3Life FitnessIntroduce the world’s first computerized exercise bike in 1970sDesign, manufacture, and market over 300 different cardio and strength-training products.How does the company figure out the profit margins on each of its 300 different model?The company use product costing systems to trace the direct materials and direct labor used by each job.The company can use the cost information to make vital business decisions which include as follows:Setting selling prices that will lead to profits on each productIdentifying opportunities to cut costsDetermining which products are most profitable and therefore deserve the most marketing emphasis
4Cost of Manufacturing a Product Most Manufacturers use one of two product costing systems in order to find the cost of producing their products.Process CostingJob Costing
5Distinguish between job costing and process costing Learning Objective 1Distinguish between job costing and process costing5
6Process CostingMass production: produce extremely large numbers of identical units through a series of uniform production steps or processes.Similar itemsTotal costs are averaged over all unitsExamplesPaint manufacturersOil refineriesCereal manufacturers6
7Job Costing Unique, custom products or small batches Total costs are accumulated by jobExamplesHospitalsCustom home buildersAdvertising agencies
9S3-1: Examples of Process and Job Costing A manufacturer of fiberglass insulationA residential plumbing contractorc. A manufacturer of fiber optic cabled. A professional home buildere. A hospital
10Learning Objective 2Understand the flow of production and how direct materials and direct labor are traced to jobs
11Flow of Inventory Through a Manufacturing System Raw MaterialsStoreroomWork in processProductionDepartmentFinished GoodsReady for saleCost of Goods SoldSold
12Production Schedule for the Month of December JobModel NumberStock or CustomerQuantityScheduledStart DateScheduled End date603X4 Cross-TrainerFor stock5012/212/6604T5-0 Treadmill6012/712/17605Custom T6-C TreadmillBears1512/1812/21606Custom S3-C Stair-Climber1212/2212/24FACTORY CLOSED FOR HOLIDAYS and ANNUAL MAINTENANCE12/2512/31
13Bill of Materials Part Number Description Quantity Needed HRM50812 Heart rate monitor50LCD620LCD entertainment screenB4906Front and rear rolling base100HG2567Hand gripsFP689Foot platformEtc.Purchasing will then:compute stock available.determine purchasing needs.make sure raw materials are on hand by production date.
14Shipping and receiving prepare receiving report Purchasing ProcessPurchasing department will issue a purchase order to its suppliers for the needed parts.Incoming shipments of raw materials are counted and recorded on a receiving report, which is typically just a duplicate of the purchase order but without the quantity pre-listed on the form.Accounting department will not pay the invoice (bill from the supplier) unless it agrees with the quantity of parts both ordered and received.Shipping and receiving prepare receiving reportPurchasing determines ordering needsPurchasing issues purchase orderAccounting matches invoice with purchase orderAccounting pays the invoice
17Job Cost Record Job Cost Record Job Number: 603 Customer: For stock Job Description: 50 units of X4 Elliptical Cross-TrainersDate Started: Dec Date Completed: _________Manufacturing Cost Information:Cost SummaryDirect Materials$Direct LaborManufacturing OverheadTotal Job CostNumber of Units÷ 50 unitsCost per UnitShipping Information:DateQuantity ShippedUnits RemainingCost Balance
18Work in Process Inventory JOB 560-Direct MaterialsDirect LaborMOHTotal Job CostWork in Process InventoryBalance SheetLife FitnessNovember 30Assets:Liabilities and Owners Equity:CashAccounts PayableAccounts ReceivableWages and Salaries PayableRaw Materials InventoryOther LiabilitiesWork in Process InventoryFinished Goods InventoryCommon StockRetained EarningsProperty and EquipmentTotal AssetsTotal Liabilities and Owner’s EquityJOB 561-Direct MaterialsDirect LaborMOHTotal Job CostJOB 562-Direct MaterialsDirect LaborMOHTotal Job CostJOB 563-Direct MaterialsDirect LaborMOHTotal Job CostThe job cost records on incomplete jobs sum to the total Work in Process Inventory shown on the balance sheet
19Materials Requisition Number: #7568Date: 12/2Job: 603Part NumberDescriptionQuantityUnit CostAmountHRM50812Heart rate monitor50$60$3,000LCD620LCD entertainment screen$1005,000B4906Front and rear rolling base100$5500Total$8,500
20Raw Materials Record Updated for Materials Received and Used Item No. HRM Description: Heart rate monitorReceivedUsedBalanceDateUnitsCostTotalRequisitionNumber11-25100$60$6,00011-30#723570$4,20030$1,80012-175$4,500105$6,30012-2#756850$3,00055$3,300
21Direct Labor Costs are Traced to Individual Jobs Labor Time RecordEmployee: Hannah Smith Week: 12/2- 12/9Hourly Wage Rate: $ Record #: 324DateJob NumberStart TimeEnd TimeHoursCost12/26023$ 606035$ 10012/38$ 16012/4 etc.
