Chapter 2 power point

Different types of companies use different types of cost systems. An effective cost system must have all of the following three characteristics:

1. Decision focus. It meets the needs of decision makers. 2. Different costs for different purposes. It can provide different cost information for different purposes. For example, it provides variable costs for decision making and full absorption costs for external reporting. 3. Cost-benefit test. It must meet a cost-benefit test. The benefits from the cost system must exceed its costs.

Normal costing applies overhead costs to production using four steps:

1. Select a cost driver, or allocation base, for applying overhead to production; (Cost drivers cause an activity's costs.) 2. Estimate the dollar amount of overhead and the level of activity for the period; 3. Compute the predetermined (or normal) overhead rate; and 4. Apply overhead to production by multiplying the predetermined rate.

the accounting system serves two purposes in manufacturing and service companies:

1. to record costs by responsibility center (department) for performance evaluation and cost control, and 2. to assign manufacturing costs to units produced (or customers served) for product (or customer) costing.

The five steps required to compute product costs, the cost of ending Work-in- Process Inventory, and the cost of finished goods using equivalent units are:

1.Summarize the Flow of Physical Units 2. Compute Equivalent Units (For example, two units, each 50% complete, represent one equivalent unit.) 3. Summarize Costs to Be Accounted For 4. Compute Unit Costs for the Current Period 5. Compute the Cost of Goods Completed and Transferred Out of Work-in-Process and the Cost of Ending Work-in-Process Inventory

Characteristics of JIT

A just-in-time inventory method reduces, or potentially eliminates, inventories and the cost of carrying them. Just-in-time compels workers to immediately correct a process making defective units because they have no inventory where they can hide defective units. Eliminating inventories helps expose production problems. With no inventory to draw from for delivery to customers, just-in-time relies on high-quality materials and production. Because just-in-time production responds to an order receipt, JIT accounting can charge all costs directly to cost of goods sold.

Basic cost flow equation: Recall from financial accounting. Beginning balance + additions -withdrawals = ending balance

Accounting systems all use the following basic cost flow equation, which is: Beginning Balance + Transfers In = Transfers Out + Ending Balance BB+ TI = TO +EB

How are materials, labor NOT directly traceable to a product categorized?

All costs, including materials and labor, not directly traceable to a product are categorized as Manufacturing Overhead. Examples include materials and labor not easily traced to a product and other manufacturing costs (excluding direct materials and direct labor) such as depreciation and insurance for the factory building, heat, light, power, and similar expenses incurred to keep the factory operating.

Process costing

Companies manufacturing with continuous flow processes use process costing to account for product costs. For standardized production Users: drink makers e.g. Coca Cola

Job costing

Companies producing customized products use job costing to record the cost of their products. For custom production jobs Users: accounting and consulting firms, health care organizations

what happens to inventory leftover after costs are charged to cost of goods sold in a JIT system?

Companies that record costs directly in Cost of Goods Sold can use a method called back flush costing to transfer any costs back to the inventory accounts, if necessary Back flush costing is a method that works backward to remove the costs from the output and then to assign manufacturing costs to Work-in-Process inventories.

Cost flow

Costs flow from basic records of materials purchases, labor costs, and overhead costs to Work-in-Process Inventory accounts that show the cost of ongoing work. When products are complete, they and their costs are transferred to Finished Goods Inventory. When sold, the cost of the products is transferred out of Finished Goods Inventory to Cost of Goods Sold.

What are equivalent units?

Equivalent units (E.U.) represent the translation of partially completed work into equivalent whole units.

Manufacturing Overhead

Includes all other costs of transforming the materials to a finished product. The third category is manufacturing overhead, which includes all the other costs of transforming the materials to a finished product.

Responsibility Center

Is any organizational unit with its own manager or managers. Experts design managerial accounting systems to serve several purposes. For purposes of planning and performance evaluation, accountants record costs by department or other responsibility centers. A responsibility center is any organizational unit with its own manager or managers. Divisions, territories, plants, and departments all exemplify responsibility centers.

