COST MANAGEMENT

Don R. Hansen
Maryanne M. Mowen

PPT 4 -1
 Chapter Four

Product and Service

Costing: Overhead
Application and Job-Order
System

PPT 4 -2
 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.

PPT 4 -3
 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.

PPT 4 -4
 Manufacturing Firms Versus
Service 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.

PPT 4 -5
 Interface of Services with the
Cost Management System

1. Intangibility
2. Perishability
3. Inseparability
4. Heterogeneity

PPT 4 -6
 Intangibility

Impact on
Relationship to Business
Cost Management System
Services cannot be stored.
There are no inventory accounts.
Services cannot be protected
There is a strong ethical code.*
through patents.
Services cannot readily be
displayed or communicated.
Prices are difficult to set. Costs must be related to
entire organization.*

*Many of these effects are also true of tangible products. PPT 4 -7

 Inseparability
Relationship to Business
Consumer is involved in
production.
Other consumers are involved
in production
Centralized mass production
of services is difficult.
*Many of these effects are also true of tangible products.
Impact on
Cost Management System
Costs often accounted for by
customer type.*
System must be generated to
encourage consistent quality.*
PPT 4 -8
 Heterogeneity

Impact on
Relationship to Business
Cost Management System
Standardization and quality A strong systems approach
control are difficult. is needed.
Productivity measurement is
ongoing.*
Total quality management
is critical.*

*Many of these effects are also true of tangible products. PPT 4 -9

 Perishability

Impact on
Relationship to Business
Cost Management System

Service benefits expire quickly. There are no inventories.

Service may be repeated often There needs to be a standardized
for one customer. system to handle repeat customers.*

*Many of these effects are also true of tangible products. PPT 4 -10
Relationship of Cost Accumulation, Cost
Measurement, and Cost Assignment
Cost Cost Cost
Accumulation Measurement Assignment

Record Costs: Classify Costs: Assign to Cost Objects:

Purchase materials Direct Materials
Assemblers’ payroll Direct Labor Product 1
Finishers’ payroll
Supervisors’ payroll
Depreciation Product 2
Utilities Overhead
Property taxes
Landscaping

PPT 4 -11
 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.

PPT 4 -12
 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.

PPT 4 -13
 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. PPT 4 -14
 Johnson Leathergoods - Unit Cost

Direct materials $1,000

Direct labor 1,080
Overhead 240
Total $2,320
 number of units  20
Unit cost $ 116
======

PPT 4 -15
 Overhead Application a Normal
Costing View

A predetermined overhead rate is calculated using the

following formula:

Overhead rate = Budgeted annual overhead/Budgeted annual activity level

PPT 4 -16
 Choosing the Activity Base

1. Units produced
2. Direct labor hours
3. Direct labor dollars
4. Machine hours
5. Direct materials

PPT 4 -17
 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.
PPT 4 -18
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.

PPT 4 -19
 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
PPT 4 -20
 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
PPT 4 -21
 Overhead Application Example
(continued)

Pocket Currency
Calculator Translator
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

PPT 4 -22
 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

PPT 4 -23
 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.

PPT 4 -24
 Comparison of Job-order and
Process Costing

Job-Order Costing Process 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

PPT 4 -25
 A Job-Order Cost Sheet

Drill Bits
Item Description: _________ 16-C
Job Order Number: _______
100
Quantity Completed: ______ 1/25/2000
Date Started: _____________
1/31/2001
Date Completed:_________

Direct Materials Direct Labor Overhead

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
$1,150
Direct Materials_______ $1,944
Total Cost_________
Direct Labor $640
_______ $19.44
Unit Cost _________
Overhead $154
_______

PPT 4 -26
A Material Requisition Form

24-A
Requisition No._______
1/25/01
Date:______ Fabrication Job No._____
Department_________ 16-C

Description Quantity Cost/unit Total Cost

Steel Stock 100 $5.00 $500

J. Jones
Delivered By___________ D. Reller
Received by______________

PPT 4 -27
 A Job Time Ticket

49
Ticket No._________
101
Employee No.______ F. Flintstone
Name____________ 1/24/2001
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

PPT 4 -28
Job-Order Costing – Material Purchases

A. Raw materials account is debited for the cost of materials

purchased

Raw Materials Work in Process

(A)

PPT 4 -29
 Exercise 4-9

Materials were purchased on account for $23,175.

