AC 351 Exam 1

Product Costs (cost classifications for preparing financial statements)

*recorded on income statement when related products are sold for financial accounting: includes all costs 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 an asset) as long as it remains in inventory awaiting sale. When units of product are sold, their costs are released from inventory as expenses and matched against sales on the income statement as cost of goods sold for manufacturing companies: includes direct materials, direct labor, and manufacturing overhead. a manufacturers product costs flow through three inventory accounts on the balance sheet - raw materials, work in process, and finished goods - prior to being recorded in cost of goods sold on the income statement

Over or underapplied overhead must be disposed of in 1 of 2 ways

1. it can be closed to cost of goods sold 2. it can be closed proportionally to work in process, finished goods, and cost of goods sold

Why do companies assign costs to their products and services?

1. it helps them fulfill their planning, controlling, and decision-making responsibilities 2. it helps them determine the value of ending inventories and cost of goods sold for external reporting purposes

Assigning manufacturing overhead costs to a specific job is difficult because

1. manufacturing overhead is an indirect cost, making it difficult or impossible to trace costs to a specific job 2. manufacturing overhead consists of many different types of cost ranging from glue to annual salaries. some are fixed and some variable 3. many companies have large amounts of fixed manufacturing overhead, meaning it stays fairly constant from one period to the next even though # of units can greatly vary - so avg cost per unit will vary from one period to next

Unadjusted Cost of Goods Sold

= beginning finished goods inventory + cost of goods manufactured - ending finished goods inventory unadjusted cost of goods sold + underapplied overhead (OR -overapplied overhead) = adjusted cost of goods sold

Raw Materials used in production (COGM)

= beginning raw materials inventory + purchases of raw materials - ending raw materials in inventory

Contribution margin

= sales - variable costs contributes towards covering the fixed costs and then towards profits for the period can be stated on a per unit basis if divided by # of units sold

Cost of Goods Manufactured (schedule of COGM)

= total manufacturing costs + beginning work in process inventory - ending work in process inventory

Activity cost pool

A "bucket" in which costs are accumulated that relate to a single activity measure in an activity-based costing system.

Absorption costing

A costing method that includes all manufacturing costs—direct materials, direct labor, and both variable and fixed manufacturing overhead—in unit product costs. all manufacturing costs are matched to units of product

Materials requisition form

A document that specifies the type and quantity of materials to be drawn from the storeroom and that identifies the job that will be charged for the cost of those materials.

Predetermined overhead rate

A rate used to charge manufacturing overhead cost to jobs that is established in advance for each period. It is computed by dividing the estimated total manufacturing overhead cost for the period by the estimated total amount of the allocation base for the period.

Schedule of Cost of Goods Manufactured

A schedule that contains 3 elements of product costs - direct materials, direct labor, and manufacturing overhead - and that summarizes the portions of those costs that remain in ending work in process inventory and that are transferred out of work in process to finished goods

Schedule of Cost of Goods Sold

A schedule that contains three elements of product costs—direct materials, direct labor, and manufacturing overhead—and that summarizes the portions of those costs that remain in ending Finished Goods inventory and that are transferred out of Finished Goods into Cost of Goods Sold.

Cost of Goods Manufactured

A transfer of costs is made within the costing system that parallels the physical transfer of goods to the finished goods warehouse. The costs of the completed job are transferred out of the work in process account into the finished goods account. The sum of all amounts transferred between these two accounts represents the Cost of Goods Manufactured for the period Job A was completed in April and totaled $158,000. Because Job A was the only job completed during April it represents the cost of goods manufactured for the month. The balance of uncompleted jobs is carried over into the next month and remains in work in process Debit: Finished Goods 158,000 Credit: Work in Process 158,000

Mixed costs (cost classifications for predicting cost behavior)

AKA semivariable costs contains both variable and fixed cost elements. total mixed cost = total fixed cost + variable cost per unit * activity level ex: white water rafting company incurs a mixed cost called fees paid to the state. It includes a license fee of $25,000 per year plus $3 per rafting party paid to the state's dept. of natural resources. y = 25,000 + 3x

