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Job Order Costing and Modern Manufacturing Practices Chapter 2: Product Costing System An integrated set of documents, ledgers, accounts, and accounting procedures used to measure and record the cost of manufactured products. Types of Costing Systems

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product costing system
Product Costing System
  • An integrated set of documents, ledgers, accounts, and accounting procedures used to measure and record the cost of manufactured products.
types of costing systems
Types of Costing Systems

Companies use product costing systems to measure and record the cost of manufactured products. Two types:

  • Job-Order Costing System.
  • Process Costing System.
job order costing
Job-Order Costing
  • Companies that produce individual products or batches of products that are unique use a job-ordering costing system.
  • Goods are made to a customer’s unique specifications.
  • A job is an individual product or batch for which a company needs cost information.
  • Examples: Construction companies, producers of equipment and tools, ship-building companies, printing companies, consulting firms.
sequence of events in a job order costing system
Sequence of Events in a Job-Order Costing System

Receive orders from customers

Begin production

Schedulejobs

Ordermaterials

why businesses need to know the cost of its products
Why Businesses Need to Know the Cost of Its Products
  • To set prices
  • To calculate profit when products are sold
  • To prepare financial statements in accordance with GAAP
  • To assess the reasonableness of the cost incurred in purchasing or manufacturing products
  • For management decision-making
product and period costs
Product Costs and Period Costs are Synonymous with Manufacturing and Nonmanufacturing costs, respectively.Product and Period Costs
classification of costs
Classification of Costs
  • Manufacturing Costs (also called Product Costs).
    • Associated with the production of goods.
    • Recorded into asset (inventory) accounts and reported on the Balance Sheet. They stay on the balance sheet until the goods are sold.
    • When goods are sold, the costs are transferred to income statement and are reported as Cost of Goods Sold
  • Non-manufacturing costs (also called period costs)
    • Associated with the period in which they are incurred.
    • Recorded in expense accounts and reported in income statement.
cost classifications for manufacturing firms
Cost Classifications for Manufacturing Firms

Manufacturing Costs (product costs): all costs associated with the production of goods.

  • Direct Material
  • Direct Labor
  • Manufacturing Overhead
manufacturing costs also called product costs
Manufacturing Costs (Also Called Product Costs)
  • All costs associated with the production of goods and services.
  • Includes Direct Material, Direct Labor, and Manufacturing Overhead (indirect costs)
  • Product costs are assigned to products and recorded in asset accounts
nonmanufacturing costs
Nonmanufacturing Costs

Nonmanufacturing Costs (period costs): all costs not associated with the production of goods.

  • Selling Costs
  • General and Administrative Costs
definitions
Definitions
  • Direct Material Cost: All materials and parts that are directly traced to items produced.
  • Indirect Material Cost: The cost of all material or parts that are not directly traced to a product. Examples: glue and screws used to make a boat.
definitions14
Definitions
  • Direct Labor: Cost of labor that is directly traced to aproduct.
  • Indirect Labor Cost: The cost of labor that is not directly traced to a product. Examples: Cost of production supervisor, over-time.
definitions manufacturing overhead
Definitions: manufacturing Overhead
  • Cost of all manufacturing activities other than direct labor and direct material and direct labor.
  • Examples: Indirect material, indirect labor, supervisory salaries, tools, utilities.
definitions full cost
Definitions: Full Cost
  • Product cost information used to prepare financial statements.
  • Includes direct labor, direct material, both variable and fixed manufacturing and overhead.
  • GAAP requires Cost of Goods Sold and Inventory to be presented using full cost information
overview of job costs and financial statement accounts
Overview of Job Costs and Financial Statement Accounts

In a Job-Order Costing System, the three product costs (materials, labor and overhead) are related to specific jobs.

job order costing system
Job-Order Costing System

In Job-Order Costing Systems the primary document (likely electronic) is called a Job-Cost Sheet. It is used to accumulate or capture the following costs:

  • Direct Material Cost.
  • Direct Labor Cost.
  • Manufacturing Overhead.
accumulating costs in a job order costing system

Manufacturingoverhead (OH)

Applied to eachjob using apredeterminedrate

Accumulating Costs in aJob-Order Costing System

Directmaterials

Traced directly to each job

THE JOB

Traced directly to each job

Direct labor

accumulating costs in a job order costing system20
Accumulating Costs in aJob-Order Costing System

Charge direct material and direct labor to each job as incurred.

Direct Materials

Job No. 1

Special documents are used to track costs for each job.