Raw Materials 23,175

Accounts Payable 23,175

PPT 4 -30
 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)

PPT 4 -31
 Exercise 4-9 (continued)

Materials totaling $19,000 were requisitioned for use

in production.

Work in Process 19,000

Raw Materials 19,000

PPT 4 -32
 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)

PPT 4 -33
 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

PPT 4 -34
Job-Order Costing – Actual Overhead

D. Overhead Control is debited for actual overhead.

Overhead Control Work in Process

(D)

PPT 4 -35
 Exercise 4-9 (continued)

Actual overhead of $15,500 was incurred and paid.

Overhead Control 15,500

Cash 15,500

PPT 4 -36
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)

PPT 4 -37
 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

PPT 4 -38
 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) (F) (F)

(C)
(E)

PPT 4 -39
 Exercise 4-9 (continued)

Completed units costing $36,085 were transferred to

finished goods.

Finished Goods 36,085

Work in Process 36,085

PPT 4 -40
 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)

PPT 4 -41
 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

PPT 4 -42
 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.
PPT 4 -43
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

PPT 4 -44
 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

PPT 4 -45
 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.

PPT 4 -46
End of Chapter 4

PPT 4 -47
COST MANAGEMENT

Don R. Hansen
Maryanne M. Mowen

PPT 4 -48
Chapter Five

Product and
Service Costing: A
Process Systems
Approach

PPT 4 -49
 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.

PPT 4 -50
 Learning Objectives (continued)

 Prepare a departmental production report using

the FIFO method.
 Prepare a departmental production report using
the weighted average method.
 Prepare a departmental production report with
transferred-in goods and changes in output
measures.
 Describe the basic features of operation costing.

PPT 4 -51
 Comparison of Job-Order and
Process Costing
Job-Order Costing
1. Wide variety of distinct 1.
products
2. Cost accumulated by job 2.
3. Unit cost computed by 3.
dividing total job costs
by units produced on that
job
Process Costing
Homogeneous products
Costs accumulated by
process or department
Unit cost computed by
dividing process costs of
the period by the units
produced in the period
PPT 4 -52
 Characteristics of Process Costing

 Homogeneous units pass

through a series of similar
processes.
 Each unit in each process
receives a similar dose of
manufacturing costs.
 Manufacturing costs are
accumulated for a process
for a given period of time.

PPT 4 -53
 Characteristics of Process Costing
(continued)
 There is a work in process account for each
process.
 Manufacturing cost flows and the associated
journal entries are generally similar to job-order
costing.
 The departmental production report is the key
document for tracking manufacturing activity
and costs.
 Unit costs are computed by dividing the
departmental costs of the period by the output for
the period. PPT 4 -54
 Process Costing Cost Flow

Direct Materials
Direct Labor
Applied Overhead

Picking Encapsulating Bottling

Finished Goods

PPT 4 -55
Service Organization Without Work in
Process Inventories
To illustrate how services without work in process inventories
are costed using a process approach, consider the teeth
cleaning process offered by most dentists.
The production costs and the number of cleanings (patients
served) for the month of March are given below:
Direct materials $ 200
Hygienist salary 2,500
Overhead 1,800
Total production cost $4,500
=====
Number of cleanings 300
Unit cost = $4,500/300 = $15 per cleaning
PPT 4 -56
 Steps for Costing Out Production
in Process Costing
1. Analysis of the flow of physical
units
2. Calculation of equivalent units
3. Computation of unit cost
4. Valuation of inventories (goods
transferred out and ending work in
process)
5. Cost reconciliation