Direct Labor

Is labor of workers who transform materials into a finished product. The second category is direct labor, which is labor of workers who transform materials into a finished product.

Comparing cost systems Job costing and process costing

Management generally finds that the comparative costs and benefits of job and process costing indicate matching the cost system to the production methods, where heterogeneous unit production of large units is best served by job costing and homogeneous production of many small units in a continuous process is best served by process costing.

Operation costing

Many companies use a hybrid of job and process costing, called operation costing. a hybrid of job and process combined Users: Levi Strauss, Dell

Two approaches to determining overhead cost include:

Normal costing and Actual costing.

Normal costing

Normal costing assigns the actual direct material and direct labor costs to products plus an amount representing "normal" manufacturing overhead. Under normal costing, a firm derives a rate for applying overhead to units produced before the production period, often a year, begins. The firm uses this rate in applying overhead to each unit as the firm produces it throughout the period.

Assume that Plantimum actually used 4,500 direct labor hours for the month. How much variable overhead did Plantimum charge to production for the month? How much fixed overhead?

Plantimum would apply the following overhead to production: Variable overhead = 4,500 direct labor hours times $2.00 per direct labor hour = $9,000 4,500hrs x $2.00 = $9,000 labor per hr Fixed overhead = = 4,500 direct labor hours times $1.00 per direct labor hour = $4,500 4,500 direct labor hr x $1 = $4,500

Actual costing

Rather than assigning normal overhead to products, accounting can assign the actual overhead costs incurred. Assigning normal overhead costs to products has advantages over assigning actual costs because it is more timely due to estimation. Actual total manufacturing overhead costs may fluctuate because of seasonality (the cost of utilities, for example) or for other reasons not related directly to activity levels. Also, if production is seasonal and total overhead costs remain unchanged, the per-unit costs in low-volume months will exceed the per-unit costs in high-volume months. Normal costs enable companies to smooth out, or normalize, these fluctuations.

For the service organization, the income statement reports:

Revenue less cost of services billed equals gross margin less expenses equals operating profit. Revenue - Cost of service billed = Gross Margin - Expense (e.g., unbilled direct labor, underapplied overhead, marketing expenses) = Operating Profit.

Normal costing advantages

Smooths seasonal and other fluctuations that don't relate directly to activity levels. More timely than actual because of estimating process.

What is the three separate accounts in each of the manufacturing departments?

The accounting system records the costs of direct materials, direct labor, and manufacturing overhead incurred in production. It uses three separate accounts in each of the manufacturing departments. Management then compares these costs with the standard or budgeted amounts and investigates significant variations, called variances. In recording costs by departments, the accounting system has served its function of providing data for departmental performance evaluation. The accounting system also assigns costs to products for managerial decision making, such as evaluating a product's profitability.

Flow of costs: Service Company Service requires labor, overhead, and sometimes materials. In consulting, public accounting, and similar service organizations, the firm collects costs by job or client and uses an accounting method similar to that used in manufacturing job shops.

The firm collects costs by job for performance evaluation, to provide information for cost control, and to compare actual with estimated costs for pricing of future jobs. The flow of costs accounted for include: Materials and overhead costs are transferred into Work-in-Process accounts for each job; and Work-in-Process costs are transferred to Cost of Services Billed.

Platinum Builders manually assembles small modular homes. In the previous year data, Platinum estimated variable manufacturing overhead cost was $100,000, 50,000 direct labor hours, and $50,000 fixed manufacturing over head The company expects the same level of activity and costs for this year. What is the variable overhead rate? What is the fixed overhead rate?

The predetermined or variable overhead rate is $100,000 divided by 50,000 direct labor hours which equals $2.00 per direct labor hour. 100,000/50,000= 2.00 The fixed overhead rate is $50,000 divided by 50,000 direct labor hours which equals $1.00 per direct labor hour. $50,000/ 50,000= $1

Direct materials

can be easily traced directly to a product. Recording costs for a manufacturing company requires more complexity than does recording costs for a retail, wholesale, or service company. Companies divide manufacturing costs into three major categories. The first category is direct materials, which are easily traced directly to a product.