Direct labor

Job No. 2

Manufacturing Overhead

Job No. 3

Apply overhead to each job using a predetermined rate.

product cost information in financial reporting and decision making
GAAP (Generally Accepted Accounting Principles) requires that inventory on balance sheets and cost of goods sold on income statements be disclosed (reported) using Full Costinformation.Product Cost Information in Financial Reporting and Decision Making
balance sheet presentation of product costs
Raw Materials Inventory.

Work in Process Inventory.

Finished Goods Inventory.

Balance Sheet Presentation of Product Costs
flow of product costs in accounts
Flow of Product Costs in Accounts

Current Manufacturing Costs

Cost of Direct Materials Used

Work in Process Inventory

Beginning WIP Inventory

+

Cost of Goods Manufactured

Cost of Direct Labor used

Current Manfacturing Costs

+

Ending WIP Inventory

Cost of Manufacturing Overhead Applied to Jobs

Finished Goods Inventory

Cost of Goods Sold

current manufacturing costs
Current Manufacturing Costs
  • Current manufacturing cost is the amount spent on production in the current accounting period
  • Includes
    • Cost of Direct Materials used in current period
    • Cost of Direct Labor used in current period.
    • Manufacturing overhead applied to jobs in current period.
direct labor
Direct Labor

Time Tickets are used to associate Direct Labor with specific Jobs.

direct materials
Direct Materials

A Materials Requisition Form is used to request the release of materials from stores inventory into production.

general flow of direct materials costs
General Flow of Direct Materials Costs

Beginning

Direct Materials

Inventory $1,000

Purchases of

Direct Materials

$5,000

=

+

Direct Materials

Available for

Use $6,000

Ending

Inventory

$2,000

Direct Materials

Used

$4,000

=

manufacturing overhead
Manufacturing Overhead

Unlike Direct Costs(Direct Materials and Direct Labor) Manufacturing Overhead is indirectly traced (allocated) to jobs using an Overhead Allocation Rate.

cost of goods sold
Cost of Goods Sold

Cost of Goods Sold.

income statement presentation of product costs
Income Statement Presentation of Product Costs

When finished goods are sold they are moved from Finished Goods to Cost of Goods Sold.

how to distribute overhead costs to different jobs
How to distribute overhead costs to different jobs

Now

Let’s calculate the pre-determined overheads rate (POHR)

use of predetermined overhead rates
Identify the items to be included as indirect overhead costs.

Estimate the costs for each of the indirect overhead items.

Select the cost-driver (allocation base).

Estimate the amount of the cost-driver rate (allocation base).

Compute the predetermined overhead rate.

Use of Predetermined Overhead Rates
manufacturing overhead costs

Estimated total manufacturing overhead cost

POHR =

Estimated total amount of cost driver (or activity base)

Manufacturing Overhead Costs
  • Manufacturing Overhead is applied to jobs using a pre-determined overhead rate (POHR)

Overhead applied = POHR × Actual activity

Based on estimates, and determined before the period begins

Actualamount of the allocation base, such as direct labor hours, incurred during the period

overhead rate example
Overhead Rate: Example

Sterling Company applies overhead based on direct- labor hours. Total estimated overhead for the year is $640,000. Total estimated labor cost is $1,400,000 and total estimated labor hours are 160,000.What is Sterling Company’s predetermined overhead rate?

overhead application example

Estimated total manufacturing overhead cost

$640,000

POHR =

POHR=

Estimated total amount of cost driver (or activity base)

160,000 direct-labor hours (DLH)

Overhead Application Example

POHR = $4.00 per DLH

For each direct labor hour worked on a job, $4.00 of factory overhead will be applied to the job.

overhead rate example44

SOLUTION

Overhead applied = POHR × Actual Direct labor Hours

Overhead applied = $4.00 per DLH × 26 DLH = $104

Overhead Rate Example
overhead application example47
Overhead Application Example

Sterling Co’s actual overhead for the yearwas $650,000 and a total of 170,000 direct labor hours were worked.

Using Sterling Co’s predetermined overhead rate of $4.00 per direct labor hour, how much overhead was appliedto all of Sterling Co’s jobs during the year?

SOLUTION

Applied Overhead = POHR × Actual Direct labor Hours

Applied Overhead = $4.00 per DLH × 170,000 DLH =$680,000

over applied overhead
Over-Applied Overhead
  • Sterling Company over-applied overhead to jobs during the year in the amount of $30,000.
  • What should Sterling Company do to bring applied overhead in line with actual overhead?
treatments of over underapplied overheads

$30,000may be allocatedto these accounts.