22Direct Labor and Materials Posted to Job Cost Record Job Number: 603Customer: For stockJob Description: 50 units of X4 Elliptical Cross-TrainersDate Started: Dec Date Completed: _________Manufacturing Cost Information:Cost SummaryDirect MaterialsReq. #7568: $ 8,500Req. #7580: $ 14,000Req. # 7595: $ 13,500Req. # 7601: $ 4,000$ 40,000Direct LaborNo. #324 (30 hours): $ 100, $ 160, etc.No. #327 (40 hours): $ 240, $ 240, etc.No. #333 (36 hours): $ 100, $ 120, etc.Etc (a total of 500 direct labor hours)$ 10,000Manufacturing Overhead$Total Job CostNumber of Units÷ 50 unitsCost per Unit
23Learning Objective 3Compute a predetermined manufacturing overhead rate and use it to allocate MOH to jobs
24Manufacturing Overhead Other manufacturing costs that cannot be directly traced to specific jobs are called Manufacturing Overhead.These indirect costs, otherwise known as manufacturing overhead, include depreciation on the factory plant and equipment, utilities to run the plant, property taxes and insurance on plant, equipment maintenance, the salaries of plant janitors and supervisors, machine lubricants, and so forth.We cannot tell exactly how much of these costs are attributable to producing a specific job. Therefore, we cannot trace these costs to jobs, as we did with direct materials and direct labor. Rather, we will have to allocate some reasonable amount of these costs to each job.Generally accepted accounting principles (GAAP) mandate that manufacturing overhead must be treated as an inventoriable product cost for financial reporting purposes. The rationale is that these costs are a necessary part of the production process: Jobs could not be produced without incurring these costs.
25Manufacturing Overhead Management needs some other reasonable basis for allocating the total manufacturing overhead costs to all of the jobs.A cost driver is the primary factor that causes a cost. For example, in many companies manufacturing overhead costs rise and fall with the amount of work performed in the factory.There are four steps in calculating the Predetermined Manufacturing Overhead Rate:Estimate total manufacturing overhead costsSelect an allocation base (cost driver)Estimate the total amount of allocation base to be usedCalculate predetermined manufacturing overhead rate (POHR)This rate will be used throughout the coming year. It is not revised, unless the company finds that either the manufacturing overhead costs or the total amount of the allocation base being used in the factory have substantially shifted away from the estimated amounts. If this is the case, management might find it necessary to revise the rate part way through the year.
26Calculating Predetermined Manufacturing Overhead Rate Total estimated mfg overhead costs Total estimated amount of allocation basePOHR*=
27Allocating Manufacturing Overhead (MOH) to Individual Jobs Allocated MOH =POHR x Amount of cost allocation activity used
28Allocating MOH to Individual Job Example:Total estimated manufacturing overhead costs = $1,000,000Cost allocation base is direct labor hours (DLH)Total estimated direct labor hours for the year = 62,500 DLHsJob #603 used 500 DLHs$1,000,000 estimated overhead costs62,500 direct labor hoursPOHR == $16 per direct labor hours*POHR stands for “Predetermined Manufacturing Overhead Rate”
29Allocating MOH to Individual Job Why does the company use a predetermined MOH rate, based on estimated or budgeted data, rather than an actual MOH rate based on actual data for the year? In order to get actual data, the company would have to wait until the end of the year to set its MOH rate. By then, the information is too late to be useful for making pricing and other decisions related to individual jobs. Managers are willing to sacrifice some accuracy in order to get timely information on how much each job costs to produce.The $16 POHR in the example in the slide means that, for every direct labor hour used in a job, $16 will be allocated to the job for manufacturing overhead.
