ATG 614 Chapter 4

Three types of potential errors in overhead application:

1. Aggregation error (arises when plantwide rate is used instead of departmental rates) 2. Specification error (arises when the wrong cost driver is used in the application rate) 3. Measurement error (common error that arises when the amounts used for estimated overhead or cost drivers are incorrect)

Underapplied or overapplied overhead can be disposed of in two ways:

1. adjust the cost of goods sold account (done when amount over or under applied is not significant) 2. adjust the production costs of the period; allocate (prorate) the underapplied or overapplied overhead among the ending balances of work-in-process, finished goods, and cost of goods sold. (done when the amount of over or underapplied overhead is significant)

four steps to obtain predetermined overhead rate:

1. estimate total factory overhead costs for the upcoming period(usually a year) 2. select the most appropriate cost driver for applying the factory overhead costs 3. estimate the total amount of the chosen cost driver for the upcoming operating period 4. divide the estimated factory overhead costs by the estimated amount of the chosen cost driver to obtain the predetermined overhead rate

three characteristics of costing methods

1. the cost accumulation method--job costing, process costing, or joint costing 2. the cost measurement method--actual, normal, or standard costing 3. the overhead application method--volume-based or activity-based

What does the statement "accounting for overhead involves an important cost-benefit issue" mean? Why is that issue important?

Since the overhead cost cannot be traced directly to a particular product, we need a good costing system, which can assign overhead accurately to specific products. It is important to balance the cost of obtaining the appropriate cost information with the value of the information obtained.

How is job costing in a service firm different from job costing in a manufacturer?

The application of job costing is very similar in manufacturing and service firms. Some differences are that service firms are likely to have a larger proportion of direct labor in jobs than are manufacturers.

What is the role of materials requisitions in a job costing system? Time tickets? Bills of materials?

a material requisition is a source document or online data entry that is used to request materials from the warehouse. A time ticket shows the time worked on each job, the pay rate, and the total labor cost chargeable to each job. The bill of materials is a list of different materials needed to manufacture a product or part.

Overhead Application under normal costing: Activity-based costing systems

allocate factory overhead costs to products using cause-and-effect criteria with multiple cost drivers. Uses volume based and nonvolume based cost drivers to more accurately allocate overhead to products based on resource consumption during activities.

Overhead Application under normal costing: Volume-based product costing systems

allocate overhead to products or jobs using a volume-based cost driver, such as units produced

predetermined factory overhead rate

an estimate rate used to apply factory overhead cost to a specific job. obtained using four steps. Usually calculated at the beginning of the year and is used throughout the year. Equation: predetermined factory OH rate= estimated total factory overhead amount for the year/estimated total amount of cost driver for the year

Materials requisition

an online data entry or a source document that the production department supervisor uses to request materials for production. Indicates the specific job charged with the materials used.

actual factory overhead

costs are incurred each month for indirect materials, indirect labor, and other production costs(including rent, insurance, tax, depreciation, etc.)

operation costing

is a hybrid costing system that uses job costing to assign direct materials costs to jobs and process costing to assign conversion costs to products or services. Typically used when direct materials used in various products differ significantly.

Overhead application

is a process of allocating overhead costs to jobs. 2 approaches: actual and normal costing

Job Costing

is a product costing system that accumulates costs and assigns them to specific jobs, customers, projects, or contracts

Rework

is the additional work performed to make a nonconforming good acceptable so it can be sold in regular channels

factory overhead applied

is the amount of overhead assigned to a job using a predetermined factory overhead rate

Scrap

is the material left over from the manufacture of the product; it has little or no value.

Costing

is the process of accumulating, classifying, and assigning direct materials, direct labor, and factory overhead costs to cost objects, most commonly products, services, or projects

Normal Spoilage

is waste that occurs under normal operating conditions

Abnormal Spoilage

is waste that should not arise under normal operating conditions.

Distinguish between job costing and process costing.

job costing is a project costing system that accumulates and assigns costs to a specific job. Process costing accumulated product or service costs by process or department and then assigns them to a large number of nearly identical products.

Cost accumulation: Job costing

jobs consist of individual products or batches; Appropriate when most costs incurred for the job can be readily identified with a specific product, batch of product, customer order, contract, or project. Types of companies include: construction, printing, custom furniture manufacturing etc. Push method: fills a warehouse. Pull method: based on customer demand

Cost accumulation: Process costing

likely to be found in a firm that produces one or a few homogenous products or services; firms often have continuous mass production. Common industries include: chemical industry, bottling companies, plastics, food products, and paper products.

Plantwide method of normal costing

moves the allocated overhead out of the Factory Overhead account and assigns it to a particular job; total overhead for all departments is used to determine the overhead rate.

Job cost sheet

records and summarizes the costs of direct materials, direct labor, and factory overhead for a particular job. The basic supporting document in a job costing system. Includes all three cost elements (materials, labor, overhead) as well as other detailed data required by management. Follows the product as it goes through the production process.

Spoilage

refers to an unacceptable unit that is discarded or sold for disposal value

Which costing system is extensively used in the service industry for hospitals, law firms, or accounting firms? Why?

service industry companies usually use a job costing system because the materials and labor used for the client or patient etc. are easily traced to that particular client or patient.

Time ticket

shows the time an employee worked on each job, the pay rate, and the total labor cost chargeable to each job. Usually part of a costing software system.

departmental overhead rate

similar to plantwide; when the usage of resources in departments differ significantly from one job to another, then this approach is considered more appropriate and accurate since job cost is based on the actual usage of the different departments, not an overall average.

underapplied overhead

the amount by which actual factory overhead exceeds factory overhead applied.

overapplied overhead

the amount of factory overhead applied that exceeds actual factory overhead cost.

what is the strategic role of a costing system?

to provide accurate cost information that is needed for product pricing, profitability analysis of products and customers, evaluation of managers, and refinement of strategic goals.

Cost Measurement: Normal costing system

uses actual costs for direct materials and direct labor, and applies factory overhead to jobs using a predetermined allocation rate. Involves estimating a portion of overhead to be assigned to each product as it is produced. Provides a timely estimate of the cost of producing each product or job.

Cost Measurement: Actual costing system

uses actual costs incurred for all products, including direct materials, direct labor, and factory overhead.

Cost Measurement: Standard costing system:

uses standard costs and quantities for all three types of manufacturing costs: direct materials, direct labor, and factory overhead.