Three manufacturing costs Direct material cost: Consist of all those material that can be identified with a specific product. Example: wood used in manufacturing of a table. Direct labor cost : Consist of all those cost that can be specifically traced or identified with a particular product. Example: wages of workers working on that table. Overhead (indirect) cost: overhead refers to the cost pool used to accumulate all indirect manufacturing costs. Indirect costs are allocated to the cost object using of cost allocation method. Example: heat, light and power for the factory, rent on factory building, property taxes on factory building, and all kind of depreciation.

Factory Overhead Overhead consists of many individual cost items. These are costs that can’t be measured or traced for a specific product. Factory overhead costs are both fixed and variable. The factory overhead controlling account is debited when costs are incurred and credited when factory overhead is applied to various job orders. i.e indirect material and labor, utility costs, depreciation of equipment and salaries of factory administrative personnel.

Plant-wide (blanket) overhead rates The most simplistic traditional costing system assigns indirect costs to cost objects using a single overhead rate for the organization as a whole. The terms blanket overhead rate or plant-wide rate are used to describe a single overhead rate that is established for the organization as a whole.

Job Order Costing A job is a production run for a specific product. A relatively small number of units generally comprise a job. Job order costing system record actual and estimated production costs in the formal accounting system leading to manufacturing statements. Construction firms use a variation of job order costing. Some overhead is applied to each job so that the contractor can recoup its general production costs which apply to all jobs but which are not traceable to any specific job.

Benefits of job costing 1.You will know on an ongoing basis which projects are profitable and which ones aren’t. 2.You will be able to get paid on a timely basis as you complete the job. 3.You can avoid committing resources to projects. If you manufacture products: 1.You will know what it cost to make each item 2.You will be able to set selling prices that cover your costs and earn a fair profit 3.You will know what product lines to expand because they’re profitable, and what product line to drop because they’re unprofitable.

General approach to job costing 1.Identify the job that is chosen cost object The cost object can be chosen through the job cost record. Companies keep a job cost record for every specific job. A job cost record, also called a job cost sheet records and accumulates all the costs assigned to a specific job, starting when work begins.

2.Identify the Direct costs of the job: Robinson identified two direct manufacturing cost categories, direct material and direct manufacturing labour. Example can be seen for the direct costs for the specific job. 3.Select the cost allocation bases to use for allocating indirect cost to the job. Indirect costs can’t be allocated to a specific product. It will be impossible to complete a job without incurring indirect cost such as supervision, manufacturing engineering, utilities and repairs. Multiple cost allocation bases are used to allocate a indirect cost because different indirect cost have different cost drivers. Example : depreciation or repair of machines is closely related to machine hours so machine hours can be used as a cost driver.

4.Identify the indirect cost associated with each cost allocation base. Now that the allocation bases has been identified, all indirect cost are now identified for that allocation base. In our example from the Robinson company they use indirect manufacturing costs to machinery hours used. 5.Compute the rate per unit of each cost allocation base used to allocate indirect costs to the job. Actual manufacturing overhead costs Actual total quantity of cost allocation base Actual manufacturing overhead rate = $ direct manufacturing labor hours Actual manufacturing overhead rate = $45 per direct manufacturing labor hour =

6.Compute the indirect costs allocated to the job. Indirect cost allocated to a job= actual quantity of each different allocation base x indirect cost rate of each allocation base 7.Compute the total cost of the job by adding all direct and indirect costs assigned to the job. Total cost= Direct cost + Indirect cost

JOB NO:CUSTOMER: Date Started:Date Completed: WPP 298 Feb. 3, 2006Feb. 28, 2006 JOB-COST RECORD Western Pulp and Paper DIRECT MATERIALS Date Received Materials Requisition No. Part No. Quantity Used Unit Cost Total Costs Feb. 3, : : 199 MB 468-A TB 267-F 8 12 $ $ $4,606 Total DIRECT MANUFACTURING LABOR Period Covered Labor-Time Record No. Employee No. Hours Used Hourly Rate Total Costs Feb. 3-9, 2006 LT 232 LT $ $ $1,579 Total MANUFACTURING OVERHEAD Date Cost pool Category Allocation-Base Units Used Allocation- Base Rate Total Costs Dec. 31, 2006Manufacturing Direct Manufacturing 88 hours$ 45$ 3,960 Labor-Hours Total $ 3,960 $ 10,145 TOTAL MANUFACTURING COST OF JOB

MATERIALS-REQUISITION RECORD Materials-Requisition Record No: Job No.: Part No. MB 468-A WPP 298 Part Description Metal Brackets Date: Quantity : 198 Feb. 3, 2006 Unit Total Cost $14 $112 Issued By:B. C lyde Received By: L. Daley Date: Feb. 3, 2006

Panel 1 Job Number: J4369 Date: July 6, 2000 Customer: Michigan Motors Product: Automobile engine valves (Valve #L181) Engineering Design Number: JDR-103 Number of Units: 1,500 Panel 2 Material Requisition Number Description Quantity Rate Amount Bar steel 720 lbs $11.50 $8, Stock 3” A35161 Subassemblies 290 units $11, Total direct materials cost $19,300.00

Panel 3 Dates Number Hours Rate Amount 8/2, 8/3, 8/4, 8/5 M16 24 $28.00 $ /2, 8/3, 8/4, 8/5 M18, M19, M , /6, 8/7, 8/8, 8/9, 8/10 A25, A26, A , /6, 8/7, 8/8, 8/9, 8/10 A32, A34, A , Total direct labor cost 268 $5, Panel 4 Support Cost Amount 117 Machine $40 per hour $ 4, Direct labor 36 per hour 9, Total overhead cost $14,328.00

Direct costs Indirect costs Cost Tracing Cost Allocation Cost Object Cost Assignment Concept of Costing System

Assigning direct and indirect costs A cost allocation is the process of assigning costs when a direct measure does not exist for the quantity of resources consumed by a particular cost object. Example: consider an activity such as receiving incoming materials. Assuming that the depreciation of the machine is strongly related to the number of hours machine was used. The basis that is used to allocate costs to cost objects is called an allocation base or cost driver. Two types of systems can be used to assign indirect costs to cost objects. They are traditional costing system and activity-based-costing(ABC) systems.

