McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved CHAPTER 13 McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost Accounting and Reporting Systems

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Decision Making Strategic, Operational, and Financial (Planning) Planning and Control Cycle Executing operational activities (Managing) Performance analysis: Plans vs. actual results (Controlling) L O 1 Implement Plans Revisit Plans Data collection and Performance Feedback

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accounting Financial Accounting Focus on External Reporting Managerial Accounting Focus on Internal Reporting Cost Accounting Focus on Cost Accumulation & Assignment L O 1

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Costs for Cost Accounting Purposes Financial Accounting Cost is a measure of resources used or given up to achieve a stated purpose. Financial Accounting Cost is a measure of resources used or given up to achieve a stated purpose. Managerial Accounting Costs are assigned to products and become expenses when products are sold. Managerial Accounting Costs are assigned to products and become expenses when products are sold. L O 1

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Research and Development The sequence of functions and activities that, over the life of the product or service, adds value for the customer. Value Chain Functions Design Production Marketing Distribution Customer Service Desired ROI L O 2

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accumulation and Assignment Cost Pool Cost Object Cost Assignment Cost Object Cost Assignment Cost Object Cost Assignment Cost objects are products, jobs, and services. L O 2

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Direct Costs and Indirect Costs Direct costs  Can be easily and conveniently traced to a unit of product or other cost objective.  Would not be incurred if the product or activity were discontinued. Indirect costs  Cannot be easily and conveniently traced to a unit of product or other cost object.  Would be incurred even if the product or activity were discontinued. L O 3

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Manufacturers... Buy raw materials. Produce and sell finished goods. Merchandisers... Buy finished goods. Sell finished goods. MegaLoMart Costs for Cost Accounting Purposes L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Merchandiser Current Assets Cash Receivables Prepaid Expenses Merchandise Inventory Manufacturer Current Assets Cash Receivables Prepaid Expenses Inventories Raw Materials Work in Process Finished Goods Costs for Cost Accounting Purposes L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Costs for Cost Accounting Purposes Manufacturer Merchandiser Ingredients Human effort Machine support + + Balance Sheet Inventory Income Statement Cost of Goods Sold = Manufactured product Purchased product Sold to Customers Sold to Customers L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved The Product Raw Materials Direct Labor Manufacturing Overhead Product Costs L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Raw materials are the ingredients of the product. Example: A radio installed in an automobile Product Costs L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Direct labor is the effort provided by workers who are directly involved with the manufacture of the product. Example: Wages paid to automobile assembly workers Product Costs L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Manufacturing overhead includes all manufacturing costs except raw material and direct labor. Examples Wages of maintenance workers, janitors,security guards. Factory utilities, property taxes, and insurance. Depreciation for factory buildings and equipment. Production supervision salaries. Examples Wages of maintenance workers, janitors,security guards. Factory utilities, property taxes, and insurance. Depreciation for factory buildings and equipment. Production supervision salaries. Product Costs L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Finished Goods Work in Process Cost of Goods Sold Direct Labor Balance Sheet Costs Inventories Income Statement Expenses Selling and Administrative Period Costs Raw Materials Material Purchases Manufacturing Overhead Selling and Administrative Product Costs and Period Costs L O 4

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Planning and control functions. Providing products or services to customers. Assessing the efficiency and effectiveness of operations. Determining unit manufacturing costs. Cost accounting systems provide the INFORMATION that supports successful decision-making. Cost Accounting Systems L O 5

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Disclose inventories and cost of goods sold. Track resources consumed by products and services. Manage activities that consume resources. Evaluate and reward employee performance. Cost accounting systems are the procedures and techniques used by management. Cost Accounting Systems L O 5

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved THE JOB Raw material Direct labor Traced directly to each job Manufacturing overhead (OH) Applied to each job using a predetermined rate Cost Accounting Systems L O 5