30Allocating MOH to Individual Job (continued) Allocated MOH for Job #603= $16 x 500 DLHs = $8,000Here we are continuing the example from the previous slide. On the prior slide, we found that the predetermined manufacturing overhead rate was $16 per direct labor hour. The given facts from the example told us that 500 direct labor hours were used for Job #603.To calculate the amount of manufacturing overhead to be allocated to Job #603, take the predetermined manufacturing overhead rate of $16 per direct labor hour TIMES the actual direct labor hours used for the job of 500. The $8,000 is the amount of manufacturing overhead which will be allocated to Job #603.*POHR stands for “Predetermined Manufacturing Overhead Rate”
31Completing the Job Cost Record Job Number: 603Customer: For stockJob Description: 50 units of X4 Elliptical Cross-TrainersDate Started: Dec Date Completed: _________Manufacturing Cost Information:Cost SummaryDirect MaterialsReq. #7568: $ 8,500Req. #7580: $ 14,000Req. # 7595: $ 13,500Req. # 7601: $ 4,000$ 40,000Direct LaborNo. #324 (30 hours): $ 100, $ 160, etc.No. #327 (40 hours): $ 240, $ 240, etc.No. #333 (36 hours): $ 100, $ 120, etc.Etc (a total of 500 direct labor hours)$ 10,000Manufacturing Overhead$16/ DL hour × 500 DL hours= $8,000$ 8,0000Total Job Cost$ 58,000Number of Units÷ 50 unitsCost per Unit$ 1.160
32When is Manufacturing Overhead Allocated? The job’s cost, as shown on the job cost record, becomes the basis for valuing inventory and the cost of goods sold.In most sophisticated systems, some manufacturing overhead is allocated to the job each time some of the allocation base is posted to the job cost record.In less sophisticated systems, manufacturing overhead is allocated only once: as soon as the job is complete and the total amount of allocation base used by the job is known.If the balance sheet date arrives before the job is complete, a company would need to allocate some manufacturing overhead to the job based on the number of direct labor hours used on the job thus far.
33When is Manufacturing Overhead Allocated? DirectMaterialsIndirectFactory OverheadAllocateWork in ProcessFinished GoodsIndirectCost of Goods SoldDirectLabor
34Cost Flow Direct Materials Direct Labor Overhead Cost of Goods Sold Direct costs are charged to the job cost record. As goods are finished, they move to finished goods inventory. As finished goods are sold, the cost of those goods sold is expensed to cost of goods sold. Gross profit can be determined by subtracting the cost of goods sold from the sales revenue.DirectMaterialsDirectLaborManufacturingOverheadCost of Goods SoldWork in ProcessFinished Goods
35E3-18AE3-18A asks you to compute a predetermined overhead rate and calculate cost of job.Dellroy Restaurant Supply manufactures commercial stoves and ovens for restaurants and bakeries. Dellroy uses job costing to calculate the costs of its jobs with direct labor cost as its manufacturing overhead allocation base. At the beginning of the current year, Dellroy estimated that its overhead for the coming year would be $300,000. It also anticipated using 25,000 direct labor hours for the year. Dellroy pays its employees an average of $20 per direct labor hour. Dellroy just finished Job 371, which consisted of two large ovens for a regional bakery. The costs for Job 371 were as follows:Job 371Direct materials used $13,000Direct labor hours usedWhat is Dellroy’s predetermined manufacturing overhead rate based on direct labor cost?
36E3-18ACalculate the manufacturing overhead to be allocated based on direct labor cost to Job 371.
37E3-18A What is the total cost of Job 371? Direct materials used Direct labor cost (110 x $20)Manufacturing overhead allocatedTotal cost of Job 371
38Determine the cost of a job and use it to make business decisions Learning Objective 4Determine the cost of a job and use it to make business decisions
39Reasons Why Management Needs Product Cost Control costs: By examining the exact costs traced to the job, management might be able to determine ways of reducing the cost of similar jobs produced in the future. For example, are the heart rate monitors costing more than they did on previous jobs?Perhaps management can renegotiate its contract with its primary suppliers, or identify different suppliers that are willing to sell the parts more cheaply.What about direct labor costs? By examining the time spent by various workers on the job, management may be able to improve the efficiency of the process so that less production time is required.Assess profitability of products: Managers will compare the gross profit on each model to the gross profit ratio of all models to determine which products to emphasize selling. Obviously, management will want to concentrate on marketing those models that yield the higher profit margins.Pricing decisions: Management can also use this information to determine how it will deal with pricing pressure. Say a competitor drops the price of its similar elliptical cross-trainer. A profit analysis could show that Life Fitness could drop the selling price of its elliptical cross-trainer by a similar amount and still make a reasonable profit.
