Chapter 4 Product costing systems 4-1 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Outline Product costing Different costs for different purposes Designing product costing systems Flow of costs in manufacturing businesses Allocating overhead costs to products Accounting for manufacturing overheads Types of product costing systems Job costing Process costing 4-2 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

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 4-3 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

4-4 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

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 4-5 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Different product costs for different purposes (cont.) 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 4-6 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

4-7 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Different product costs for different purposes (cont.) Current or future product costs –Current product costs are relevant for inventory valuation –Future product costs may be relevant for input into some decisions such as pricing Frequency of cost information –Infrequently for long-term decisions or some short-term decisions –More regularly for inventory valuation In summary, product costs may differ over –The range of costs included –Current or future costs –How frequently product costing information is required 4-8 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

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 compared 4-9 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Flow of costs in manufacturing businesses For inventory valuation in external financial reports only manufacturing costs are assigned to products, as required by Australian accounting standards Manufacturing costs consist of: –Direct material –Direct labour –Manufacturing overhead 4-10 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Flow of costs in manufacturing businesses (cont.) 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 4-11 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

4-12 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

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 as they have no observable relationship with the product they need to be allocated to products –These cost are indirect costs to the product 4-13 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Allocating overhead costs to products (cont.) 1.Aggregate overhead costs into cost pools 2.Identify the overhead cost driver(s) –The factor or activity that causes cost to be incurred 3.Calculate a predetermined (or budgeted) overhead rate per unit of cost driver 4.Apply manufacturing overhead costs to products at the budgeted (or predetermined) overhead rate, multiplied by the quantity of cost driver consumed by the product 4-14 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

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 –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 4-15 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

4-16 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Accounting for manufacturing overhead (cont.) 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 4-17 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Accounting for manufacturing overhead (cont.) Most firms dispose of underapplied or overapplied overhead at the end of the year only –monthly fluctuations may average out over a year One reason for underapplied or overapplied manufacturing overhead is an error or inaccuracy in the predetermined overhead rate 4-18 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Types of product costing systems Conventional product costing systems range from job costing to process costing 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 such as lawyers, accountants, consulting engineers 4-19 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Types of product costing systems (cont.) 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 such as routine processing of cheques by banks, handling of licence applications by government departments 4-20 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Types of product costing systems (cont.) Process costing involves –Estimating the cost of production processes –Calculating the average cost per unit by dividing the cost of the process by the number of units produced –Where there are sequential processes, the costs of products produced in one department are transferred into the next department Some product costing systems have features of both job costing and process costing 4-21 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

4-22 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Job costing Bill of materials—lists all the materials required for a job Material requisition forms—authorises 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 4-23 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Purchase of materials Raw material inventoryxxxx Account payablexxxx Transferring direct material to jobs Work in process inventoryxxxx Raw material inventoryxxxx 4-24 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Use of indirect material in production Manufacturing overheadxxxx Manufacturing supplies inventoryxxxx Charging direct labour to jobs Work in process inventoryxxxx Wages payablexxxx 4-25 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Accounting for indirect labour Manufacturing overheadxxxx Wages payablexxxx Accounting for manufacturing expenses Manufacturing overheadxxxx Prepaid rentxxxx Depreciation on equipmentxxxx … etc Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Application of manufacturing overhead Work in process inventoryxxxx Manufacturing overheadxxxx Completion of production job Finished goods inventoryxxxx Work in process inventoryxxxx 4-27 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Sale of goods Accounts receivablexxxx Sales revenuexxxx Cost of goods soldxxxx Finished goods inventoryxxxx 4-28 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Job costing (cont.) Underapplied overhead Cost of goods soldxxxx Manufacturing overheadxxxx –Or the reverse entry if overhead is overapplied 4-29 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Process costing The approach taken in process costing depends on –The existence of work in process (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 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

4-31 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Summary Different measures of product costs are appropriate for different purposes –Past costs for inventory valuation –Current and future costs for decision-making, which may include non-manufacturing costs Overhead costs are allocated to product costs according to their consumption of an overhead cost driver The choice of product costing system depends on the characteristics of the product and production environment and may range from job costing to process costing 4-32 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith