1. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-1 Chapter 4 Product costing systems

2. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-2 Product costing Product costing systems –Accumulate product-related costs and use procedures to assign them to the final products –In some businesses, upstream and downstream costs are regarded as product related –Upstream costs—research and development, product design, supply –Downstream costs—marketing, distribution, customer service Product costs are the input to the product costing system

3. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-3

4. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-4 Different product costs for different purposes Product costs can include upstream, manufacturing and downstream costs Inclusion of various costs depends on the timeframe and type of decision to be made Managers’ needs for product cost information will vary depending on the type of decision to be made and managers’ personal preferences continued

5. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-5 Different product costs for different purposes Cost for inventory valuation for external reporting must include only manufacturing costs For long-term decisions about products, a wider definition may be used Product costs are used to value inventory, for short-term decision making and strategic decision making, for planning and controlling costs, and for cost reimbursement continued

6. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-6

7. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-7 Different product costs for different purposes Current or future product costs? –Current product costs are relevant for inventory valuation –Future product costs may be relevant for input into some decisions Frequency of cost information? –Infrequently for long-term decisions, or even short-term decisions –More regularly for inventory valuation In summary, product costs may differ over –The range of costs included –Current or future costs –Frequency of information required

8. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-8 Designing product costing systems Identify the managers’ needs All product cost information may not come from a single product costing system –Future product costs –Long-term product costs –Inventory valuation Cost and benefits of providing various cost estimates must be assessed

9. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-9 Flow of costs in manufacturing businesses For inventory valuation in external financial reports, manufacturing costs only are assigned to products. This is in line with Australian accounting standards Manufacturing costs consist of: –Direct material –Direct labour –Manufacturing overhead continued

10. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-10 Flow of costs in manufacturing businesses Manufacturing costs flow through several manufacturing ledger accounts –Raw materials inventory –Work in process inventory –Finished goods inventory –Cost of goods sold expense –Profit and loss account Australian accounting standards require that upstream and downstream costs are expensed in the period in which they are incurred –May be included in product costs where relevant to managers’ decision making

11. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-11

12. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-12 Allocating overhead costs to products To estimate the cost of a product we need to identify the cost of resources used to produce the product Some resources are consumed directly by products, and are traced directly to each product –Direct material and direct labour Overhead costs are essential to production, but have no observable relationships to the product; they need to be allocated –These cost are indirect costs to the product continued

13. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-13 Allocating overhead costs to products 1. Identify the overhead cost driver –The factor or activity that causes cost to be incurred 2. Calculate a predetermined (or budgeted) overhead rate per unit of cost driver 3. Apply manufacturing overhead costs to products at the budgeted (or predetermined) overhead rate, multiplied by the quantity of cost driver consumed by the product

14. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-14 Accounting for manufacturing overhead Two types of manufacturing overhead are recorded in an accounting system Actual manufacturing overhead –Manufacturing overhead costs incurred throughout the accounting period –Charged (debited) to the manufacturing overhead account Applied manufacturing overhead –Estimate of the overhead resources used to manufacture a product –Applied to products using a predetermined overhead rate –Credited to the manufacturing overhead account continued

15. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-15

16. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-16 Accounting for manufacturing overhead At the end of an accounting period, total actual manufacturing overhead may not equal total applied manufacturing overhead Disposing of underapplied or overapplied overhead at the end of the accounting period … –Close the underapplied or overapplied overhead to cost of goods sold or –Prorate to cost of goods sold, work in process inventory and finished goods inventory continued

17. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-17 Accounting for manufacturing overhead Most firms dispose of underapplied or overapplied overhead at the end of the year only Do not close monthly, as monthly fluctuations will average out over a year One reason for underapplied or overapplied manufacturing overhead is an error or inaccuracy in the predetermined overhead rate

18. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-18 Types of product costing systems Job costing –Manufacturing costs traced to individual jobs –Products produced in distinct jobs/batches which are significantly different –Printers, furniture manufacturers, machinery manufacturers –Many service firms  lawyers, accountants, consulting engineers continued

19. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-19 Types of product costing systems Process costing –Production costs traced to process/department and averaged across all units produced –Mass production or repetitive environment –Petrol production, processed food, chemical and plastics manufacturers –Repetitive services  routine processing of cheques by banks, handling of licence applications by government departments continued

20. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-20 Types of product costing systems Process costing involves … –Estimating the cost of production processes, and –Calculating the average cost per unit by dividing the cost of the process by the number of units produced –The costs of products that are produced in one department are transferred into the next department Some product costing systems have features of both job costing and process costing

21. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-21

22. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-22 Job costing Bill of materials—lists all the materials required for a job Material requisition forms—authorise the movement of raw materials from the warehouse to the production department Job cost sheet—summarises the costs of direct material, direct labour and manufacturing overhead for a particular job

23. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-23 Job costing Purchase of materials Raw material inventoryxxxx Account payablexxxx Transferring direct material to jobs Work in process inventoryxxxx Raw material inventoryxxxx continued

24. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-24 Job costing Use of indirect material in production Manufacturing overheadxxxx Manufacturing supplies inventoryxxxx Charging direct labour to jobs Work in process inventoryxxxx Wages payablexxxx continued

25. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-25 Job costing Accounting for indirect labour Manufacturing overheadxxxx Wages payablexxxx Accounting for manufacturing expenses Manufacturing overheadxxxx Prepaid rentxxxx Depreciation on equipmentxxxx … etc. continued

26. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-26 Job costing Application of manufacturing overhead Work in process inventoryxxxx Manufacturing overheadxxxx Completion of production job Finished goods inventoryxxxx Work in process inventoryxxxx continued

27. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-27 Job costing Sale of goods Accounts receivablexxxx Sales revenuexxxx Cost of goods soldxxxx Finished goods inventoryxxxx continued

28. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-28 Job costing Underapplied overhead Cost of goods soldxxxx Manufacturing overheadxxxx –Or the reverse entry if overhead is overapplied

29. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-29 Process costing The approach taken in process costing depends on –The existence of WIP inventory at the end of the accounting period –The degree to which products are identical in their consumption of direct material and specific production processes Simple forms of process costing assume no WIP inventory More complex forms of process costing involving WIP are covered in Chapter 5

30. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 4-30