40Reasons Why Management Needs Product Cost Discounts on high-volume sales: Often times, customers will expect discounts for high-volume sales. Knowing the cost of products will help Life Fitness know whether a discounted price will still be profitable for the company.Bids on contracts: Suppose management at Life Fitness has the opportunity to bid on a contract to supply custom treadmills for a nearby university fitness center. Management can use the job cost records from past treadmill jobs to get a good idea of how much it will cost to complete the custom order. For example, the custom treadmills may require additional components not found on the standard models.The markup percentage or final bid price is agreed upon in a written contract before the company goes ahead with production.Factor in these additional costs to get an estimate of the total job cost, before it is produced. Life Fitness will most likely use cost-plus pricing to determine a sales price for the custom job. Financial statement preparation: Finally, the job cost information is critical to preparing the company’s financial statements. Why? Because the information is used to figure out the total Cost of Goods Sold shown on the income statement, as well as the Work in Process and Finished Goods Inventory accounts shown on the balance sheet.
41Learning Objective 5Compute and dispose of overallocated or underallocated manufacturing overhead
42Overhead Application Example FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000. What is FedCorp’s predetermined manufacturing overhead rate?
43Overhead Application Example (continued) FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000. What is FedCorp’s predetermined manufacturing overhead rate? POHR = $200,000 ÷ 10,000 = $20 per DLH
44Overhead Application Example (continued) FedCorp’s actual manufacturing overhead for the year was $190,000. A total of 11,000 direct labor hours were worked. Using FedCorp’s predetermined manufacturing overhead rate of $20 per direct labor hour, how much overhead was allocated to all of FedCorp’s jobs during the year?
45Overhead Application Example (continued) FedCorp’s actual manufacturing overhead for the year was $190,000. A total of 11,000 direct labor hours were worked. Using FedCorp’s predetermined manufacturing overhead rate of $20 per direct labor hour, how much overhead was allocated to all of FedCorp’s jobs during the year? MOH Allocated = $20 x 11,000 = $220,000
46Now we look at what to do if (WHEN) actual MOH does not equal allocated MOH. Continuing same example (FedCorp)
47Overhead Application Example (continued) FedCorp’s actual overheadFedCorp’s allocated overheadDifference$190,000$220,000$ 30,000“Target” was $190,000;actually allocated $220,000. Overapplied by $30,000.
48Underallocated or Overallocated Manufacturing Overhead Underallocated (undercosted)– not enough allocated to jobs– too little expenseOverallocated (overcosting)– too much allocated to jobs– too much expense
49Underallocated or Overallocated Manufacturing Overhead Why/How?Estimated manufacturing overhead costs were higher or lower than actualUsed more or less of the estimated allocation base than projected2 Solutions:Adjust cost of goods soldProrate between Cost of Goods Sold, Work in Process Inventory, Finished Goods Inventory
50Prepare journal entries for a manufacturer’s job costing system Learning Objective 6Prepare journal entries for a manufacturer’s job costing system
51General Journal ntries for Materials Procurement DATEDESCRIPTIONREFDEBITCREDITMaterials inventory – canvas 70,000Accounts payable 70,000Materials inventory – thread 1,100Accounts payable 1,100Once the materials are received and verified against the purchase order and the invoice received from the supplier, the purchase is recorded as a debit to Materials Inventory and a credit to Accounts Payable.These materials will remain in the raw materials storeroom until they are needed for production. The liability in Accounts Payable will be removed when the supplier is paid.
53Accounting for Materials Raw MaterialsWork in ProcessDirect MaterialDirect MaterialMaterialPurchasesIndirect MaterialManufacturing OverheadActual Overhead Costs
54S3-10: T-Account for Raw Materials Beginning balPurchasesRequisitionedEnding balShort Exercise 3-10 asks you to record purchase and use of materials .Trekker manufactures backpacks. Its plant records include the following materials-related transactions:Purchases of canvas (on account) $70,000Purchases of thread (on account) ,100Material requisitions:Canvas ,000ThreadMake the journal entries to record these transactions. Post these transactions to the Raw Materials Inventory account. If the company had $35,680 of Raw Materials Inventory at the beginning of the period, what is the ending balance of Raw Materials Inventory?
