COST MANAGEMENT

1. COST MANAGEMENT Don R. Hansen Maryanne M. Mowen

2. Chapter Four Product and Service Costing: Overhead Application and Job-Order System

3. Learning Objectives • Differentiate the cost accounting systems of service and manufacturing firms and of unique and standardized products. • Discuss the interrelationship of cost accumulation, cost measurement, and cost assignment. • Compute a predetermined overhead rate, and use the rate to assign overhead to production.

4. Learning Objectives (continued) • Explain the difference between job-order and process costing, and identify the source documents used in job-order costing. • Describe the cost flows associated with job-order costing, and prepare the journal entries. • Explain why multiple overhead rates may be preferred to a single, plantwide rate.

5. Manufacturing Firms VersusService Firms Manufacturing involves putting together materials, labor, and overhead to produce a new product. The good produced is tangible and can be inventoried and transported from the plant to the customer. A service is characterized by its intangible nature. It is not separable from the customer and cannot be inventoried.

6. Interface of Services with theCost Management System 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity

7. Intangibility Relationship to Business Impact on Cost Management System Services cannot be stored. Services cannot be protected through patents. Services cannot readily be displayed or communicated. Prices are difficult to set. There are no inventory accounts. There is a strong ethical code.* Costs must be related to entire organization.* *Many of these effects are also true of tangible products.

8. Inseparability Relationship to Business Impact on Cost Management System Consumer is involved in production. Other consumers are involved in production Centralized mass production of services is difficult. Costs often accounted for by customer type.* System must be generated to encourage consistent quality.* *Many of these effects are also true of tangible products.

9. Heterogeneity Relationship to Business Impact on Cost Management System Standardization and quality control are difficult. A strong systems approach is needed. Productivity measurement is ongoing.* Total quality management is critical.* *Many of these effects are also true of tangible products.

10. Perishability Relationship to Business Impact on Cost Management System Service benefits expire quickly. Service may be repeated often for one customer. There are no inventories. There needs to be a standardized system to handle repeat customers.* *Many of these effects are also true of tangible products.

11. Relationship of Cost Accumulation, Cost Measurement, and Cost Assignment Cost Measurement Classify Costs: Cost Assignment Assign to Cost Objects: Cost Accumulation Record Costs: Purchase materials Assemblers’ payroll Finishers’ payroll Supervisors’ payroll Depreciation Utilities Property taxes Landscaping Direct Materials Direct Labor Overhead Product 1 Product 2

12. Cost Accumulation Cost accumulation refers to the recognition and recording of costs. The cost accountant needs to develop source documents, which keep track of costs as they occur. A source document describes a transaction. Data from these source documents can then be recorded in a data-base. Well-designed source documents can supply information in a flexible way.

13. Cost Measurement There are two commonly used ways to measure the costs associated with production: actual costing and normal costing. An actual cost system uses actual costs for direct materials, direct labor, and overhead to determine unit cost. Normal costing systems measure overhead costs on a predetermined basis and use actual costs for direct materials and direct labor.

14. Johnson Leathergoods - Example Suppose that Stan Johnson forms a new company, Johnson Leathergoods, which specializes in the production of custom leather products. Stan believes that there is a market for one-of-a-kind leather purses, briefcases, and backpacks. In its first month of operations, he obtains two orders: the first is for 20 leather backpacks for a local sporting goods store; the second is for 10 distinctively tooled briefcases for the coaches of a local college. Stan agrees to provide these orders at a price of cost plus 50 percent.