$30,000 may beclosed directly to cost of goods sold.

Work inProcess

FinishedGoods

Cost of Goods Sold

Cost of Goods Sold

Treatments of Over/Underapplied Overheads

OR

Sterling Co’s Method

treatments of over underapplied overheads50
Sterling Co’s Cost of Goods Sold

______________________________________

Treatments of Over/Underapplied Overheads

Manufacturing Overhead

ActualOverheadCosts

$650,000

OverheadAppliedto jobs

$680,000

Unadjusted Balance

$30,000 overapplied

overhead allocation rate
Overhead Allocation Rate

Overhead Allocation Rate =

Overhead Cost

Allocation Base

overhead allocation base
Overhead Allocation Base
  • Alternative bases include:
  • Direct labor hours
  • Direct labor cost
  • Machine hours
  • Direct material cost.
activity based costing abc and multiple overhead rates
ABC is a method of assigning overhead based on a number of different allocation bases (rather than just one). ABC groups overhead costs into Cost Pools.Activity-Based Costing (ABC) and Multiple Overhead Rates
predetermined overhead rates
Predetermined Overhead Rate =

Estimate Total Overhead Cost

Estimated Level of Allocation Base

Predetermined Overhead Rates
eliminating overapplied or underapplied overhead
Actual costs (Materials, Labor and Overhead) are accumulated in the Manufacturing Overhead Account and

Overhead is applied to production based on the Predetermined Overhead Rate.

Eliminating Overapplied or Underapplied Overhead
eliminating overapplied or underapplied overhead continued
Unless estimates are perfect, there will be either a debit or credit balance in the Manufacturing Overhead account.

If actual > applied, a debit balance, results, thus underapplied overhead.

If actual < applied a credit balance, results, thus overapplied overhead.

Eliminating Overapplied or Underapplied Overhead (continued)
eliminating overapplied or underapplied overhead continued58
Manufacturing Overhead should have a zero balance at year-end

Often closed it out to Cost of Goods Sold.

Theoretically it should be allocated between Work in Process, Finished Goods and Cost of Goods Sold.

Eliminating Overapplied or Underapplied Overhead (continued)
job order costing for service companies
Job-Order Costing is also used by service companies.

Examples include hospitals (patients) and automobile repair firms.

Job-Order Costing for Service Companies
modern manufacturing practices and product costing systems
Just-in-Time (JIT) Production.

Computer-Controlled Manufacturing.

Total Quality Management (TQM).

Modern Manufacturing Practices and Product Costing Systems
quick review question 1
Which of the following is a period cost?

Raw materials costs.

Manufacturing plant maintenance.

Wages for production line workers.

Salary for the vice president of finance.

Quick Review Question #1
quick review answer 1
Which of the following is a period cost?

Raw materials costs.

Manufacturing plant maintenance.

Wages for production line workers.

Salary for the vice president of finance.

Quick Review Answer #1
quick review question 2
Which of the following is a direct materials cost?

Steel for a ship builder.

Production supervisor salary for an auto manufacturer.

Factory rent.

Pocket protector for company accountant.

Quick Review Question #2
quick review answer 2
Which of the following is a direct materials cost?

Steel for a ship builder.

Production supervisor salary for an auto manufacturer.

Factory rent.

Pocket protector for company accountant.

Quick Review Answer #2
quick review question 3
Beginning work-in-process plus total manufacturing costs minus ending work-in-process equals

Cost of materials used.

Finished goods inventory.

Cost of goods sold.

Cost of goods manufactured.

Quick Review Question #3
quick review answer 3
Beginning work-in-process plus total manufacturing costs minus ending work-in-process equals

Cost of materials used.

Finished goods inventory.

Cost of goods sold.

Cost of goods manufactured.

Quick Review Answer #3
quick review question 4
Cost of Goods Sold is $200,000, beginning Finished Goods is $50,000, ending Finished Goods is $100,000 and ending Work in Process is $10,000. What is the Cost of Goods Manufactured?

$100,000

$250,000

$50,000

$150,000

Quick Review Question #4
quick review answer 4
Cost of Goods Sold is $200,000, beginning Finished Goods is $50,000, ending Finished Goods is $100,000 and ending Work in Process is $10,000. What is the Cost of Goods Manufactured?

$100,000

$250,000

$50,000

$150,000

Quick Review Answer #4