56Accounting for Labor Wages Payable Work in Process Direct LaborDirect MaterialIncurredIndirect LaborDirect LaborManufacturing OverheadActual Overhead CostsThe flow of data for the accounting required to track labor starts in both the Wages Payable (MFG Wages) and Manufacturing Overhead (MFG OH) accounts. The costs flow from the MFG OH head account to MFG Wages and are then combined to be transferred into the Work in Process Account.
57Accounting for Manufacturing Overhead Actual Overhead Costs` Work in ProcessOverhead Applied to Work in ProcessActual Overhead Costs`Direct MaterialDirect LaborOverheadAll of the other indirect costs of operating the manufacturing plant during the month are also accumulated in the Manufacturing Overhead account until they can be allocated to specific jobs.Since we accumulated all actual manufacturing overhead costs into an account called Manufacturing Overhead (through debiting the account), we now allocate manufacturing overhead costs out of the account by crediting it.
58Accounting for Finished Goods Once the job has been completed, the three manufacturing costs shown on the job cost record are summed to find the total job cost. If the job consists of more than one unit, the total job cost is divided by the number of units to find cost of each unit.We see the flow of costs from Work In Process to Finished Goods Inventory. From Finished Goods Inventory, the items are sold, and move from this account to the Cost of Goods Sold account, where they become part of the Income Statement.The jobs are physically moved off of the plant floor and into the finished goods warehouse. Likewise, in the accounting records the jobs are moved out of Work in Process Inventory (through a credit) and into Finished Goods Inventory (through a debit).To record the sale of products, two journal entries are needed. The first journal entry records the revenue generated from the sale and shows the amount due from the customer. As shown here, the second journal entry reduces the company’s Finished Goods Inventory, and records the Cost of Goods Sold.All costs incurred outside of manufacturing function of the value chain, period cost, would be expensed in the current month and shown as “operating expenses” on the company’s income statement.
59Accounting for Finished Goods Work in ProcessFinished GoodsDirect MaterialDirect LaborManufacturing OverheadCost of Goods ManufacturedCost of Goods ManufacturedCost of Goods SoldCost of Goods SoldCost of Goods Sold
60Manufacturing Overhead Analysis $20,000$ 18,000$18,000$20,000$2,000$2,000Overhead was under applied - Cost of Goods Sold is UNDERSTATEDOverhead was over applied - Cost of Goods Sold is OVERSTATEDCost of Goods Sold
61Closing Manufacturing Overhead Under Allocated Manufacturing OverheadOver allocated Manufacturing Overhead$20,000$18,000$ 18,000$2,000$2,000$2,000$2,000Cost of Goods SoldCost of Goods Sold$2,000$2,000
62E3-49B Exercise 3-49B asks you to prepare journal entries. Record the following transactions in general journal.a. Received bill for Web site expenses, $2,200.b. Incurred manufacturing wages, $19,000, 55% of which was direct labor and 45% of which was indirect labor.c. Purchased materials on account, $18,000.d. Used in production: direct materials, $9,500; indirect materials, $4,000.e. Recorded manufacturing overhead: depreciation on plant, $14,000; prepaid plant insurance expired, $1,700; plant property tax, $3,500 (credit Property Tax Payable).f. Allocated manufacturing overhead to jobs, 190% of direct labor costs.g. Cost of jobs completed during the month, $38,000.h. Sold all jobs (on account) completed during the month for $62,000. Assume a perpetual inventory system.
63E3-49B a. Advertising expense Cash b. Work in process inventory GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDITa. Advertising expenseCashb. Work in process inventoryManufacturing overheadWages Payablec. Raw materials inventoryAccounts payable63
64E3-49B d. Work in process inventory Manufacturing overhead GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDITd. Work in process inventoryManufacturing overheadRaw materials inventory64
65E3-49B e. Manufacturing overhead Accumulated depreciation, plant GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDITe. Manufacturing overheadAccumulated depreciation, plantPrepaid insuranceProperty tax payable65
66E3-49B f. Work in process inventory Manufacturing overhead GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDITf. Work in process inventoryManufacturing overheadg. Finished goods inventoryWork in process inventory66
67E3-49B h. Accounts receivable Sales revenue Cost of goods sold GENERAL JOURNALDATEDESCRIPTIONREFDEBITCREDITh. Accounts receivableSales revenueCost of goods soldFinished goods inventory67