PPT 4 -57
 A Cost Analysis

1,000 units - $5,000 materials added; 1,500 units - $8,000 materials added;
$10,000 conversion costs added $13,000 conversion costs added

Cost added Costs

to BWIP Work in added
Process to EWIP
Cost of Cost of Units
Units Started Completed

10,000 units; $23,000 9,500 units

mat’l added; $120,175
conversion cost added

Input Costs = Output Costs

$158,175 = $158,175
PPT 4 -58
 The Concept of Equivalent Units

1,000 units - 20% materials added; 1,500 units - 1/3 materials added;
60% conversion costs added 50% conversion costs added

Units in Units
BWIP Work in in
Process EWIP
Units Units
Started Completed

10,000 units; 9,500 units

Units of Input = Units of Output
Units in BWIP + Units Started = Units in EWIP + Units Completed
1,000 + 10,000 = 1,500 + 9,500

PPT 4 -59
 The Concept of Equivalent Units
(continued)
Equivalent Units Calculation:
Materials Conversion Costs
Units Completed 9,500 9,500
Ending WIP 500 750
Total Units Processed *10,000 *10,250
Beg. WIP Inventory (200) (600)
Units Processed
This Period **9,800 **9,650
==== ====

*Equivalent units for weighted average (total units worked on)

** Equivalent units for FIFO (units worked on this period)

PPT 4 -60
 Example
No Beginning Inventory

Materials are added at the beginning of the process.

Units started 24,000
Units completed and transferred out 20,000
Units in process, May 31, 25% complete 4,000

Costs:
Cost Added
Materials $126,000
Conversion Costs 42,000

PPT 4 -61
 Example
No Beginning Inventory (continued)

Step 1 - Physical Flow:

Units to account for:
Units, BWIP 0
Units started 24,000
Total 24,000
=====
Units accounted for:
Units completed 20,000
Units, EWIP 4,000
Total 24,000
====

PPT 4 -62
 Example
No Beginning Inventory (continued)

Step 2 - Equivalent units:

Materials Conversion
Units completed 20,000 20,000
EWIP 4,000 1,000
Total Equivalent Units 24,000 21,000
==== ====

PPT 4 -63
 Example
No Beginning Inventory (continued)

Step 3 - Unit Cost:

Unit Cost = $126,000/24,000 + $42,000/21,000
= $5.25 + $2.00
= $7.25

PPT 4 -64
 Example
No Beginning Inventory (continued)

Step 4 - Valuation of Inventories:

Goods Transferred Out:
$7.25 x 20,000 = $145,000
Ending Work in Process:
($5.25 x 4,000) + ($2.00 x 1,000 = $23,000

PPT 4 -65
 Example
No Beginning Inventory (continued)

Step 5 - Cost Reconciliation:

Cost Assigned:
Goods transferred $145,000
EWIP 23,000
$168,000
=======
Cost to Account For:
BWIP $126,000
Cost added 42,000
$168,000
=======

PPT 4 -66
 FIFO Costing Example
Production:
Units in process, October 1, 70% complete 10,000
Units completed and transferred out 60,000
Units in process, October 31, 40% complete 20,000
Costs:
Work in process, October 1:
Materials $ 1,000
Conversion costs 350
Total work in process $ 1,350
======
Current costs;
Materials $12,600
Conversion costs 3,050
Total current costs $15,650
======
PPT 4 -67
 FIFO Costing Method

Under the FIFO costing method the equivalent units

and manufacturing costs in beginning work in process
are excluded from the current-period unit cost
calculation. Thus, FIFO recognizes that the work and
costs carried over from the prior period legitimately
belong to that period.

