Managerial Accounting by James Jiambalvo Chapter 2: Manufacturing Costs and Job-Order Costing Systems Slides Prepared by: Scott Peterson Northern State University

Chapter 2: Manufacturing costs and Job-Order Costing Systems Chapter Themes: It’s all about the concept of inventories. Think about how costs can be attached to products. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems. More

Chapter 2: Manufacturing costs and Job-Order Costing Systems Chapter Themes: It’s all about the concept of inventories. Think about how costs are attached to products. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs. More

Chapter 2: Manufacturing costs and Job-Order Costing Systems Chapter Themes: It’s all about the concept of inventories. Think about how costs are attached to products. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Cost Classifications for Manufacturing Firms Unlike retailers who purchase goods for resale, manufacturers make what they sell. Therefore, the manufacturer must differentiate between manufacturing and nonmanufacturing costs to determine what their goods cost. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Manufacturing Costs Manufacturing costs, by definition, are all costs which are associated with the production of goods. The three traditional categories of manufacturing costs include: Direct Materials Direct Labor Manufacturing Overhead Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Direct Material Direct material costs include raw materials and components that are directly traceable to the final finished product. Here think of a home builder’s direct material costs. Raw materials include lumber and sheetrock. Components include light fixtures and sprinkler system components. Materiality IS important here… Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems. More

Direct Material …because direct materials DO NOT include minor material costs which are not easily or cost justifiably traced to the final finished product. The home builder would probably not include nails, screws and other small, inexpensive fasteners in direct materials. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Direct Labor Direct labor costs, like direct material costs, include labor that is directly traceable to the final finished product. Using the home builder example, salaries of carpenters are considered direct labor. Construction supervisory salaries, though, are not. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Manufacturing Overhead Manufacturing Overhead includes all manufacturing costs that are not considered Direct Materials or Direct Labor. By definition, it includes Indirect Materials and Indirect Labor. Using the home builder example, Manufacturing Overhead might include construction supervisor salaries and fasteners such as screws, nails and tape. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Nonmanufacturing Costs Nonmanufacturing costs are simply costs which are not associated with the production of goods. Sometimes called period costs, this category includes selling, general and administrative costs. For the home builder, this includes the bookkeeper’s salary. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Selling Costs As the name implies, selling costs include costs associated with securing and filling customer orders. Examples include advertising, sales salaries and commissions, and other support costs for this function. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

General and Administrative Costs As the name implies, General and Administrative Costs include costs associated with the firm’s general management. Often associated with corporate headquarters including executive salaries, depreciation on office equipment and buildings etc.. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Product and Period Costs These two terms are synonymous with Manufacturing and Nonmanufacturing costs, respectively, discussed previously. They are important because they refer to the timing of expenses as much as the description. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Product Costs Product costs, a.k.a. manufacturing costs, are also called inventoriable costs. The reason is that these costs, Direct Materials, Direct Labor and Manufacturing Overhead, are inventoried until which time they are sold and become expenses; Cost of Goods Sold. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Period Costs Period Costs, a.k.a., nonmanufacturing costs, include Selling, General and Administrative. They are called Period Costs because they are expensed in a certain accounting period regardless of production schedules. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Product Cost Information in Financial Reporting and Decision Making Often the information needed by internal managers stands in sharp contrast to external reporting requirements promulgated by Generally Accepted Accounting Principles (GAAP). GAAP requires Full Costing and management decision making requires incremental information. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Balance Sheet Presentation of Product Costs Until sold, Product Costs (Inventoriable Costs) are carried in one of three inventory accounts on the balance sheet: Raw Materials Inventory. Work in Process Inventory. Finished Goods Inventory. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Raw Materials Inventory Raw Materials Inventory includes the cost of raw materials on-hand which are to be used in forthcoming production. Using the home builder example, Raw Materials might include lumber, sheetrock, shingles etc… Bear in mind, however, most home builders do not often carry inventory, rather they use a form of Just-in-Time and rely on delivery. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Work in Process Inventory Work in Process inventory includes production which was begun but not completed during the accounting period. At December 31, for example, a home builder may have several different projects started and enclosed, but all completed to varying degrees, 20%, 35%, 60% and so on. The value of these projects are included in this inventory account. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Finished Goods Inventory Finished Goods Inventory includes products which are complete, in inventory and ready for sale. For the home builder this would include a spec home which is completed, ready for sale, for for which an owner has not yet been found. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Flow of Product Costs in Accounts In an accounting system, product costs (does anyone remember the buzzwords here?) flow from one inventory account to another. The final resting place prior to sale for all Product Costs is Finished Goods Inventory. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems. Instructors, click on the words Product Costs to reveal the terms for students.