Other Manufacturing Overhead Entries

All manufacturing overhead costs are debited to the manufacturing overhead account as soon as they are incurred Assume Ruger Corporation recognized $13,000 in accrued property taxes and $7,000 in prepaid insurance expired Debit: Manufacturing Overhead 20,000 Credit: Property taxes payable 13,000 Credit: Prepaid insurance 7,000 Assume the company recognized $18,000 in depreciation of factory equipment Debit: Manufacturing Overhead 18,000 Credit: Accumulated Depreciation 18,000

Cost of Goods Sold Entries

As finished goods are shipped to customers, their costs get transferred from Finished Goods to Cost of Goods Sold. If the entire job is shipped, then the entire cost is transferred, but if only a portion is immediately sold, unit product cost is used to determine how much product cost should be transferred Assume 750 of 1,000 units was sold by the end of the month for a sales revenue of $225,000. Because 1,000 units were produced and the total cost was $158,000, the unit cost is $158. 158*750= $118,500 Debit: Accounts Receivable 225,000 Credit: Sales 225,000 Debit: Cost of Goods Sold 118,500 Credit: Finished Goods 118,500

Basic Manufacturing Overhead Entry

Debit: Manufacturing overhead 40,000 Credit: Accounts Payable* 40,000 *or cash

Issue of Direct and Indirect Materials

During April, materials requistion forms were prepared to authorize withdrawing $52,000 in raw materials from the storeroom for use in production. These raw materials included $50,000 of direct materials and $2,000 of indirect materials Debit: Work in Process 50,000 Debit: Manufacturing Overhead 2,000 Credit: Raw Materials 52,000

Labor Cost

In April, the employee time tickets included $60,000 recorded for direct labor and $15,000 for indirect labor. The entry is: Debit: Work in Process 60,000 Debit: Manufacturing Overhead 15,000 Credit: Salaries and Wages Payable 75,000 Only the direct labor cost is added to the work in process account - also added to the individual job cost sheet at same time

Need for Predetermined Overhead Rate

Many factors can cause fluctuations in actual overhead rate. To avoid fluctuations, actual overhead rates could be computed less frequently, but then a job's actual overhead would not be known until the end of the year or when computed.

Purchase and issue of materials

On April 1, Ruger Corp. had $7,000 in raw materials on hand. During the month, the company purchased on acct. and add $60,000 in raw materials. The purchase is recorded: Debit: Raw Material 60,000 Credit: Acct. Payable 60,000 Raw material is an asset account when raw material are purchased they are initially recorded as an asset - Not an expense

Nonmanufacturing Costs

Period expenses and should be charged directly to the income statement - have no effect on product costs should not go into the manufacturing overhead account -Assume Ruger corporation incurred $30,000 in selling and administrative salary costs during April Debit: Salaries Expense 30,000 Credit: Salaries and Wages Payable 30,000 -Assume depreciation on office equipment during April was $7,000 Debit: Depreciation Expense 7,000 Credit: Accumulated Depreciation 7,000 -Assume advertising was $42,000 and other selling and administrative expenses in april totaled $8,000 Debit: Advertising expense 42,000 Debit: Other selling and administrative expense 8,000 Credit: Accounts Payable* 50,000 *or cash

Applying Manufacturing Overhead journal entry

Use the predetermined overhead rate Assume the predetermined overhead rate is $6 per machine hour, and there were 15,000 machine hours worked in a period Debit: Work in Process 90,000 Credit: Manufacturing Overhead 90,000

Direct cost (assigning cost to cost objects)

a cost that can be easily and conveniently traced to a specific cost object ex: the salary of the sales manager at a specific office is a direct cost to that office

Indirect cost (assigning cost to cost objects)

a cost that cannot be easily and conveniently traced to a specified cost object. (to be traced to a cost object such as a particular product, the cost must be caused by the cost object) ex: a factory makes several varieties of canned soups. the factory manager's salary is an indirect cost of producing chicken noodle soup, one of their varieties. the cost is indirect because the salary cannot be traced to one specific variety of soup. this is a common cost, a type of indirect cost.

