring or making a product. Product costs "attach" to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale.
Cost of goods manufactured
includes the manufacturing costs associated with the goods that were finished during the period.
fixed cost
is a cost that remains constant, in total, regardless of changes in the level of the activity. If expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity.
Operation costing
is a hybrid of job-order and process costing because it possesses attributes of both approaches.
activity base
is a measure of what causes the incurrence of a variable cost.
activity base
is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally.
A plantwide overhead rate
is a single overhead rate that is used throughout an entire factory.
Activity-based costing
is an alternative approach to developing multiple predetermined overhead rates.
Managerial accounting
is concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions.
Financial accounting
is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators.
When it applies more overhead to production than it actually incurs, it
it results in overapplied overhead.
Equivalent units=
number of partially completed units x percentage completion
The adjustment for overapplied
overhead decreases cost of goods sold and increases net operating income.
cost behavior
refers to how a cost reacts to changes in the level of activity, The most commonly used classifications of cost behavior are variable, fixed, and mixed costs:
Cost behavior
refers to how a cost will react to changes in the level of activity.
Committed fixed costs
represent investments with a multiyear planning horizon that cannot be easily adjusted in the short term.
allocation base
such as direct labor-hours, direct labor-dollars, or machine-hours, is used to assign manufacturing overhead to individual jobs.
indirect labor
that cannot be easily or conveniently traced to specific units of product.
Overhead application
the process of assigning overhead costs to specific jobs using the following formula:
Variable Cost
varies, in total, in direct proportion to changes in the level of activity. A variable cost per unit is constant.
Direct labor has often been used as the allocation base for overhead because:
◦Direct labor information was already being recorded. ◦Direct labor was a large component of product costs. ◦Managers believed direct labor and overhead costs were highly correlated.
activity base ex
◦Units produced ◦Machine hours ◦Miles driven ◦Labor hours
Indirect costs ex
◦manufacturing overhead