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Ideally, the allocation base is a cost driver that causes overhead. Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Overhead applied = POHR × Actual activity Actual amount of the cost driver such as units produced, direct labor hours, or machine hours incurred during the period. Based on estimates, and determined before the period begins. Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cruisers, Inc., applies overhead based on direct labor hours. Total estimated overhead for the year is $4,200,000. Total estimated labor hours are 300,000. What is Cruisers’ predetermined overhead rate? Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved For each direct labor hour worked on a job, $14.00 of factory overhead will be applied to the job. POHR = $14.00 per DLH $4,200, ,000 direct labor hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accounting Systems Cruisers, Inc., produced 86 SeaCruiser sailboats during the month working a total of 20,640 labor hours and incurring these costs: raw materials $368,510; and direct labor $330,240. What is the cost per SeaCruiser sailboat? L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved What will Cruisers do if actual and applied overhead are not equal? Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accounting Systems Cruisers’ actual overhead for the year was $4,250,000 for a total of 310,000 direct labor hours. How much total overhead was applied to Cruisers’ jobs during the year? Use Cruisers’ predetermined overhead rate of $14.00 per direct labor hour. L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cruisers’ actual overhead for the year was $4,250,000 for a total of 310,000 direct labor hours. How much total overhead was applied to Cruisers’ jobs during the year? Use Cruisers’ predetermined overhead rate of $14.00 per direct labor hour. Cost Accounting Systems SOLUTION Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $14.00 per DLH × 310,000 DLH = $4,340,000 L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cruisers’ actual overhead for the year was $4,250,000 for a total of 310,000 direct labor hours. How much total overhead was applied to Cruisers’ jobs during the year? Use Cruisers’ predetermined overhead rate of $13.00 per direct labor hour. Cost Accounting Systems SOLUTION Applied Overhead = POHR × Actual Direct Labor Hours Applied Overhead = $14.00 per DLH × 310,000 DLH = $4,340,000 Applied Overhead $4,340,000 Actual Overhead $,250,000 Overapplied by $90,000 Overhead is overapplied for the year. What will Cruisers do? L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Work in Process Finished Goods Cost of Goods Sold $90,000 may be allocated to these accounts. $90,000 may be closed directly to cost of goods sold. Cost of Goods Sold Smaller amounts OR Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Smaller amounts Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Let’s examine the cost flows in a product costing system. We will use T-accounts and start with materials. Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Raw Materials Material Purchases Direct Materials Mfg. Overhead Indirect Materials Work in Process Indirect Materials ActualApplied Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Next let’s add labor costs and applied manufacturing overhead to the cost flows. Are you with me? Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Direct Labor Mfg. Overhead Salaries and Wages Payable Work in Process Direct Materials Overhead Applied to Work in Process Indirect Labor Direct Labor Overhead Applied Indirect Labor Indirect Materials ActualApplied If actual and applied manufacturing overhead are not equal, a year-end adjustment is required. Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Now let’s complete the goods and sell them. Still with me? Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost of Goods Mfd. Finished Goods Cost of Goods Sold Cost of Goods Mfd. Cost of Goods Sold Work in Process Direct Materials Direct Labor Overhead Applied Cost Accounting Systems L O 6

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved A schedule of cost of goods manufactured is prepared to assist managers in understanding and evaluating the overall cost of manufacturing products. Cost Accounting Systems L O 7

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Use the following information to prepare a statement of cost of goods manufactured for Cruisers, Inc. for April: Raw materials inventory: March 31 $126,900 April 30 $106,250 Raw materials purchases: April $347,860 Use the following information to prepare a statement of cost of goods manufactured for Cruisers, Inc. for April: Raw materials inventory: March 31 $126,900 April 30 $106,250 Raw materials purchases: April $347,860 Cost Accounting Systems L O 7

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cost Accounting Systems L O 7

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved The cost of goods manufactured during the period is used to compute cost of goods sold for the period. Beginning finished goods inventory numbers are assumed amounts. L O 7 Cost Accounting Systems

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved The income statement is prepared using established financial accounting procedures. Sales and expense numbers are assumed amounts. L O 7 Cost Accounting Systems

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Raw Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Variable Costing Absorption Costing Product Costs Period Costs Product Costs Period Costs Cost Accounting Systems L O 8 Absorption Costing and Variable Costing