Sunk cost (cost classifications for decision making)

a cost that has already ben incurred and that cannot be changed by any decision made now or in the future. are not differential costs because they cannot be changed. irrelevant, should be ignored in decisions ex: a company paid $50,000 ten years ago to make a product that is no longer sold.

Common cost

a cost that is incurred to support a number of cost objects but cannot be traced to them individually. type of indirect cost

Job Order Costing

a costing system used in situations where many *different* products, jobs, or services are produced each period costs are traced and allocated to jobs, and then the costs of the job are divided by the # of units to arrive at avg cost per unit

Bill of materials

a document that lists the type and quantity of each type of direct material needed to complete a unit of product

Cost driver

a factor, such as machine hours, beds occupied, computer time, or flight hours that causes overhead costs. i.e. what drives the overhead costs

Job cost sheet

a form that records the direct materials, direct labor, and manufacturing overhead costs charged to a job

Allocation base

a measure such as direct labor-hours or machine hours that is used to assign overhead costs to products and services

Plantwide overhead rate

a single predetermined overhead rate that is used throughout a plant, usually direct labor hours or cost often overly simplistic and incorrect to assume that direct labor hours is a company's only manufacturing overhead cost driver

Activity based absorption costing vs traditional absorption costing

activity-based uses more cost pools than traditional activity-based includes some activities and activity measures that do not relate to the volume of units produced, where the traditional relies exclusively on allocation bases that are driven by volume of production

Cost of a completed job

actual direct materials cost, actual direct labor cost, and manufacturing overhead applied (based on estimates - actual overhead costs do not get charged to jobs and do not appear on job cost sheet or work in process account)

Administrative costs (nonmanufacturing costs)

all costs associated with the general management of an organization rather than with manufacturing or selling can be direct (salary of an accounting manager in charge of accounts in the east region is a direct cost of that region) or indirect (salary of a CFO who oversees all of a company's regions) ex: executive compensations, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration as a whole.

Selling costs (nonmanufacturing costs)

all costs that are incurred to secure customer orders and get the finished product to the customer. can either be direct (advertising campaign for specific product) or indirect (salary of a marketing manager that oversees numerous products) sometimes called order-getting and order-filling costs ex: advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.

Subsidiary ledger

all of a company's job cost sheets set of financial records that explain what specific jobs comprise the amounts reported in work in process, finished goods, and cost of goods sold

Quality cost / cost of quality

all of the costs that are incurred to prevent defects or that result from defects in products four groups: prevention, appraisal, internal failure, external failure

Period costs (cost classifications for preparing financial statements)

all the costs that are not product costs. all selling and administrative expenses are treated as period costs recorded in the period the expenses are incurred using the usual rules of accrual accounting ex: sales commissions, advertising, executive salaries, public relations, rental costs of administrative offices

Discretionary fixed costs

also known as managed fixed costs usually arise from annual decisions by management to spend on certain fixed cost items can be cut for short periods with minimal damage to the long-run goals of an organization ex: advertising, research, PR, management development programs

Product-level activity

an activity that relates to specific products and typically must be carried out regardless of how many batches are run or units of product are produced and sold includes tasks such as designing a product and making engineering design changes to a product depends on the number of products supported rather than the number of batches run or the number of units of product produced and sold

Activity measure

an allocation base that is used as the denominator for an activity cost pool

Time ticket

an hour-by-hour summary of the employee's activities throughout the day. helps automatically post direct labor costs to job cost sheets. (indirect labor is treated as manufacturing overhead and does not get posted to job cost sheets)

Contribution approach

an income statement format that organizes costs by their behavior. costs are separated into variable and fixed categories rather than being separated into product and period costs for external reporting purposes aids planning, controlling, and decision making

Raw materials

any materials that are used in the final product the finished product of one company can become the raw materials of another company ex: the plastics produced by one company are raw material another company uses in its personal computers.