PPT 4 -68
 FIFO Costing (continued)

Step 1- Physical Flow Analysis

Inputs: Outputs:
BWIP 10,000 EWIP 20,000
Started 70,000 Completed 60,000

Total 80,000 Total 80,000

===== =====

*Step one is the same for weighted average and FIFO

PPT 4 -69
 FIFO Costing (continued)

Step 2 - Calculation of Equivalent Units

Materials Conversion
EWIP 20,000 8,000
Completed 60,000 60,000
Units Worked On in Total 80,000 68,000
BWIP 10,000 7,000
Units Worked On this Period 70,000 61,000
===== =====

PPT 4 -70
 FIFO Costing (continued)

Step 3 - Computation of Unit Cost Calculation

Materials Conversion Total

Beginning WIP $ 1,000 $ 350 $ 1,350
Added this period 12,600 3,050 15,650
Total $ 13,600 $ 3,400 $17,000

Added this period $ 12,600 $ 3,050 $15,650

Equivalent units  70,000  61,000
Unit cost $ 0.18 $ 0.05 $ 0.23
======= ======= ======
PPT 4 -71
 FIFO Costing (continued)

Step 4 - Value of Goods Completed and EWIP (Short-cut

method)

Total Input Costs $17,000

Less: EWIP
Materials (20,000 x $0.18) $3,600
Conversion Cost (8,000 x $0.05) 400 4,000
Cost of Goods Completed $13,000
======

PPT 4 -72
 FIFO Costing (continued)
Step 5 - Cost Reconciliation
Manufacturing costs are reconciled as follows:

Costs to account for:

Beginning work in process $ 1,350
Incurred during the period:
Materials $12,600
Conversion costs 3,050 15,650
Total costs to account for $17,000
======
Costs accounted for:
Goods transferred out:
Units, beginning work in process $ 1,500
Units started and completed 11,500
Goods in ending work in process 4,000
Total costs accounted for $17,000
======
PPT 4 -73
 Journal Entries

Work in Process--Mixing 12,600

Materials 12,600
To record requisitions of materials for October.

Work in Process--Mixing 3,050

Conversion Cost Control 3,050
To record the application of overhead and incurrence of direct labor.

Work in Process--Tableting 13,000

Work in Process--Mixing 13,000
To record the transfer of cost of goods completed from Mixing to
Tableting.

PPT 4 -74
 Weighted Average Costing

Step 1- Physical Flow Analysis

Inputs: Outputs:
BWIP 10,000 EWIP 20,000
Started 70,000 Completed 60,000

Total 80,000 Total 80,000

===== =====

*Step one is the same for weighted average and FIFO

PPT 4 -75
Weighted Average Costing (continued)

Step 2 - Calculation of Equivalent Units

Materials Conversion
EWIP 20,000 8,000
Completed 60,000 60,000
Equivalent units 80,000 68,000
===== =====

PPT 4 -76
Weighted Average Costing (continued)

Step 3 - Computation of Unit Cost Calculation

Materials CC Total
Beginning WIP $ 1,000 $ 350 $ 1,350
Added this period 12,600 3,050 15,650
Total $ 13,600 $ 3,400 $17,000
Equivalent units  80,000  68,000
Unit cost $ 0.17 $ 0.05 $ 0.22
======= ======= ======

PPT 4 -77
Weighted Average Costing (continued)

Step 4 - Valuation of Inventories

Cost of Goods Transferred Out (0.22 x 60,000 ) = $13,200

Ending Work in Process:

Materials: ( $0.17 x 20,000) $3,400
Conversion: ($0.05 x 8,000) 400 3,800
Total $17,000
======

PPT 4 -78
 Basics of Operation Costing

Operation costing is a blend of job and process

costing procedures applied to batches of
homogeneous products. This costing system uses
job-order procedures to assign materials costs to
batches and process procedures to assign conversion
costs.
Work orders are used to collect production costs for
each batch.

PPT 4 -79
End of Chapter 5

PPT 4 -80