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Process Costing Job Order Costing  Costs are accumulated by job.  Used for production of large, unique, high-cost items.  Built to order rather than mass produced.  Many costs can be directly traced to each job. Cost Accounting Systems - Absorption L O 8

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Typical job order cost applications:  Special-order printing  Building construction Also used in service industries  Hospitals  Law firms Process Costing Job Order Costing L O 8 Cost Accounting Systems - Absorption

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved  Costs are accumulated by departments.  Used for production of small, identical, low-cost items.  Mass produced in an automated continuous process.  Costs cannot be directly traced to each unit of product. Process Costing Job Order Costing L O 8 Cost Accounting Systems - Absorption

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Typical process cost applications:  Petrochemical refinery  Paint manufacturer  Paper mill Process Costing Job Order Costing L O 8 Cost Accounting Systems - Absorption

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Variable costing Balance Sheet Costs Inventories Income Statement Expenses Cost of Goods Sold Selling and Administrative Period Costs Work in Process Finished Goods Raw Materials Variable Manufacturing Overhead Material Purchases Direct Labor Selling and Administrative Fixed Manufacturing Overhead Absorption costing Absorption and Variable Costing L O 8

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Fixed costs are not really the costs of any particular product. Variable Costing Absorption Costing All manufacturing costs must be assigned to products to properly match revenues and costs. Absorption and Variable Costing L O 8

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Absorption Costing These are capacity costs and will be incurred even if nothing is produced. Variable Costing Depreciation, taxes, insurance and salaries are just as essential to products as variable costs. Absorption and Variable Costing L O 8

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Variable Costing Absorption costing product costs are misleading for decision making. They are the numbers that appear on our external reports. Absorption Costing Absorption and Variable Costing L O 8

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved A BC A C B Activity-Based Costing (ABC) L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost that should be assigned to each job. Assigning overhead is difficult. I agree! Activity-Based Costing (ABC) L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Level of Complexity Overhead Allocation TraditionalP lantwide Overhead Rate Activity-Based Costing Activity-Based Costing (ABC) L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved In the ABC method, we recognize that many activities within a department drive overhead costs. In the ABC method, we recognize that many activities within a department drive overhead costs. A BC A C B Activity-Based Costing (ABC) L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Identify activities and assign indirect costs to those activities. Central idea... Products require activities. Activities consume resources. Activity-Based Costing (ABC) A BC A C B L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved  More detailed measures of costs.  Better understanding of activities.  More accurate product costs for... –Pricing decisions. –Product elimination decisions. –Managing activities that cause costs.  Benefits should always be compared to costs of implementation. The Benefits of ABC L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Most cost drivers are related to either volume or complexity of production. Examples: machine time, machine setups, purchase orders, production orders. Three factors are considered in choosing a cost driver: Causal relationship. Benefits received. Reasonableness. Identifying Cost Drivers L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Overhead Actual Rate Activity × Rate = Estimated overhead costs in activity cost pool Estimated number of activity units  Identify activities that consume resources.  Assign costs to a cost pool for each activity.  Identify cost drivers associated with each activity.  Compute overhead rate for each cost pool:  Assign costs to products: Activity-Based Costing Procedures L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Let’s look at an example comparing traditional costing with ABC. We will start with traditional costing. Activity-Based Costing L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Cruisers, Inc. manufactures sailboats and canoes. Overhead is applied at the rate of $14 per direct labor hour. Production for May was 100 sailboats requiring 24,000 hours, and 1,000 canoes requiring 13,000 hours. Overhead applied using traditional costing is: Traditional Costing vs. ABC L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Activity-Based Costing Same amount of annual total overhead used earlier in the chapter. Cruisers plans to adopt activity-based costing and identifies these activities and costs for computing overhead rates. L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Using the following activity center data, determine the amount of overhead applied to the two products using activity-based costing. Activity-Based Costing L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Activity-Based Costing Let’s complete the table. L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved Activity-Based Costing L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved This result is not uncommon when activity-based costing is used. Many companies have found that lower volume, more complex products have greater overhead costs than previously realized. Activity-Based Costing L O 9

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved End of Chapter 13