Income Statement Presentation of Product Costs Ultimately when manufactured goods are sold they are moved from Finished Goods to Cost of Goods Sold. This is how costs of manufacturing goods is matched with revenue resulting from sales of those goods. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Cost of Goods Manufactured Cost of Goods Manufactured is an important concept. It represents the sum of costs attached to products which were transferred form Work in Process to Finished Goods during any given time period. It is calculated as follows: Beginning Work in Process + Total Manufacturing Costs – Ending Work in Process. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Cost of Goods Sold This is also an important concept and one that most students have seen before. It represents the total cost of all goods sold during a particular accounting period. It is calculated as follows: Beginning Finished Goods + Cost of Goods Manufactured (previous slide) - Ending Finished Goods. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Types of Costing Systems There are two major types of product costing systems, Job-Order Costing Systems and Process Costing systems. Generally speaking, Job-Order costing is applicable to situations where each unit or batch of output is at least somewhat unique. A good example here is the homebuilder. Process Costing applies to situations where all units of output are essentially the same. An example here is food processing. Related Learning Objectives: Distinguish between manufacturing and nonmanufacturing costs and between product and period costs. Discuss the three inventory accounts of a manufacturing firm. Describe the flow of product costs in a manufacturing firm's accounts. Discuss the types of product costing systems.

Overview of Job Costs and Financial Statement Accounts In a Job-Order Costing System, the three product costs are attached to products via the Job-Cost Sheet. It is important to recognize here that cost flows through a Job-Order system are based on the status of jobs. That status could be either in process, in finished goods or sold. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Job-Order Costing System In Job-Order Costing systems the primary document (likely electronic) is called a job-cost sheet. It is used to capture costs of producing that product. Using the home builder example, a job-cost sheet would be prepared for each home. And the costs it captures are the usual suspects, materials, labor and overhead! Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Direct Material Cost The document used to request the release of materials to production is called a materials requisition. This requisition indicates the type, quantity and cost of material as well as the job number to which it will be assigned. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Direct Labor Cost The document which is used to trace direct labor cost to production is called a time ticket (or job ticket or work ticket or time card…). The time ticket indicates how much time was spent on which job. Note that when several employees all work on the same job, the time card data will be aggregated and then applied to each job. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Manufacturing Overhead Unlike Direct Materials and Direct Labor which are directly traceable to the job, manufacturing overhead is added to each job in a slightly more complex manner. Manufacturing Overhead is applied to specific jobs as opposed to being traced. And it is applied based on some common characteristic referred to as an allocation base. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Overhead Allocation Rate The rate at which Manufacturing Overhead is applied to various jobs is a function of the the Overhead Allocation Rate. It is calculated by dividing the estimated overhead by the allocation base discussed in the previous slide. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Assigning Costs to Jobs: A Summary How are costs attached to jobs? Direct Material: Material Requisition Forms. Direct Labor: Labor Time Tickets. Manufacturing Overhead: Overhead Application Rate. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Activity-Based Costing (ABC) and Multiple Overhead Rates Although companies apply overhead based on a single factor such as direct labor, ABC is a method of assigning overhead based on a number of different allocation bases. ABC groups overhead costs into cost pools. Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Predetermined Overhead Rates Most companies develop overhead application rates based on estimates of total overhead costs (numerator) and the estimated level of the allocation base (denominator) as follows: Estimated total overhead cost Estimated level of allocation base Related Learning Objectives: Explain the relation between the cost of jobs and the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts. Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs. Explain the role of a predetermined overhead rate in applying overhead to jobs.

Eliminating Overapplied or Underapplied Overhead Recording Manufacturing Overhead is a two-step process. First, actual costs are accumulated in the Manufacturing Overhead Account and second, overhead is applied to production based on the Predetermined Overhead Rate. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing. More

Eliminating Overapplied or Underapplied Overhead As a result, unless estimates are perfect, there will be either a debit or credit balance in the Manufacturing Overhead account. If actual costs are more than estimates applied, a debit balance will result and we have underapplied overhead. If applied overhead is more than actual overhead, the result is overapplied overhead. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing. More

Eliminating Overapplied or Underapplied Overhead So what happens to this underapplied or overapplied amount at the end of the year? Since the Manufacturing Overhead account should have a zero balance at year-end, we often close it out to Cost of Goods Sold. Theoretically, though, it should be allocated to Work in Process, Finished Goods and Cost of Goods Sold. Materiality is the key here. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Job-Order Costing for Service Companies Although we have used primarily manufacturing examples so far, Job-Order Costing is also used by service companies. Examples include hospitals (patients) and automobile repair firms. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Changes in Manufacturing Practices and Product Costing Systems In an effort to become more globally competitive, U.S. companies have made fundamental changes in their operations and philosophies. Here are some examples: Just-in-Time (JIT) Production Computer-Controlled Manufacturing Total Quality Management (TWM) Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Just-in-Time (JIT) Production In JIT, physical inventories (Direct Materials and Work in Process) are kept to a minimum. In the case of Direct Materials, manufacturers rely on suppliers to deliver raw materials “Just-in-Time” for production. The home builder is a good example of this, usually waiting until nearly the day of building to take delivery of various materials such as lumber and shingles. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Computer-Controlled Manufacturing Companies also rely heavily on Computer-Controlled Manufacturing systems. Computers are used to control equipment and robots and to increase flexibility and accuracy of the production process. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

Total Quality Management Total Quality Management (TQM) has to do with ensuring that products and processes are of the highest quality. It is also a matter of continuous improvement. This is achieved by listening to the needs of customers, making products right the first time, reducing the number of defective products that must be reworked and encouraging workers to continuously improve their production processes. Related Learning Objectives: Explain why the difference between actual overhead and overhead allocated to jobs using a predetermined rate is closed to Cost of Goods Sold or apportioned among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Discuss changes in the manufacturing environment of U.S. companies and how they affect product costing.

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