15. Johnson Leathergoods - Unit Cost Direct materials $1,000 Direct labor 1,080 Overhead 240 Total $2,320  number of units  20 Unit cost $ 116 ======

16. Overhead Application a NormalCosting View A predetermined overhead rate is calculated using the following formula: Overhead rate = Budgeted annual overhead/Budgeted annual activity level

17. Choosing the Activity Base 1. Units produced 2. Direct labor hours 3. Direct labor dollars 4. Machine hours 5. Direct materials

18. Choosing the Activity Level Expected activity level is simply the production level the firm expects to attain for the coming year. Normal activity level is the average activity usage that a firm experiences in the long term (normal volume is computed over more than one year). Theoretical activity level is the absolute maximum production activity of a manufacturing firm. Practical activity level is the maximum output that can be realized if everything operates efficiently.

19. Basic Concept of Overhead Application In attempting to understand the concept of applied overhead, there are two points that should be emphasized. 1. Applied overhead is the basis for computing per-unit overhead cost. 2. Applied overhead is rarely equal to a period’s actual overhead.

20. Overhead Application Example Suncalc, Inc., produces two unique, solar-powered products: a pocket calculator and a currency translator used to convert foreign currency exchange rates into dollars and vice versa. The company has the following estimated and actual data for 2001: Budgeted overhead $360,000 Normal activity (in direct labor hours) 120,000 Actual activity (in direct labor hours) 100,000 Actual overhead $320,000

21. Overhead Application Example (continued) Now assume that the firm bases its predetermined overhead rate on normal activity measured in direct labor hours (DLH). Thus, for 2001: Predetermined overhead rate = Budgeted overhead/Normal activity = $360,000/120,000 direct labor hours = $3 per DLH Using the overhead rate, applied overhead for 2001 is: Applied overhead = Overhead rate x Actual activity usage = $3 per DLH x 100,000 DLH = $300,000

22. Overhead Application Example (continued) Pocket Currency CalculatorTranslator Units produced 80,000 90,000 Direct labor hours 40,000 60,000 Overhead applied to production ($3 x DLH) $120,000 $180,000 Overhead per unit $1.50 $2.00

23. Overhead Variance The difference between actual overhead and applied overhead an overhead variance. If actual overhead is greater than applied overhead, then the variance is called underapplied overhead. If applied overhead is greater than actual overhead, the the variance is called overapplied overhead. The firm has underapplied overhead by ($320,000 - $300,000) or $20,000

24. Disposition of Overhead Variance The overhead variance is disposed of in one of two ways. 1. All overhead variance is allocated to cost of goods sold. 2. The overhead variance is allocated among work in process, finished goods, and cost of goods sold.

25. Comparison of Job-order andProcess Costing Job-Order CostingProcess Costing 1. Wide variety of distinct 1. Homogeneous products products 2. Cost accumulated by job 2. Costs accumulated by process or department 3. Unit cost computed by 3. Unit cost computed by dividing total job costs dividing process costs of by units produced on that the period by the units job produced in the period

26. A Job-Order Cost Sheet Drill Bits 16-C Item Description: _________ Job Order Number: _______ Quantity Completed: ______ Date Started: _____________ Date Completed:_________ Direct Materials Direct Labor Overhead 100 1/25/2000 1/31/2001 Req. No. Amount Ticket # Hours Rate Amt. Hours Rate Amt. 24-A $500 49 40 $10 $400 40 $1.60 $64 46-B 650 71 30 8 240 30 3.00 90 Cost Summary Direct Materials_______ Total Cost_________ Direct Labor _______ Unit Cost _________ Overhead _______ $1,150 $1,944 $640 $19.44 $154

27. A Material Requisition Form 24-A Requisition No._______ Date:______ Department_________ Job No._____ 1/25/01 Fabrication 16-C Description Quantity Cost/unit Total Cost 100 $5.00 $500 Steel Stock J. Jones D. Reller Delivered By___________ Received by______________

28. A Job Time Ticket 49 Ticket No._________ 101 1/24/2001 F. Flintstone Employee No.______ Name____________ Date_________ Start Time Stop Time Total Time Rate Amt. Job No. 10:00 a.m. 4:00 p.m. 6.0 hours $10 $60 16-C Approved by