Cost object

anything for which cost data are desired, including products, customers, and organizational subunits

Normal cost system

applies overhead cost to jobs by multiplying a predetermined overhead rate by the actual amount of the allocation base incurred by the jobs

Activity-based absorption costing

assigns all manufacturing overhead costs to products based on the activities performed to make those products activity: an event that causes the consumption of manufacturing overhead resources

Matching principle

based on the accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized

Quality cost range should be

between 2% and 4%

The key to job cost accuracy is

choosing the correct allocation base

Fixed cost (cost classifications for predicting cost behavior)

cost that remains constant, in total, regardless of changes in the level of activity. always remains constant unless influenced by an outside force, such as a landlord increasing rent fixed cost per unit can change depending on amount of units produced. activity level increases, fixed cost per unit decreases, and vice versa. as a general rule it is not recommended to report fixed cost on an average per unit basis on internal reports because it can give the false impression of the fixed cost changing as the activity level changes manufacturing examples: depreciation, insurance, property taxes, rent, supervisor salaries

Differential cost & revenue (cost classifications for decision making)

cost: a future cost that differs between any two alternatives revenue: future revenue that differs between any two alternatives always relevant costs. only the differences between alternatives are relevant; all items not affected by the decision in question can be ignored can be fixed or variable AKA incremental cost, however, incremental cost should technically only refer to an increase in cost from one alternative to another, and decreases should be referred to as decremental costs. Differential costs encompasses both of these

Quality cost report

details the prevention costs, appraisal costs, and costs of internal and external failures that arise from the company's current quality control efforts helps managers see the financial significance of defects helps managers identify where to focus their quality efforts helps managers see whether their quality costs are poorly distributed

Making decisions (cost classifications)

differential cost (differs between alternatives) sunk cost (should be ignored) opportunity cost (forgone benefit)

Total job cost

direct materials + direct labor + manufacturing overhead

Total manufacturing costs (COGM)

direct materials + direct labor + manufacturing overhead applied to work in process

Prime cost

direct materials cost + direct labor cost

Managers use job cost information to

establish plans, make advertising and product decisions, make pricing decisions

Appraisal costs (quality cost)

goal is to catch defects before they make it to customer incurred in an effort to keep defective products from falling into the hands of customers maintaining an army of inspectors is expensive and ineffective when it comes to quality control ex: test and inspections, maintenance of test equipment, depreciation of test equipment key words: test, inspection

Prevention costs (quality cost)

goal to avoid having defects in the first place incurred in an effort to keep defective products from falling into the hands of customers ex: systems development, quality engineering, quality training, supervision of prevention activities, audits of the effectiveness of the quality system key words: quality, prevention

Manufacturing overhead (manufacturing costs)

includes all manufacturing costs except direct materials and direct labor. ex: indirect materials, indirect labor, depreciation, utility costs, property taxes, insurance premiums that are associated with operating the factory

Assigning cost to cost objects (cost classifications)

indirect costs direct costs

Process costing

is used most commonly in industries that convert raw materials into homogeneous (i.e. the same) products, such as bricks, soda, or paper, on a continuous basis ex of companies that would use process costing: Scott Paper (paper towels), General Mills (flours), ExxonMobile (gasoline and lubricating oils), Coppertone (sunscreens), and Kellogg's (breakfast cereals), may also be used in utilities that produce gas, water, and electricity

When a company uses predetermined overhead rates to apply overhead costs to jobs,

it is almost a certainty that the amount of overhead applied to all jobs during a period will differ from the actual amount of overhead costs incurred during the period when a company applies less overhead than it actually incurs, it's called *underapplied overhead* (adjustment increases cost of goods sold and decreases net operating income) when a company applies more overhead than it actually incurs, it is called *overapplied* overhead (adjustment decreases cost of goods sold and increases net operating income)

Basing the predetermined overhead rate on activity at capacity

keeps the predetermined overhead rate per unit stable and doesn't make the product shoulder the cost of unused capacity ex: machine is capable of producing 100,000 units but demand is only 60,000 units. this method would use 100,000 as the denominator instead of 60,000 and account for the unused capacity

