PRODUCT COSTING

PRODUCT COSTING
• Product costing is a process of accumulating, classifying, and assigning
direct materials, direct labor and factory overhead costs to products or
services.

• Category of Costing Method

a. Cost Accumulation Method – Job Costing or process costing
b. Cost Measurement Method – actual, normal or standard costing
c. Overhead Assignment Method – volume-based or activity-based
 JOB ORDER COSTING
Job order costing is a procedure of accumulating the three elements of cost,
materials, labor and overhead by job order basis.

It could be summarized as follows:

1. Job Order costing applied to cost as follows:

a. Direct Materials and direct labor costs are traced to a particular job.
b. Cost not directly traceable (overhead) are applied to individual job
using a predetermined overhead application rate.
2. The overhead rate is a pre-determined yearly rate using as base, labor
hours, machine hours, or labor cost.
3. Practically, the difference between the overhead applied and actual
overhead is closed to cost of goods sold at the end of the period
 JOB ORDER SYSTEMS
• Job-Order Costing System, the jobs or batches of products or services are the cost objects. For the
purpose of determining product costs, all manufacturing costs incurred are assigned to jobs.

• A job-order costing system is appropriate in a situation in which most costs incurred for the job can
be readily identified with specific customers, contract, or projects.

• Often found in medium, to small firms that produce for customers order.

• Companies that uses this costing system includes construction, printing, special equipment
manufacturing, ship building custom furniture manufacturing, professional services, medical
services, advertising companies

• More costly than process costing; Ideal for company that producing relatively large,
heterogeneous items.
JOB-ORDER COSTING
 PROCESS COSTING
• Process Costing is applied to firms often have continuous mass production
of homogeneous products.

• It is economically infeasible to trace most cost to individual products

• Industries where process costing is common include the chemical industry,

bottling companies, plastics, food products and paper products.

• Is a method of cost accumulation that accumulates production costs by

departments.
PROCESS COSTING
 COST MEASUREMENT
• Actual Costing System – uses actual cost incurred for all products cost
including direct materials direct labor and factory overhead.

• Actual costing are rarely used because they can produce unit product
costs that fluctuate significantly, causing potential errors in pricing, adding/
dropping product lines, and for performance evaluations.

• Most actual factory overhead costs are known only at or after the end of
the period rather than at the completion of the batch or products, thus,
actual costing cannot provide accurate unit product cost information on a
timely basis.
 COST MEASUREMENT
• Normal Costing System uses actual costs for direct materials and direct
labor and normal costs for factory overhead.

• Normal costing 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 batch of product

 COST MEASUREMENT
• Standard Costing System uses standard costs and quantities for all three
types of manufacturing costs: Direct materials, direct labor and factory
overhead.

• Standard costs are target costs the firm should attain.

• It provide a basis for cost control, performance evaluation and process

improvement.
 COMPARATIVE COST MEASUREMENT
AND THE BASIS OF PRODUCT COSTING
Types of Cost Used For

Costing System Direct Materials Direct Labor Factory Overhead

Actual Costing Actual Cost Actual Cost Actual Cost

Normal Costing Actual Cost Actual Cost Applied Overhead

cost (using pre-
determined rate(s))
Standard Costing Standard Cost Standard Cost Standard Cost
 OVERHEAD ASSIGNMENT UNDER NORMAL
COSTING: VOLUME BASED OR ACTIVITY BASED
The bases of overhead allocation or assignment to products include
a. Volume-based method
1. Number of units produced
2. Direct labor hours

b. Activity-Based Method
1. Multiple cost drivers based on resource consumption during
various activities
 OVERHEAD ASSIGNMENT UNDER NORMAL
COSTING: VOLUME BASED OR ACTIVITY BASED
• Volume-Based Product costing system allocate overhead to products or jobs using
a volume-based cost driver, such as unit produce. These approach relies heavily
on the assumption that each product uses the same amounts of overhead, since
each product is charges the same amount.

• Neither of these assumption turns out to be sufficiently accurate in many

companies, so firms use activity-based approach

• Activity-Based Costing (ABC) system allocate factory overhead cost to products

using cause-and-effect criteria with multiple cost drivers.

• ABC systems use both volume-based and nonvolume-based cost drivers to more
accurately allocate factory overhead cost based on resource consumption
during various activities.
 SUMMARY OF ACCOUNTING
PROCEDURES IN JOB-ORDER COSTING
1. Record the purchase and issue of materials with journal entries
2. Record labor costs with journal entries
3. Calculate pre-determined overhead rate and use it to assign overhead
costs to a job
4. Record applied factory overhead cost with journal entries
5. Complete a job cost sheet an calculate the average cost per unit of a job
6. Record actual factory overhead cost with journal entries
7. Compute over-and under applied overhead
8. Calculate cost of goods manufactured and cost of goods sold
 DISPOSITION OF OVER AND UNDER
APPLIED FACTORY OVERHEAD
• An OVER APPLIED OVERHEAD occurs when the applied overhead exceeds
the ACTUAL OVERHEAD INCURRED during a period.