Traditional costing systems ABC systems Direct costs Indirect costs Cost tracing Cost allocations Cost objects Cost Allocations and Cost Tracing

Traditional Costing Systems Overhead cost accounts (for each individual category of expenses) Cost center 1 (Normally departments) Cost center 2 (Normally departments) Cost center N (Normally departments) Cost objects (Products, services and customers) First stage allocations Second stage allocations (Direct labour or machine hour) Direct cost

Applying the three-stage allocation process requires the following four steps: 1.Assigning all manufacturing overheads to production and service cost centres; 2.Reallocating the cost assigned to service cost centres to production cost centres; 3.Computing separate overhead rates for each production cost centre; 4.Assigning cost centre overheads to products or other chosen cost objects. An illustration of the three-stage process for a traditional costing system

Inexpensive to operate Extensive use of arbitrary cost allocations Low levels of accuracy High cost of errors Simplistic systems Traditional Costing System Levels of Sophistication

Service dept S1 S2S3 S4 Producing dept DM DL FO DM DL FO DM DL FO Conceptual view of the separate department overhead rates Cost objects Cost objects Cost objects Cost objects Cost objects Cost objects

Stage 1 : Assigning all manufacturing overhead to production and service departments. Cost Basis of allocation Property taxes, lighting and heating Employee-related expenditure: works management, works canteen, payroll office Depreciation and insurance of plant and machinery Area Number of employees Value of items of plant and machinery Common cost are allocated to all the departments. Some cost can be directly related such as salary of the engineer working in the service quality department, however other need to be allocated using an allocation base.

Stage 2 :Reallocating the cost assigned to service cost centers to production cost centers. the next step is to reallocate the costs that have been assigned to service cost centres to production cost centres. Service departments or support department are those departments that exist to provide services of various kinds of other units within the organization. For example, the costs of the cafeteria can be reallocated to the production cost center by using number of workers in the factory as the allocation base. There are three methods in reallocating the cost from service to production departments. 1.DIRECT METHOD 2.STEP METHOD 3.ALGEBRIC METHOD

Y X A B Y X A B Y X A B Producing departmentService department Part 1 Direct method Part 2 Step method Part 3 Algebraic method Diagram of 3 diff, allocation methods

Stage 3: Assigning cost center overheads to products or other chosen cost objects. In the final step is to allocated the overheads to products passing through the production centers. Volume base allocation is used to assign the overhead costs to the products. Example, number of units produced, number of machine hours used.

(£) Indirect wages and supervision Machine cenres: X Y Assembly Materials procurement General factory support Indirect materials Machine centres: X Y Assembly Materials procurement General factory support Lighting and heating Property taxes Insurance of machinery Depreciation of machinery Insurance of buildings Salaries of works management The annual costs for the Enterprise Company which has three production centres (two machine centres and one assembly centre) and two service centres (materials procurement and general factory support) are as follows:

The following information is also available: Book Value of Machinery (£) Area Occupied (sq. metres) Number Of employees Direct Labour hours Machine hours Machine shop: X Y Assembly Stores Maintenance Details of total material issues to the production centres are as follows: (£) Machine shop X Machine shop Y Assembly

Item of expenditure Indirect wage and supervision Indirect materials Lighting and heating Property taxes Insurance of machinery Depreciation of machinery Insurance of buildings Salaries of works management Reallocation of service centre costs Materials procurement General factory support Machine hours and direct labour hours Machine hour overhead rate Direct labour hour overhead rate Direct Area Book value of machinery Book value of machinery Area Number of employees (1) Value of materials issued Direct labour hours (2) Total (£) Basis of allocation Machine centre Y (£) Assembly (£) Materials procurement (£) General factory support (£) Machine centre X (£) £2.15£3.80 £1.80 OVERHEAD ANALYSIS SHEET Production centresService centres

£2.15£3.80 £1.80 Reallocation of Service centre costs Materials procurement General factory support Machine hours and direct labour hours Machine hour overhead rate Direct labour hour overhead rate Value of materials issued Direct labour hours (2)

cost centre overheads cost centre direct labour hours or machine hours Machine centre X = Machine centre Y = Assembly department = £ £ £ = £2.15 per machine hour = £3.80 per machine hour = £1.80 per direct labour hour machine hours machine hours direct labour hours

Product A £ Direct costs (100 units x £100) Overhead allocations Machine center A (100 units x 5 machine hours x £2.15) Machine center B (100 units x 10 machine hours x £3.80) Assembly (100 units x 10 direct labour hours x £1.80) Total cost Cost per unit (£16 675/100 units) = £ Product B £ Direct costs (200 units x £200) Overhead allocations Machine center A (200 units x 10 machine hours x £2.15) Machine center B (200 units x 20 machine hours x £3.80) Assembly (200 units x 20 direct labour hours x £1.80) Total cost Cost per unit (£66 700/200 units) = £