Direct labor (manufacturing costs)

labor costs that can be easily traced to individual units of product. sometimes called touch labor ex: assembly line workers, carpenters, electricians

Unused Capacity

machine is capable of producing 100,000 units but demand is only 60,000 units. this method would use 100,000 as the denominator instead of 60,000 and account for the unused capacity by: (amt of allocation base at capacity - actual amt of allocation base) * predetermined overhead rate (100,000-60,000) x $0.02 = $800 is the cost of unused capacity Used for internal reporting. Should be reported as a period cost on income statement as "cost of unused capacity" under "other expenses"

Accounting for costs in manufacturing companies (cost classifications)

manufacturing costs: direct materials indirect materials manufacturing overhead nonmanufacturing costs: selling costs administrative costs

Activity base

measure of whatever causes the incurrence of a variable cost, sometimes referred to as a cost driver. common activity bases are direct labor-hours, machine-hours, units produced, and units sold other examples: miles driven by salesperson, pounds of laundry cleaned by a hotel, number of calls handled by tech support staff assume activity base under consideration is total output (total volume of goods and services provided) unless stated otherwise

Closing over or underapplied overhead proportionally to work in process, finished goods, and cost of goods sold

more accurate (and complex) than closing completely into COGS 1. break down total overhead cost applied during the period into three pieces - the portion in work in process at the end of the period, the portion in finished goods at the end of the period, and the portion applied to COGS during the period 2. state each of these three amounts as a percent of the total overhead cost applied during the period 3. derive the amounts needed for the journal entry by multiplying the percentages from step 2 by the amount of overapplied or underapplied overhead Manufacturing overhead applied to production = 90,000 (Underapplied overhead = 5,000) manufacturing overhead applied to job A = 60,000 manufacturing overhead applied to job B = 30,000 Job A = 15,000 in finished goods, 45,000 in COGS Job B= 30,000 in work in process FG: 15000/90000=16.67%, COGS: 45000/90000=50%, WIP: 30000/90000=33.33% FG: .1667 x 5000 = $833.50 COGS: .5 x 5000 = $2,500 WIP: .3333 x 5000 = $1,666.50 ENTRY: Debit: work in process 1,666.50 Debit: finished goods 833.50 Debit: cost of goods sold 2,500 Credit: manufacturing overhead 5,000 (opposite debits and credits if overhead had been overapplied)

Batch-level activity

performed each time a batch is handled or processed, regardless of how many units are in the batch. the amount of resources consumed depends on the number of batches run rather than the number of units in the batch includes tasks such as placing purchase orders, setting up equipment, and transporting batches of component parts

Opportunity cost (cost classifications for decision making)

potential benefit that is given up when one alternative is selected over the other. not found in accounting records, but must be explicitly considered in every decision a manager makes. virtually every alternative involves an opportunity cost ex: you get paid $200/week. you decide to take a week off for vacation. $200 in lost wages is an opportunity cost of going on vacation

Preparing financial statements (cost classifications)

product costs (inventoriable) period costs (expensed)

ISO 9000 standards

quality control guidelines international measure of quality

Indirect materials (manufacturing overhead)

raw materials such as solder to make electrical connections or glue to hold chair together. cannot be easily or conveniently traced to finished products

Direct materials (manufacturing costs)

raw materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product. ex: the seats Airbus purchases to put in their commercial aircraft, or the electronic components Apple uses in its iphones

Indirect labor (manufacturing overhead)

refers to employees, such as janitors, supervisors, materials handlers, maintenance workers, and night security guards, that play an essential role in running a manufacturing facility; however, the cost of compensating these people cannot be easily or conveniently traced to specific units of product

Cost behavior

refers to how a cost reacts to changes in the level of activity. as activity level rises and falls, a particular cost may rise and fall as well - or it may remain constant. for planning purposes, a manager must be able to anticipate which of these will happen.