• An UNDER APPLIED OVERHEAD occurs when the actual overhead costs

incurred exceeds the applied overhead costs.

• Firms vary in their treatment of over or under applied overhead.

 DISPOSITION OF OVER AND UNDER
APPLIED FACTORY OVERHEAD
Since actual production cost should be reported in the period they were
incurred, total product cost at the end of the accounting period should be
based on actual rather than applied overhead.

Under-applied or over-applied overhead can be disposed of in two ways:

1. Adjust the Cost of Goods Sold Account
2. Adjust the production costs of the period – prorate the discrepancy
among the amounts of the current period’s applied overhead remaining in
the ending balance of the WIP Inventory, the Finished Goods Inventory,
and Cost of Goods Sold account
 DISPOSITION OF OVER AND UNDER
APPLIED FACTORY OVERHEAD
If the amount of over and under applied is not significant – generally adjusted
to Cost of Goods Sold (most expedient for disposing overhead discrepancies)

If the amount is significant – often prorated.

Proforma Entries: (Underapplied)

Cost of Goods Sold xxx
Factory Overhead Applied xxx
Factory Overhead Control xxx
 PREPARATION OF
STATEMENT OF COST OF GOODS MANUFACTURED
Statement f Cost of Goods Manufactured refers to the cost of the jobs completed whether
they were started before or during the current accounting period.

Terms to remember:
1. Direct Materials – Materials which become an integral part of the finished product
2. Direct Labor – labor which acts directly on the product and physically transforms the
product by machine.
3. Manufacturing Overhead – consists of all product cost other than direct materials and
direct labor
4. Prime cost- sum of direct materials and direct labor costs
5. Conversion Cost – sum of direct labor costs and manufacturing overhead
6. Manufacturing cost – sum of direct materials, direct labor cost and manufacturing
overhead
7. Under-applied or Over-applied manufacturing overhead – the difference between the
actual overhead incurred and the applied (estimated overhead)
 PREPARATION OF
STATEMENT OF COST OF GOODS MANUFACTURED
The usual format of the statement is presented below:
 STATEMENT OF COST OF GOODS SOLD
• The usual format of the statement is presented below:
 ALLOCATION OF SERVICE (SUPPORT)
DEPARTMENT COSTS

Service departments benefits the manufacture of products even

though they are not directly involved in converting raw materials into
finished goods. For this reason, service department costs must be
reallocated to producing departments, both in computing
predetermined overhead rates and in measuring actual overhead
costs of producing departments.
 ALLOCATION OF SERVICE (SUPPORT)
DEPARTMENT COSTS
Methods of Service Cost Allocations

1. Direct Method – The cost of each service department is allocated directly

to producing department

2. Step-Down Method – involves allocation of service department costs to

both service and producing department. Cost of the most widely-used
service department or the department with the highest total cost are first
allocated to all other department. The costs of the next most widely-used
service department are then allocated.
3. Reciprocal Method – allocate costs by explicitly including the mutual
services provided among all service department.
 ACCOUNTING FOR SPOILAGE
AND REWORK
• Spoilage - these are units that do not meet production standards.
• Spoilage may be normal or adnormal.
• Normal Spoilage costs are inventoriable costs.
• Normal Spoilage attributable to a specific job occurs because of customer’s
specification, the job bears the cost of spoilage reduced by the disposal value of
the spoilage.
• Normal spoilage common to all jobs, maybe due to internal failure, the spoilage
inherent in production will occur when a specific job is worked on. But the
spoilage is not attributable to, and hence, is not charged to the specific job,
instead, the spoilage will be costed as manufacturing overhead.
• Abnormal Spoilage are not considered to be inventoriable costs and are written
off as costs of the period during which the abnormal spoilage is detected
 ACCOUNTING FOR SPOILAGE
AND REWORK
• Abnormal Spoilage are not considered to be inventoriable costs and are
written off as costs of the period during which the abnormal spoilage is
detected;

• If the spoilage is abnormal, the net loss is charged to an abnormal loss

account. Unlike normal spoilage costs, abnormal spoilage costs are not
included as part of the cost of good units produce.
 ACCOUNTING FOR SPOILAGE
AND REWORK
• Rework is units of production that are inspected, determined to be
unacceptable, repaired, and sold as acceptable finished goods.

• Normal rework attributable to specific job, rework cost will be charge to job.

• Normal rework common to all jobs, rework cost are charged to

manufacturing overhead and spread through overhead allocation, over all
jobs.

• Abnormal rework, it is recorded by charging abnormal rework to a loss

account.
• PLEASE REFER TO EXCEL FILE FOR ILLUSTRATIONS