29. Job-Order Costing – Material Purchases A. Raw materials account is debited for the cost of materials purchased Raw Materials Work in Process (A)

30. Exercise 4-9 Materials were purchased on account for $23,175. Raw Materials 23,175 Accounts Payable 23,175

31. Job-Order Costing – Material Requisitions B. Raw Materials is credited for the cost of materials issued to jobs. Work in Process is debited for the cost of materials issued to jobs. Raw Materials Work in Process (A) (B) (B)

32. Exercise 4-9 (continued) Materials totaling $19,000 were requisitioned for use in production. Work in Process 19,000 Raw Materials 19,000

33. Job-Order Costing – Direct Labor Incurred C. Wages Payable is credited for direct labor. Work in Process is debited for the cost of direct labor. Wages Payable Work in Process (C) (C)

34. Exercise 4-9 (continued) Direct labor payroll for the month was $17,850 with an average wage of $8.50 per hour. Work in Process 17,850 Wages Payable 17,850

35. Job-Order Costing – Actual Overhead D. Overhead Control is debited for actual overhead. Overhead Control Work in Process (D)

36. Exercise 4-9 (continued) Actual overhead of $15,500 was incurred and paid. Overhead Control 15,500 Cash 15,500

37. Job-Order Costing – Applied Overhead E. Overhead Control is credited for applied overhead. Work in Process is debited for applied overhead. Overhead Control Work in Process (D) (E) (E)

38. Exercise 4-9 (continued) Factory overhead is charged to production at the rate of $7.00 per direct labor hour. Work in Process 14,700 Overhead Control 14,700

39. Job-Order Costing – Transfer of Completed Goods F. Credit Work in Process for the COGM. Debit Finished Goods for the COGM. Work in Process Finished Goods (B) (C) (E) (F) (F)

40. Exercise 4-9 (continued) Completed units costing $36,085 were transferred to finished goods. Finished Goods 36,085 Work in Process 36,085

41. Job-Order Costing – Recognition of Expense G. Credit Finished Goods for value of units sold. Debit Cost of Goods Sold for value of units sold. Finished Goods Cost of Goods Sold (G) (G)

42. Exercise 4-9 (continued) Bags costing $30,000 were sold on account for $36,000. Cost of Goods Sold 30,000 Finished Goods 30,000 Accounts Receivable 36,000 Sales Revenue 36,000

43. General Contractor Example Direct Materials House #1 $ 90,000 House #2 100,000 House #3 30,000 Direct Labor House #1 $ 65,000 House #2 70,000 House #3 15,000 Overhead is applied at 50 percent of DLC. Houses #1 and #2 are completed during the period House #1 is sold for $200,000 cash.

44. General Contractor Example – Solution Work in Process Finished Goods (1) 220,000 (4) 187,500 (2) 150,000 (4) 187,500 (5) 205,000 (6) 187,500 (3) 75,000 (5) 205,000 52,500 205,000 Cost of Goods Sold (6) 187,500 187,500

45. Job Cost Sheets for Example House #1 House #2 (1) 90,000 (2) 65,000 (3) 32,500 (1) 110,000 (2) 70,000 (3) 35,000 187,500 205,000 House #3 (1) 30,000 (2) 15,000 (3) 7,500 52,500

46. Accounting for Spoilage If the defective work was a consequence of the demanding nature of this particular job, then rework (spoilage) is assigned to the job. On the other hand, if the defective work was a consequence of assigning new, untrained labor to the job, then the rework (spoilage) is assigned to overhead control.

47. End of Chapter 4

48. COST MANAGEMENT Don R. Hansen Maryanne M. Mowen

49. Chapter Five Product and Service Costing: A Process Systems Approach

50. Learning Objectives • Describe the basic characteristics of process costing, including cost flows, journal entries, and the cost of production report. • Describe process costing for settings without work in process inventories. • Define equivalent units, and explain their role in process costing.