Committed fixed costs

represents organizational investments with a multiyear planning horizon that can't be significantly reduced even for short periods of time without making fundamental changes ex: investments in facilities and equipment, as well as real estate taxes and insurance premiums and salaries of top managment

Internal failure costs (quality cost)

result from identifying defective products before they are shipped to customers. price paid to avoid external failure costs incurred because defects occur despite efforts to prevent them ex: net cost of scrap, net cost of spoilage, rework labor, downtime caused by quality problems, disposal of defective products, analysis of the cause of defect, keying errors

External failure costs (quality cost)

result when a defective product is delivered to a customer incurred because defects occur despite efforts to prevent them ex: cost of field service and handling complaints, warranty repairs/replacements, product recalls, liability, lost sales

Quality circles

small groups of employees that meet on a regular basis to discuss ways to improve quality related to prevention costs

A company can reduce total quality cost by

spending more & focusing on prevention and appraisal

Conversion cost

sum of direct labor and manufacturing overhead these costs are incurred to convert direct materials into finished products

Activity rate

the cost accumulated in the numerator of an activity cost pool divided by the quantity of the activity measure in its denominator

Cost of goods manufactured

the manufacturing costs associated with units of product that were finished during the period as jobs are sold they are transferred from finished goods to cost of goods sold and at this point they are finally recorded as an expense on the income statement (before they are in inventory accounts on the balance sheet)

What is the cause of underapplied or overapplied overhead?

the method of applying overhead jobs using a predetermined overhead rate assumes that actual overhead costs will be proportional to the actual amount of the allocation base incurred during the period in reality, much of the overhead often consists of fixed costs that do not change as the number of machine hours incurred goes up or down. additionally, spending on overhead items may or may not be under control. if individuals responsible for overhead costs do a good job, costs should be less than expected, and if the individuals do a poor job, the costs will be more than expected

Overhead application

the process of assigning overhead cost to jobs overhead applied to a particular job = predetermined overhead rate * amount of the allocation base incurred by the job is not the actual amount of overhead caused by the job, is simply a share of the total overhead that was estimated at the beginning of the year

If a product has high *quality of conformance* that means

the product meets or exceeds its design specifications and is free of defects that diminish its appearance or degrade its performance AKA no defects

Relevant range

the range of activity within which the assumption that cost behavior is strictly linear is reasonable valid narrow steps (such as salaried employees) are often called step-variable costs, while wider steps are treated as fixed costs within the relevant range ex: the Mayo Clinic rents a machine for $20,000/month that can test up to 3,000 blood samples in a month. the assumption that the rent for the machine is $20,000/month is only valid for 0-3,000 samples. if the clinic needed to test 5,000 samples/month, they would need to rent a second machine. so the fixed cost is $20,000 for 0-3,000 samples, $40,000 for 3,001-6,000 samples, and so on. increases in discrete steps instead of a linear fashion

Cost structure

the relative proportion of fixed, variable, and mixed costs in an organization

Traditional income statements vs Contribution format income statements

traditional are used for external reporting purposes. rely on cost classifications for preparing financial statements (product and period costs) to depict the financial consequences of past transactions contribution format are prepared for internal management purposes, they use cost classifications for predicting costs behavior (variable and fixed costs) to better inform decisions affecting the future

Closing over or underapplied overhead to cost of goods sold

underapplied overhead by $5,000 Debit: Cost of Goods Sold 5,000 Credit: Manufacturing overhead 5,000 (opposite for overapplied overhead - debit manufacturing overhead and credit cost of goods sold) this has the effect of increasing cost of goods sold and decreasing net operating income

Multiple predetermined overhead rates

uses more than one overhead rate to apply overhead costs to jobs (either department based or activity based) more complex and more accurate because it reflects differences among jobs or departments in terms of how they consume overhead costs

Predicting cost behavior in response to changes in activity (cost classifications)

variable cost (proportional to activity) fixed cost (constant in total) mixed cost (variable and fixed elements)

Variable cost (cost classifications for predicting cost behavior)

varies in direct proportion to changes in the level of activity. i.e. cost is variable with respect to its activity base total variable costs change as activity levels change, but variable cost is constant if expressed on a per unit basis (ex: $30 per catered meal) ex: cost of goods sold for a merchandising company, direct materials, direct labor, indirect materials, commissions, shipping costs