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